21 Feb 2020
The Recent Change in Focus from Valuation to Profitability
Posted at 12:05h
I was recently reading an article in The Mint newspaper on “How Startups Crack the Profits Puzzle”. The article gave a detailed account on how Indian startups are using several levers from demand generation to a tech led flexible supply change, in making sure they hit profitability as demanded by their venture capital investors.
There is a term commonly heard in the Indian VC ecosystem: “Trends”. What are the trends of the year? In which sectors are venture capital firms investing in this year? I have also often heard from entrepreneurs who have raised funding, that they were lucky to be in the sector that was the trend of that year.
Coming from an entrepreneurial and investor background, I have a different take on this. While valuation is important and even in traditional industries like airlines and telecom, we have seen several years of loss funding with many times no profitability in site, the focus on only a substantial increase in valuation with each round of funding, for every sector is not sustainable. So, when you hear of funds that have invested following trends and valuation alone face the heat, it doesn’t surprise me.
Being an entrepreneurial investor in the startup ecosystem myself, I agree that you cannot compare tech company valuations to the traditional sectors, but I believe that the basics of building a business do not change. Business is essentially based on providing a product or service to meet a customer need. If you study in depth some of the greatest companies of the world, at the core of it lies this. This is something that people often forget in their rush to define and invest in trends.
My experience has been that an investor makes money when they focus on investing for the long run and investing in companies that are actually creating something of value. Many people question the recent valuation of tech companies in the US, or the high valuation of Indian Unicorns. While I do not have an explanation for all of them, I do know that smart entrepreneurial investors keep a long-term view and invest in good companies, good management and good entrepreneurs. And this hasn’t changed from the time when Warren Buffet started investing. So, whether one invests in the equity markets or the venture capital space, what’s important to understand is to pick people who don’t follow trends but focus on markets and companies. So when one reads on a recent change of focus on profitability from valuation, I look at it as just another trend in the VC ecosystem, which is the flavor of the year.