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The Impactful Investing: Your gateway to exclusive financing opportunities via social entrepreneurship

by Sandeep Kumar

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In recent years, investors’ demand is growing and so is the need for sustainability. Modern investors now look out for investment options that not only increase their returns, but are also contributing positively to social and environmental issues. In order to make sure both the needs are fulfilled, the answer can be found in the field of sustainable finance. By funding social enterprises, investors can ensure that their money is utilised for the benefit of the society and also provides returns.

Sustainable finance for Social Entrepreneurship

For any enterprise it is important to ensure financial sustainability to carry out its operations. Social enterprises essentially try to maximise their profits in order to carry out programs that will help overcome social and environmental issues. Thus, social impact and positive financial outcome, both are equally important for such a firm. In order to achieve these objectives, sustainable financing is very important.

There are several ways in which social enterprises can raise funds- donations, grants, crowdfunding, loans. However, these methods come with some drawbacks or the other. They take time to raise funds, involve costs, or some kind of competition. Sustainable finance through impact investors are valuable to bridge the gap between social development and funding. Before we look into the benefits of impact investments in particular, let us understand what the different approaches are available in sustainable finance.

Different approaches – SRI, ESG, and Impact Investing

Different approaches in sustainable investment consists of following:

  • Socially Responsible Investing (SRI)

It includes a value based investment system, in which the investor avoids taking up options that are against his/her believes or value system. Example, a person who hates smoking would avoid investing in a firm that produces tobacco products.

  • Environmental, Social and Corporate Governance (ESG) Investing

ESG looks at the environmental, social and governance practices of the firm that would significantly impact the performance of firms’ finances, and thus the return on investments. The main objective of this approach is to focus on the financial performance of the investment.

  • Impact Investing

This approach weighs financial performance and positive social impact equally. Such funds are often used to support causes that are not directly addressed by public financial markets. 

How is impact investment different?

While the above three terms may appear similar, they are different. It is important to note that SRI and ESG investing involve publicly traded assets, whereas impact investing considers private funds. Impact investing is more transparent in terms of assessing how the investor’s funds are used. SRI and ESG are more of a screening process for social and sustainable investment; while impact investing focusses on actually generating a positive impact.

The Global Impact Investment Network (GIIN), defines impact investing as “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”. Impact investment is not just philanthropic, rather it combines it with rigorous analytics of traditional investing. This is achieved by expanding accessibility of goods and services to the deprived section of the society, or through the use of environment-friendly and inclusive production processes. Such investments also target a wide range of areas including agriculture, clean energy, health, education, infrastructure, etc. While public funds and philanthropic measures help in providing for the poor, the role of impact investing is to give them a push as they climb the income ladder.  

Positive Outlook of Impact Investing

The Global Impact Investing Network (GIIN), the impact investing market is estimated to be as big as $715 Bn in the year 2020. The survey also finds that investors report that their portfolios have been performing at par and even exceeding their expectations in terms of both environmental and social impact, as well as financial impact.

 Source: GIIN, 2020 Annual Impact Survey

A report by Impact Investors Council of India estimates that Indian impact investing has shown growth at 26% CAGR in the last decade (2010-2019). $10.8 Bn funds have been mobilized by 586 impact serving about 490 Million beneficiaries, most of which belong to low income communities who are underserved by traditional investors. Impact investments have seen a gradual growth over the decade, especially since 2018 with average deal size tripling from $5 Mn in 2010 to $17 Mn in 2019.

With such high growth rates and the effects of Covid-19 pandemic, investors are now making a conscious decision to move towards sustainable investing. Moreover, the growing number of fintechs and use of advanced technologies, make investing a hassle-free process for all. The adoption of modern and innovative techniques will further accelerate the future growth of impact investing.

Source: Impact Investors Council of India

Since the share of impact investment in financial services has grown over the years, it has helped in fulfilling SDGs of reducing poverty, creating jobs and economic growth, gender equality, industry, innovation and infrastructure. Every dollar invested through impact funding has been able to crowd in at least twice the commercial capital. Impact investing has played a significant role in funding Seed and Series-A capital, and also provided for about 70% of the later-stage financing. Indian impact investing is largely focused on financial services. This will help achieve the goal of economic growth, which will eventually serve in accomplishment of other SDGs including poverty alleviation, gender equality, zero hunger, etc.

