Startup Temperature Check

Rajinder: Hi and welcome to Matrix Moments. My name is Rajinder and I am a director at Matrix Partners India. With me today is Avnish Bajaj, Founder and Managing Director at Matrix.

Today’s episode is an episode on the startup temperature check. Excited to have you with us, Avnish. Let’s start with the elephant in the room. WeWork what does it means for the startup ecosystem? And, is this is a one-off story? Do you think there are more? What about in India, do you think there are causalities out there that we haven’t seen as yet?

Avnish: Well, first of all thank you for having me back. Last time, you and I did an episode I think it backfired on us. We did one on term sheets and all of our founders re-negotiated their term sheets with us. I am just joking. But good to be back and look at how quickly things change.

I don’t want to talk too much about WeWork. Each company, frankly, people can google it and they can read a lot more than I can talk. But let’s step back and talk about the environment and the business models and how that are changing.

So, I think the biggest change that has happened is this growth at all cost has gone away. And I think if people don’t recognize that - or my advice to any founder out there would be please recognize that. Is that the right strategy at some time, we will come to that. But right now that is not getting rewarded. Unfortunately in the past what has happened is growth at all cost has been getting funded in various ways. But the ultimate source of funding is the public markets. And the public markets have passed a verdict not just with WeWork. I was reading some statistics of the last few call it 10 – 12 companies that have gone public which are loss making, I think 70% are trading below their prices including Uber, Lyft so on and so forth.

Does it have an impact across the ecosystem? Absolutely. I think one needs to understand the food chain of funding. And the food chain starts with the IPO at the top. And it doesn’t start with a late stage private equity round at the top. It starts with an IPO at the top. And it percolates down. And that market is sending very clear signals. By the way, that market is not sending new signals. That market has always believed what it is telling us now, which is models have to make sense, economics has to make sense, has to be a path to profitability.

What has happened over the last three years is people were able to delay that message and delay listening to that message with all these private rounds. So you know that I think in my life I can’t remember when $100 million round of fund raising became such a normal thing to talk about and they became mega rounds. All new kinds of terms have come in this industry in the last 3 - 4 years. Mega rounds, private IPOs. It always happens in the bubble. This one has lasted a very long time.

I think it’s changing. Whether it’s bursting, I hope it doesn’t burst too hard because it affects all of us. But, it generally does when it does bust. So, I think there has been unsustainable behavior which has been fueled by very low cost capital – private capital fuelling that behavior. I think that story is ending, yes.

How will it play out in India? Like I said, it all percolates down. It will play out. Hopefully, not too badly because we didn’t see as much of the excess. There are few companies that have raised capital. Most of them - by the way the good news is even if you look at our portfolio whether it’s Ola, Quikr, Dailyhunt, Mswipe. I may be forgetting a couple, Limeroad, we have been talking profitability for about 18 months now.

Now it’s not like we saw this coming. It was more that guys Indian market is different. It’s not that deep. If you are raising tons of capital at very high prices, that is going to expect a very very large IPO, not sure Indian market is deep enough. And it wasn’t us. It is the entrepreneurs getting to that realization on their own.

So, I think hopefully the damage will be lower. The damage will be lower. The change in sentiment and deal flow and all will be dramatic, absolutely.

Rajinder: It sounds like the impact the way you are characterizing it, it’s going to be more pronounced with later stage companies than early stage. Or, do you think there’s going to be a cascading effect on early stage as well?

Avnish: Food chain. So IPO, later stage, early stage, seed. So it will make its way down. It will absolutely make its way down. I think and we have seen this both multiple times what generally happens is as it starts coming down - now I am going to give you one contra reason which makes me more optimistic. But if I were to take the pessimistic view, it would come down and each stage of funding would start shrinking.

We have done a lot of seeds. Our peers have done a lot of seeds. Assuming they can’t raise the next round of capital, we would have to put in that round of capital or some version of that. And therefore, each stage starts drying up. So absolutely, it is going to affect.

Now the contra argument, which I think doesn’t change the fact that there will be a correction and it will be deep, but it changes a little bit of how soft that landing can be, is that the market has deepened, and that the entrepreneurs are far far better today. They have been improving with every cycle. And this one is – the good news is each one is a new high. And I think this is the highest we have seen. These guys are some of them are mid-career and we will talk some about this. They are not going to fail. They just take a little bit long.

Rajinder: Yes. No, actually that’s a good point. So, I think the founders that you are referring to here are A) Experienced, B) Understand how to build businesses. So, how should they be thinking about 2020? Should they be more aggressive because some of the larger companies in the ecosystem are perhaps getting more conservative? Or, do you think they should be extending runway and kind of making sure that their companies have enough time to actually achieve product market fit? How should they be thinking about events?

Avnish: Yes. So the lifecycle of a startup is actually very simple in some ways. I know the journey is very hard, but on paper the lifecycle is very simple. You start, you get early PMF, you get scalable PMF. Then, you get scalable profitable PMF. And then, of course, you get profits and you go public. And then you start, you don’t have PMF.