Sector-wise Impact (Source: Impact Investors Council of India) 

Your ticket to a positive impact

As the Covid-19 pandemic has derailed the economy, there is greater need to focus on SDGs to get back on the track of development. A broader focus on social entrepreneurship and sustainable finance options is needed to bring the economy back on track.  Social entrepreneurship is always supported by the government, since it helps them to get to the path of development by bringing a change about a change in the social and environmental issues.

Impact investing is the modern way of obtaining the twin goals of greater social impact and financial return. It is gaining popularity as more people strive for sustainability. In the Indian scenario, majority of the impact based funding is focussed on the financial institutions that help achieve global goals of greater economic efficiency and poverty alleviation. Other areas that are served through impact investing include gender equality, clean and affordable energy, better well-being through education, health, sanitation, etc. So if you want your funds to grow by bringing a positive change in solving social problems, impact investing is the way.

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This article has been co-authored by Tamanna Kapur, who is in the Research and Insights team of Torre Capital.

BYJU’s: The next big tech unicorn to curb the appetite for IPOs in the Indian Markets

by Sandeep Kumar

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BYJU’S is India’s biggest training organization and the maker of India’s most famous K-12 learning application, which offers profoundly versatile, drawing-in, and powerful learning programs for understudies. Revaluating how understudies learn in the time of cell phones, the BYJU’S approach consolidates top-notch instructors, demonstrated educational strategies, creative innovation, and information science to convey customized learning across grades. Byju’s likewise offers to instruct administrations for cutthroat tests, for example, JEE, NEET, CAT, IAS, and worldwide tests like GRE and GMAT.

Since India authorized a lockdown in the nation over in late March, closing schools and other public spots, Bangalore-settled start-up Byju’s has arisen as one of the quintessential stages for school-going understudies on the planet’s second-biggest web market. It took the start-up around four and a half years to gather 40 million understudies. Since the lockdown, its client base has expanded to 65 million.

Snapshots 

  • Notable Investors: Blackstone, Blackrock, Ant Group, Tiger Global, T. Rowe Price, Silverlake
  • Last Funding Round: Series F (Nov 2019)
  • Amount: $ 1.5 Bn
  • Valuation: $15 Bn
  • Employees: 21,000+
  • Founder: Byju Raveendran and Divya Gokulnath

The market for fast-growing IT stocks

The education market in India as a whole is worth around $135 Bn with approximately 360 Mn learners. The Edtech segment of India is divided into 6 parts:

· Pre K-12

· K-12

· Test Preparation

· Higher education

· Continued learning

· B2B Edtech areas

The opportunity in the Edtech market is huge and Edtech startups are contending for a larger share of the pie. The Indian Edtech market investments in 2020 were led by big names like Byju’s, Unacademy, Toppr, etc. The market managed to garner $2.22 Bn funding in 2020 up from $553 Mn in 2019. Byju’s and Unacadmey have been the MVPs raisng over $1.64 Bn and $347.5 Mn. 

As there is a shift in methods of teaching there is an increase in focus on self paced learning and the idea of continued learning after college through professional courses this has been the driving force behind the innovations of the content is made and how it is delivered to the consumer. There are quite a few factors at play that led to the growth of investments in Edtech market. A major one being the increase in government spending allocation to the education sector from $ 11.3 Bn in 2018–19 to $ 13.2 Bn in 2020–21 and the launch of the National Education Policy this year. Another driver of growth is the increasing internet penetration in India especially in tier 3 and 4 cities

 

The pandemic fever

In just a matter of days, the pandemic forced people indoors that changed the way they worked and lived. Lockdown, though confining for the public at large was a gate opener for the Edtech market that was looking for a breakout in investor’s attention. An abundance of startups was able to benefit from the favorable conditions created in the market. Also, many new startups popped up across sub-segments to ride the Edtech wave this year. Large and small Edtech companies offering solutions for remote learning witnessed off-the-charts levels of activity — up by as much as 600%.

Global scenario and opportunities

Education has been one of the most traditional industries, however, that is changing in recent years we have seen applications of advanced technology in education and learning. Education is no longer only associated with the traditional classroom. The learning process now tends to leverage Edtech solutions like online classes, learning management systems, and others to make education more effective and accessible. The pandemic lead to further growth in demand for Edtech solutions sets the pace in the Edtech industry for many years to come.

 

 Source: Holon IQ

China, with the largest education market in the world, has led education VC investment growth over the past five years. China now makes up over 60% of all Global VC investment in education, the USA 15%, India, 14%, and Europe 5% in 2020. While not as large, VC investment in Indian Edtech is worthy of note, growing almost 4x since 2018.

Is it undervalued or overvalued?

A plethora of investors and VCs back Byju’s, some of the most prominent names are The BlackStone Group, Blackrock, T. Rowe Price, etc. Byju’s raised approximately $1.55 Bn in its latest funding round Series F (Jun 2021) which increased its market valuation to $15.05 Bn

 

 

Byju’s most prominent competitors namely Vedantu, Unacademy and Toppr have an average Enterprise Value to Revenue Multiple close to 136x which is way higher than Byju’s 15x.

Peer comparison

Strategic partnerships

Over the years Byju’s have had numerous mergers and acquisitions, to name a few Vidyartha, Osmo, Labin App, WhiteHat Jr. and the most recent one Aakash Educational Services Ltd(AESL). With these acquisitions, all in edtech startups having their own niche offering, Byju’s is becoming on giant umbrella encompassing everything. The acquisition of WhiteHat Jr. aims to expand its product offerings, and widen its base in India, as well as the US where WhiteHatJr already has a presence. The latest acquisition of AESL, a leader in test prep services, brings together the best in offline and online learning. They aim to create India’s largest digitally enabled, omnichannel test preparation company.

The road ahead

Going forward Byju’s is planning to launch Byju’s Future School, the startup’s international business, which will be led by Karan Bajaj, founder of WhitHat Jr., which Byju’s acquired last year. The company plans to expand internationally in U.S., U.K., Brazil, Indonesia, and Mexico next month and explore other geographies later this year. At launch, BYJU’S Future School will offer coding and math lessons. New subjects like Music, English and Fine Arts will be part of future plans. The company aims to reach 350mn users worldwide by FY 2022. The company is also piloting a model in India where schools are working with BYJU’S in imparting coding education within the school curriculum.

Conclusion

With the plans to expand its operation across cities and internationally, the company has the necessary funds for the expansion and investing in R&D of new methods of augmented learning through Artificial Intelligence, Machine Learning, and analytics. Banking on the massive subscriber base with the aim to expand it further, Byju’s will sure have data to feed its models and be able to provide truly customizable learning for each individual subscriber.

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This article has been co-authored by Ayush Dugar and Khubaib Abdullah, who is in the Research and Insights team of Torre Capital.

Pension funds trying to change the world — is it justified?

by Sandeep Kumar

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Simply put, a pension fund or a pension pot is basically a pot of money that provides retirement income. So, when you and I retire, we’re going to need to live off the money. We might have saved up but right now when we are working, we can invest money into our retirement and that is where a pension fund comes in. It is a large sum of money that is being invested in order to pay you and me when we retire.

Pension funds often pool huge sums of money to be invested in capital markets like the stock and bond markets, in order to produce profit (returns). It represents an institutional investor that invests substantial sums of money in both private and public corporations. The primary purpose of a pension fund is to ensure that there will be enough money to cover employees’ pensions after they retire in the future.

The rise of pension funds

The “unseen revolution” altering corporate ownership in the United States is now evident to all, fifteen years after it was first documented. Around one-tenth of the equity capital of America’s publicly owned corporations is held by the 20 largest pension plans (13 of which are pensions of state, municipal, or nonprofit employees). In total, institutional investors — most notably pension funds — own over 40% of the common stock of the country’s large (and many medium) corporations. Public employee pension funds, which are the largest and fastest expanding, are no longer willing to be passive investors. They are increasingly demanding a say in the companies in which they invest, such as veto power over board appointments, executive salaries, and key corporate charter elements. Pension funds also control over 40% of the medium- and long-term debt of the country’s larger corporations, which is still widely disregarded. As a result, these institutions have become both the largest lenders and owners of corporate America. For years, finance texts have highlighted that the lender’s power is equal to, if not greater than, that of the owner.

One of the most dramatic power swings in economic history is the rise of pension funds as dominant owners and lenders. General Motors developed the first modern pension fund in 1950. Pension funds now have $2.5 trillion in assets, split about evenly between common stocks and fixed-income instruments, after four decades. These assets will continue to increase aggressively for at least another ten years, according to demographics. In the 1990s, unless there is a prolonged depression, pension funds will have to invest $100 billion to $200 billion in new resources per year.