If you don’t have PMF or if you have early PMF, go slow. Don’t go fast. If you have scalable PMF, I am a little bit torn because I know the answer in the third case. I am a little bit torn here.

If you have scalable profitable PMF, go fast. Go aggressive. And profitable doesn’t mean company level profitability. You have unit level profitability. And we should actually talk about how in our view unit level profitability plays out in a Uber, Ola, WeWork kind of example versus local logistics and stuff like that.

So, if you have a business that is working, a downturn is the best time to become more aggressive because you will get funded. Or, worst case, you are not reliant on funding. You will slowdown your growth and hopefully become profitable. As an entrepreneur that’s what I would be looking at that with the capital that I have in the bank or maybe if can raise a bit more, can I slow my growth lever down and reach profitability?

By definition for that to work, I have to be making decent amount of money at my unit level or contribution margin level. Then, I can slow things down, slow down marketing stuff like that and breakeven. That gives my destiny in my control. With that in my control, I would say go aggressive if you have scalable profitable PMF.

If you have scalable PMF, I am a little bit concerned or weary because scalable PMF may be a false positive. You don’t know if you can make money from it. Airlines have PMF, none of them can make money from it. So, I would probably in that situation as an entrepreneur start focusing more on unit economics, more on getting my margin up. And if that plays out and I see that my contribution margin is going up or I can make this work, then I would again become aggressive.

If on the other hand, it’s slows me down and says, okay, this piece is harder, then I would go in the earlier bracket, conserve. So whether you are aggressive – whether you are on offense or defense depends a little bit on this curve.

Rajinder: Sounds like it’s more nuanced therefore. So you spoke of mobility. Then you spoke of airlines, ecommerce, hyperlocal logistics. This whole scalable PMF versus scalable profitable PMF, how should one start thinking about unit level margin because unit level margin…?

Avnish: Sorry to interrupt. But let’s take that. So let’s take Uber, Ola as an example. They have been spoken about world over as loss-making businesses. Tons of losses. I think it was a choice. The business model is not loss making. So first let’s talk about early PMF and scalable PMF and let’s take it more in the context of an Ola or India where one could argue – not one could argue, the fact is that they were giving a 10X experience. We all know what a black and yellow ride looks like. They were giving a 10X experience, so there was no question on early PMF or scalable PMF.

Now people might think that is not profitable PMF, but that’s not the case. On a per ride basis, the contribution margin on a per ride basis in this business is about 30-40%. What was happening was because you know you have a early PMF and you have scalable PMF, you want to be the largest in the market, people then have practices that you can argue are irrational, but I would call them rational because you are trying to capture market share because it’s very seldom that you find such deep markets. Mobility is a very very deep market.

So in that what both of them were doing was passing most of that margin and way beyond it to the drivers and to the customers. But, at the unit level they have a scalable profitable PMF. WeWork, I am not sure. And generally, I would say we need a 10X experience for it. I think WeWork is a great experience. And like I said I don’t want to delve so much into that model. But is it a rental arbitrage? Is it truly - on each unit from what I understand the lease obligations are far higher than the rentals, that’s a loss making unit. So that’s an issue there.

So I would say if you step back, I think generally if you give 10X experiences, you are able to make money at least at a unit level. And if you are able to make money at a unit level in a deep market, i.e., scalable PMF, you will be able to make money at a corporate level, but is nuanced like that. And it is not one size fits all. And as an entrepreneur you should be thinking about deeper into where some of this fits.

Rajinder: So one of the things you said earlier, I want to go back it is you spoke of this new breed of entrepreneurs that are now starting up. People who have built businesses before either as intrapreneurs or as entrepreneurs in the past and now starting their second or third company. You are a repeat entrepreneur yourself, is second time over easier? Or, is it just as hard? And are entrepreneurs given how markets have changed more likely to find the scalable profitable PMF that you are speaking of?

Avnish: Yes. I think even before we get to repeat entrepreneurs, credit to you I remember at one of our offsites, you had mentioned how we as Matrix were missing a certain archetype of founder. Missing meaning we weren’t backing them. And there were plenty of them in the market which was the experienced entrepreneur. We had hit success with the young 20-somethings, the chutzpah and the fearlessness. So that’s where the thought started to watch out.

Now by definition a repeat entrepreneur can only happen when a market is repeating. So for the first time we have - I mean our US counterparts have said that they have built their franchise on repeat entrepreneurs. This is the first time we are getting an opportunity because people have seen the full cycle all the way from starting a company to exiting and making some money.

I don’t think the journey will be easier. I think it will be different. And, I have said this to some of the repeat entrepreneurs, I think what you may find and I think you found globally also is I think the failure rate of repeat entrepreneurs will be lower because they know what they know. They know a lot of what they don’t know which is a big big difference. And, they are very thoughtful about that GTM. Salonie and I are going to do another podcast around GTM - around go-to-market strategies. I think the repeat entrepreneurs think a lot more about GTM than first time entrepreneurs because they have been through it.

PMF everybody wonders about, but GTM, how do you crack that PMF? But sometimes I wonder in being a very deliberative entrepreneur, do you become less of an instinctive entrepreneur. So my call is some of the large – both will work. Some of the largest market cap may still get created by the young 20-somethings with the chutzpah. But the failure rate of these guys with repeat will be much lower. I think they will be far more successful.

Journey? The “failure” here may look like what should have taken one year, it’s taking three years. But my mean it will happen. And it’s self-servicing me also because we have backed up the truck with Jiten and Anurag and some many of them. And we are doing few more. So, I think that’s how it’s going play out. Let’s see.

Rajinder: No, I agree with you. I also think the point is that the market has deepened.

Avnish: Very good point.

Rajinder: We have seen now 3 or 4 cycles. I think you and many others started kind of call it in the first cycle.

Avnish: I am not that much older.

Rajinder: And then there was the second cycle which kind of was the tapering of the ecommerce story in 2012. And then there was call it the third cycle around 15 – 16. And seems like we are perhaps at the beginning of kind of the fourth cycle.

Avnish: More at the end. So I would say 99 – 2000, bubble; 2007- 08 bubble which you guys didn’t see as much because it was more in the offline sectors, but there was a internet bubble also when all the VC started, so we went on sprint. A lot of them did. 10 – 11, 14 – 15, so this is fifth then. It’s somewhere close to the end of it for sure. And you know I have talked about the three Vs of a bubble which is value, volume, velocity.

So velocity is just crazy right now. And value, volume had been going up. I could argue value and volume can be justified by the market dept. velocity can never be. Velocity is only justified by FOMO. And FOMO investing is generally has a lower hit rate. So somewhere close to the end.

Rajinder: But I guess the point I was trying to make was with each cycle even though the cycle seems to be turning, the fact is that the market is still maybe 2 or 3X or maybe even more deeper than the previous cycle. So, how should people think about 2020? And both investors and founders what do you think is going to…?

Avnish: So founders we spoke about. And I am sure that in 2021 somebody is going to replay this and say that you were wrong, which is fine. It’s far out away. I don’t think we will get through 2020 without some serious dislocation. I don’t know what it is, but there will be a serious dislocation. And I think it will be a global level interconnected worlds. It could come very soon. I thought it was starting late last year frankly in December. I don’t know. But I think there will be a serious – whether it comes in tech, whether it comes in geopolitics, whether it comes in something, elections, I don’t know. But there will be a very serious disruption.

In my lifetime, this is the longest cycle without a serious disruption. And I go back to the periods that have read about. I am not that old, but there was one in ‘73. The ‘79 was I think was the Iran revolution. ‘71 – ‘72 was maybe some oil shock or something. There was ‘87 with stock market crash. Before that there was something in ‘80. ‘91 was desert storm Gulf. Between ‘97 and ‘98 one was the Russian crisis and one was oil crisis. See now it is coming into your lifetimes. Then we know the rest. 2000, 2008, this is 11 years. It is going to be 12 years.

And I think my advice to investors by the way who haven’t see all of this, this is not how the world works. And if you have learnt stuff over the last 12 years that you think this is how it works, it is going to come as a very rude shock, how bad it can get. And the problem is the longer it lasts on the up, the deeper the correction. But anyway it’s coming. I lost the train of the question. What was the – so advice, yes.

So I think the investors are going to have a moment of reckoning. And I think it is coming. The founders we discussed how they navigate some of these. So if you assume that something will blow up, you have to navigate like we discussed earlier. I think as far as investors are concerned, they are starting to recognize. I can see the nervousness already out there.

Rajinder: Thanks, Avnish. I think I would like to end on a more positive note.

Avnish: So I want to. You said every market – so, I think the way to think about it is it has been step functions. And I believe that now I look forward to recessions or to a blow up. Earlier I used to look forward to – I used to fear the blow up. Now I feel greedy about the blow up. The best companies are started in recessions. The best companies are able to hire the best talent. They have the least amount of competition.

And to your other point, you look at each blowup, we have ended up at a higher place. So I actually think of this business as a business of creative disruption. Innovation doesn’t come without creation and disruption. So, you are trying to be innovative. You are trying to create something. If you are trying to create something by definition it’s new, somebody has to fund it. Somebody has to fund it. People have to buy it. You need to attract capital. By definition that starts feeding on itself until it destructs. But then the wheat separates from the chaff and the new emerged company – by the way, the company that is the best of this first phase also wants the thing to blowup because they know they will survive. But there is too much irrational competition. I think it’s normal.

And I think the good news is that every time it ends up at a higher level. And in India, I think that curve is going to steepen over the next decade. We have talked about GDP per capita number of times. It is reaching at a stage where this curve is going to steepen. So that’s the good news.

Rajinder: So my takeaway is cycle is going to turn, but there are going to be two or three massive companies that starts sometimes next year. And, I guess our job is to be in business with the best of that.

Avnish: Absolutely. Sounds good.

Rajinder: Thank you.

Salonie: Thank you for tuning in. And you can find a transcribed version of this podcast on matrixpartners.in. You can also follow us on Twitter and LinkedIn for more updates.