Source: Financial Stability Board

 

 

 

Types of pension funds and its difference

There are two key types of pension funds. The first type is Defined contribution and the second type is Defined benefit.

Regardless of how well the fund performs, a defined benefit fund distributes a fixed income to the recipient. The employee contributes a set amount to the fund. These donations are invested prudently by the fund managers. They must outperform inflation while not losing the principal. The fund management must make a sufficient return on investment to cover the benefits. Any gap must be covered by the employer. It’s similar to an insurance company’s annuity. In this instance, the employer acts as the insurance company, bearing all of the risks if the market falls. Because of this risk, several firms have discontinued offering these policies.

In a defined contribution plan, the employee’s rewards are determined by the performance of the fund. 401(k)s are the most common of them. If the fund’s value falls, the employer is not required to pay out defined benefits. The employee assumes all of the risks.

The most significant distinction between a defined benefit and a defined contribution plan is the risk shift. The defined benefit is being rolled out because it is old school. Defined contribution on the other hand is around for the most part today. Most employers, companies, and individuals are likely to be on defined contribution pension schemes.

Country-wise comparison of pension funds

Globally, the quality of pension systems accessible to workers varies substantially. According to the Mercer CFA Institute Global Pension Index 2020, the Netherlands has the best system, whereas the United States is nowhere near the top.

· Netherlands: Its retirement income system is based on a flat-rate public pension and a semi-mandatory occupational pension tied to wages and collective bargaining agreements. The majority of employees in the Netherlands are members of these occupational plans, which are defined-benefit plans that are industry-wide. Earnings are based on an average over a lifetime.

· Denmark: Denmark features a public basic pension system, an income-related supplementary pension benefit, a fully funded defined-contribution plan, and required occupational pension plans.

· Israel: The retirement income system in Israel is made up of a universal state pension as well as private pensions with the mandatory employee and employer payments. Annuities are typically paid via the private pension system.

How pension fund diversifies its investments

By shifting their concentration to other assets, pension funds can protect themselves from a stock market meltdown. Most pension funds have typically sought growth by investing in shares, but with global stock market valuations so high, the short-term outlook appears dismal. Alternative assets, such as private credit, private equity, and real assets, may outperform a standard growth portfolio on a risk-adjusted basis.

Investors are shifting their focus to alternative credit investments in search of yield due to low bond rates and scheme demographics. As contributions fall, a growing number of schemes become cash flow negative, putting an emphasis on income-generating assets while requiring forced sales of growth assets.

Because interest rates on traditional assets like gilts and investment-grade bonds are so low, trustees are looking into alternative credit markets like high yield, private lending, royalties, and long-term leasing.

 

Performance of pension funds during the financial crisis

  • The funds’ investment performance all suffered in the early aftermath of the pandemic’s outbreak. Their returns, on the other hand, have fared “significantly better” than they did during the global financial crisis when they fell far short of their standards.
  • The funds’ ability to withstand shock was aided by the swift and unprecedented monetary and fiscal support provided in response to the rapid spread of Covid-19. However, improvements in the asset class mix and risk management capabilities of the funds also contributed to the funds’ ability to withstand shock.
  • Since the financial crisis, pension funds have extended their exposure to alternative asset classes such as private equity, infrastructure, and real estate, which has helped to mitigate the risk of their public assets.
  • In addition, the robust liquidity positions of pension funds have helped to protect them from market volatility.
  • During the market upheaval in the first half of 2020, these funds had minor liquidity stress, in contrast to the previous financial crisis. We feel that since then, advances in risk management governance mechanisms have been effective in protecting funds from market volatility.

Source: OECD website

 

How pension fund tackles inflation?

Inflation protection refers to assets that tend to appreciate in value when inflation rises. Inflation-adjusted bonds (such as TIPS), commodities, currencies, and interest-rate derivatives are examples of these. Although the use of inflation-adjusted bonds is frequently justifiable, some have expressed worry about the greater allocation of pension fund assets in commodities, currencies, or derivatives due to the additional idiosyncratic risk they represent.

Liability matching, sometimes known as “immunisation,” is an investing technique that compares the timing of predicted future expenses to the timing of future asset sales and revenue streams. The method has gained traction among pension fund managers, who use it to reduce the risk of a portfolio’s liquidation by matching asset sales, interest, and dividend payments to planned pension payments. This is in contrast to simpler techniques that aim to maximise return regardless of when withdrawals are made.

To supplement social security payments, pensioners living off the income from their portfolios, for example, rely on secure and consistent payments. A matching strategy would entail buying stocks strategically in order to receive dividends and interest at regular periods. A matching strategy should ideally be in place well before the retirement years begin. To ensure that its benefit commitments are met, a pension fund would use a similar technique.

Pension fund driving sustainable investing

Pension funds might be a powerful force in persuading businesses to embrace ESG goals such as tackling climate change and increasing employment justice. However, they must balance these objectives with their fiduciary responsibility to protect their members’ retirement savings. They must also overcome obstacles in the United States, such as gaps in ESG adoption measurements and misunderstanding about government restrictions on such investments. According to the paper, total assets managed by U.S. institutional investors using ESG principles have increased significantly over the last 15 years, reaching $6.2 trillion in 2020, with public pension funds accounting for more than half of that (54%). Climate change and war risks in terrorist or repressive regimes have recently risen to the top of investors’ concerns, followed by tobacco usage, corporate governance, and sustainable natural resource and agriculture practices. Investors’ appetites for ESG principles, on the other hand, oscillate between extremes.

According to the Wall Street Journal, ESG fund investors are moving their focus from growth to value companies, while other institutional investors are “lining up trillions of dollars to support a shift away from fossil fuels.”

Conservative risk measures

Pension funds make guarantees to their members, ensuring that they will be able to retire with a particular level of income in the future. This means they must be risk-averse while simultaneously generating sufficient returns to cover the guarantees. As a result, together with blue-chip stocks, fixed-income instruments make up a large portion of pension portfolios. Pension funds are increasingly looking for additional returns in real estate and alternative asset classes, albeit these assets still make up a modest portion of their overall portfolios.

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This article has been co-authored by Sayan Maitra and Yogesh Lakhotiawho are in the Research and Insights team of Torre Capital.

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The Impactful Investing: Your gateway to exclusive financing opportunities via social entrepreneurship

by Sandeep Kumar

Keep up to date with the latest research

In recent years, investors’ demand is growing and so is the need for sustainability. Modern investors now look out for investment options that not only increase their returns, but are also contributing positively to social and environmental issues. In order to make sure both the needs are fulfilled, the answer can be found in the field of sustainable finance. By funding social enterprises, investors can ensure that their money is utilised for the benefit of the society and also provides returns.

Sustainable finance for Social Entrepreneurship

For any enterprise it is important to ensure financial sustainability to carry out its operations. Social enterprises essentially try to maximise their profits in order to carry out programs that will help overcome social and environmental issues. Thus, social impact and positive financial outcome, both are equally important for such a firm. In order to achieve these objectives, sustainable financing is very important.

There are several ways in which social enterprises can raise funds- donations, grants, crowdfunding, loans. However, these methods come with some drawbacks or the other. They take time to raise funds, involve costs, or some kind of competition. Sustainable finance through impact investors are valuable to bridge the gap between social development and funding. Before we look into the benefits of impact investments in particular, let us understand what the different approaches are available in sustainable finance.

Different approaches – SRI, ESG, and Impact Investing

Different approaches in sustainable investment consists of following:

  • Socially Responsible Investing (SRI)

It includes a value based investment system, in which the investor avoids taking up options that are against his/her believes or value system. Example, a person who hates smoking would avoid investing in a firm that produces tobacco products.

  • Environmental, Social and Corporate Governance (ESG) Investing

ESG looks at the environmental, social and governance practices of the firm that would significantly impact the performance of firms’ finances, and thus the return on investments. The main objective of this approach is to focus on the financial performance of the investment.

  • Impact Investing

This approach weighs financial performance and positive social impact equally. Such funds are often used to support causes that are not directly addressed by public financial markets. 

How is impact investment different?

While the above three terms may appear similar, they are different. It is important to note that SRI and ESG investing involve publicly traded assets, whereas impact investing considers private funds. Impact investing is more transparent in terms of assessing how the investor’s funds are used. SRI and ESG are more of a screening process for social and sustainable investment; while impact investing focusses on actually generating a positive impact.

The Global Impact Investment Network (GIIN), defines impact investing as “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”. Impact investment is not just philanthropic, rather it combines it with rigorous analytics of traditional investing. This is achieved by expanding accessibility of goods and services to the deprived section of the society, or through the use of environment-friendly and inclusive production processes. Such investments also target a wide range of areas including agriculture, clean energy, health, education, infrastructure, etc. While public funds and philanthropic measures help in providing for the poor, the role of impact investing is to give them a push as they climb the income ladder.  

Positive Outlook of Impact Investing

The Global Impact Investing Network (GIIN), the impact investing market is estimated to be as big as $715 Bn in the year 2020. The survey also finds that investors report that their portfolios have been performing at par and even exceeding their expectations in terms of both environmental and social impact, as well as financial impact.

 Source: GIIN, 2020 Annual Impact Survey

A report by Impact Investors Council of India estimates that Indian impact investing has shown growth at 26% CAGR in the last decade (2010-2019). $10.8 Bn funds have been mobilized by 586 impact serving about 490 Million beneficiaries, most of which belong to low income communities who are underserved by traditional investors. Impact investments have seen a gradual growth over the decade, especially since 2018 with average deal size tripling from $5 Mn in 2010 to $17 Mn in 2019.

With such high growth rates and the effects of Covid-19 pandemic, investors are now making a conscious decision to move towards sustainable investing. Moreover, the growing number of fintechs and use of advanced technologies, make investing a hassle-free process for all. The adoption of modern and innovative techniques will further accelerate the future growth of impact investing.

Source: Impact Investors Council of India

Since the share of impact investment in financial services has grown over the years, it has helped in fulfilling SDGs of reducing poverty, creating jobs and economic growth, gender equality, industry, innovation and infrastructure. Every dollar invested through impact funding has been able to crowd in at least twice the commercial capital. Impact investing has played a significant role in funding Seed and Series-A capital, and also provided for about 70% of the later-stage financing. Indian impact investing is largely focused on financial services. This will help achieve the goal of economic growth, which will eventually serve in accomplishment of other SDGs including poverty alleviation, gender equality, zero hunger, etc.

Sector-wise Impact (Source: Impact Investors Council of India) 

Your ticket to a positive impact

As the Covid-19 pandemic has derailed the economy, there is greater need to focus on SDGs to get back on the track of development. A broader focus on social entrepreneurship and sustainable finance options is needed to bring the economy back on track.  Social entrepreneurship is always supported by the government, since it helps them to get to the path of development by bringing a change about a change in the social and environmental issues.

Impact investing is the modern way of obtaining the twin goals of greater social impact and financial return. It is gaining popularity as more people strive for sustainability. In the Indian scenario, majority of the impact based funding is focussed on the financial institutions that help achieve global goals of greater economic efficiency and poverty alleviation. Other areas that are served through impact investing include gender equality, clean and affordable energy, better well-being through education, health, sanitation, etc. So if you want your funds to grow by bringing a positive change in solving social problems, impact investing is the way.

 – – – – –

 

This article has been co-authored by Tamanna Kapur, who is in the Research and Insights team of Torre Capital.

“All that glitters is not gold” — Growing valuation bubble of Indian start-ups

by Sandeep Kumar

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 The valuation game

The Venture Capital valuation is a simple game, but never an easy one. While there is little to learn, to play it perfectly takes years, if not decades of experience under the belt.

So how do the VCs arrive at that valuation figure? Market Opportunity? Product Market Fit? Strong Founder Team? Disruptive Product Offering? Extensive Network Economics?

Nah.

Capital invested divided by the stake diluted. That’s it!

The VC chooses the amount of capital he is ready to deploy and the stake he wants to have in the company. Of course, the wish is to part with the least capital for the most stake. Now coming up with these two numbers, the capital chunk to invest and the amount of stake to buy, this is where experience comes in.

The winning bet in your portfolio

Most VCs have personal favorite ranges which they are comfortable with. Some VCs may like to hold only a few concentrated bets while others may want to deploy small amounts into numerous startups. The premise is the same. Each VC wishes to hold at least one winner in its portfolio, the winning bet that ‘returns the fund’.

This gets us to staging. The valuations do nothing to the VC portfolio, except increase the unrealized returns section, which, as the name suggests, are ‘unrealized’ and don’t mean anything unless the company makes an exit from that valuation.

But what if the company is not yet ready for an IPO or a buyout?

The VCs of course know this. Hence when they get together to finance a startup at some stage, let’s say series A, they are offering just enough money to take the startup to the next funding stage. This continues until the IPO or buyout.

Nowhere do the VCs use the DCF or any other model to find a fair value of the shares of the startup. Startup valuation is not a valuation game, it’s a pricing game. It is not about finding a startup trading at a lower than its fair value price and hoping the market corrects itself, the game is about finding another buyer who will be ready to pay higher. All this has nothing to do with cash flows generated from the assets held by the startup, adjusted for the underlying risks of all sorts (DCF basically). All these valuations are nothing more than exhaust fumes as suggested by Fred Wilson, an NYC based VC:

“Early-stage valuations aren’t valuations. They are the exhaust fumes of negotiation about two things — the amount raised and the amount of dilution.”

The information asymmetry

Now let’s take a look at what we have: You are a VC that is trying to get a stake in some startup. What do you do to get an idea of how much you should pay? You don’t have DCF or any other model to help. So, you look at what similar companies have been valued at. With new business models operating in diverse geographies, you realize that it is hard to say how you can define a similar company. Let’s say you came up with food delivery as one category. Despite the difference in the business models, one can hardly cobble together a list of 4–5 startups in the Indian space.

So, the VC game is plagued with opaque, inconsistent deal information. While the figures the VC arrives at are most probably wrong and have nothing to do with reality, they have nothing to worry about as long as they are able to find someone who’s ready to buy at a higher price from them.

The Indian startups in numbers

The past few years have been a gala time for the Indian startups who have managed to secure funding unabated despite the pandemic and its blues.

Startups in India managed to raise $7.8 Bn until April itself. This is a significant number almost 70% of the total $12.1 Bn raised in 2020 and more than 50% of $14.2 billion raised in 2019.

The average funding size has increased to $25.21 Mn, up from $14.94 Mn in 2020. There have been 402 funding rounds until April itself, against 1,114 deals in 2020 and 1,036 in 2019.

Overvaluation and the global landscape

The push towards absurd overvaluations has been a result of the negative interest rate environment. Post the GFC, there was heavy lending and even more borrowing. So much so that people had to pay up money just so that they could lend money. Of course, this led people to look for alternative avenues to park their money and generate juicy returns. The baseless optimism and hollow belief in spotting the next Bezos, Zuck, or Musk have led to an audacious amount of money flowing in, creating completely senseless valuations, having no roots in reality.

Tesla, more than $13 Bn in debt at the end of last year, recently had a market capitalization of $160 Bn, greater than General Motors and Ford combined. At the IPO price, Square was valued at close to $3 Bn, which is 50% below the $6 Bn valuations for which it had raised money from private investors a year before. Uber which in accounting terms stands at around 5x times its revenues, is also grossly overvalued as it is nowhere close to being the leader in the driverless car’s space. WeWork tried to go for a $47 Bn listing but ended up getting corrected to $8 Bn.

The WeWork fiasco was dubbed as a wake-up call in a Morgan Stanley report stating that the days of ‘’ were over.

Unicorns were considered rare. Today, however, the United States has a herd of more than 100 of them, with 100 more outside the US. Each worth a billion dollars or more.

Will history repeat itself?

Let’s talk about the Indian scenario and the startups which we believe are overvalued and most likely to come back to their intrinsic value as and when the markets correct themselves.

1. Byju’s: World’s most valuable Ed-Tech Company

Byju’s operates an online learning platform. It also creates a mobile app for pupils that offers a variety of learning activities. Exam preparation classes are also available. Original material, watch-and-learn movies, rich animations, and interactive simulations are all available to users on the site. The firm is having an EV/Revenue multiple of 17x.

It is the only major player in the Ed-Tech space in India, which has led the company to raise multiple rounds of funding and leading to an enormous increase in valuation. Knowledge in today’s world is free, however, Byju’s creates unique content with animation and the product often seems to be overpriced. In recent times there were a number of instances on various social media platforms where people questioned the pressure on the sales team and how Byju’s is so concerned about their sales when they try to push their offering in the market.

In the long run, the expected return from Byju’s is questionable. Below is the chart of the revenue and valuation of Byju’s over the last five years.

2. Cred — The borrower’s messiah

Losses in billions of dollars are nothing new for hyper-funded companies, especially when they’re chasing size and consumers at any cost. CRED’s metrics tell a tale in and of itself. CRED has made a profit of $71,000 in its second year of operation. CRED hasn’t been able to monetize its user base in FY20, despite acquiring a large customer base with a high propensity to spend and consume.

While the two-year-old company’s sales remained low, its total expenditure increased by more than 5.9 times to $52 Mn in FY20, compared to $9 Mn in FY19. The greatest cost center for the financial firm was advertisement and marketing, which accounted for 47.6% of total expenditure. From $3 Mn in FY19, such costs increased by 9.3 times to$25 Mn. During the fiscal year that ended in March 2020, CRED spent Rs 726.7 to earn a single rupee of operating revenue. CRED’s yearly loss in FY20 was INR 360.3 Crore, up 5.9 times from the $8 Mn it lost in FY19. The current cash burn is difficult to sustain, with an appalling EBITDA margin of -1979.5% in FY20, and the company will have to focus on its collections.

Despite registering astronomical losses it has attained a unicorn status by raising its valuation to $2.2 Bn in 2021. It is worth noting that the company is founded and led by Kunal Shah who is a known name in the start-up world for founding and leading numerous companies which may be an explanation behind the astronomical valuation of Cred. The graph below shows the valuation and losses of Cred over the years.

3. CarDekho — India’s leading car search venture

CarDekho helps users buy cars along with expert reviews, detailed specs, and prices, comparisons as well as videos and pictures of all car brands and models available in India. It has recently acquired an auto marketplace, Carmudi (Philippines) in late 2019 to expand business in Southeast Asia. GirnarSoft, the parent company of Jaipur-based automobile-related services behemoth CarDekho, has seen its losses increase by 155% to $45 Mn in FY2020. This comes after the company’s losses had already increased by 39% in the previous year.

Despite that CarDekho has managed to raise its valuation. Last year, Cars24, a CarDekho competitor, increased its consolidated revenue to $418 Mn and achieved unicorn valuation, and has a much lower EV/Revenue multiple. Let us now see the EV/Revenue Multiple of the peers in this game through the table below.

As per the last reported revenue and valuation figures.

We can infer from the table that CarDekho has a huge EV/Revenue multiple which signifies that the valuation of the firm is increasing at a much faster rate with respect to the revenue that the company generates, leading to overvaluation of the company. The graph below shows the valuation and revenue of CarDekho.

4. Unacademy

Unacademy is a Bangalore-based educational technology startup in India. Unacademy lessons are available in the form of Live Classes, which are both free and available on a subscription basis. Unacademy earned $12 Mn in revenue but spent $53 Mn, resulting in a loss of INR 300 crore. Employee benefits accounted for 23.7% of the edtech start-up’s costs, while other expenses accounted for 75%.

While 2020 brought plenty of development, the corporation would need to significantly increase its expenditures to reverse the losses it had in the fiscal year 2020, which ends on March 31, 2020. Unacademy’s revenue in FY21 is estimated to be over $55 Mn. It’s worth $3 Bn or approximately 35 times the expected income. The graph shows the valuation and loss of BharatPe.

5. BharatPe

When we talk about e-commerce giants, PayTm, Amazon, and Flipkart all wanted payments to take place within their own closed networks. BharatPe’s goal was to achieve what all the large brands were afraid to do: simplify things for retailers by adopting a standardized interoperable QR code. It allowed shops, street food vendors, and tea vendors to accept payments using any UPI app (PhonePe, Google Pay, PayTM, and so on) without having to download the apps. It was a simple and cost-effective approach with an added layer of security. The payment system’s complexity was reduced by a factor of ten by combining multiple UPI apps into a single sticker.

BharatPe was able to achieve early success by keeping things simple. BharatPe’s product strategy is based on making things simple for merchants, and the company uses P2M transactions as a springboard for future services. Because BharatPe does not charge merchants a setup or transaction fee, its fundamental feature money collection using QR codes is essentially a loss-maker for the company. It must spend a large amount of money to manage the servers that process millions of transactions every day. However, this provides BharatPe access to merchants who are passionate about their products and eagerly accept their offers. Despite having no visible revenue stream and without even earning a penny, the valuation of the company is increasing, and currently, it stands at $900 Mn, very close to the unicorn status. The graph shows the valuation and revenue of BharatPe.

The apprehensive loop of growing valuations

The indications are all too familiar. With large markets, illustrious founders, rapid growth, and top early-stage VCs on your side, you have a good chance of raising the next big round, even if you don’t yet have unicorn status (the desired billion-dollar value). And when major acquisitions are made for unproven companies, and valuations double or triple in a matter of months, it begs the question: are we in a bubble? This is always a challenge because most people only realize they were in an economic bubble after it has burst in the past.

Rich valuation multiples have also spread from the typical suspects — consumer internet companies — to enterprise software providers. This is a first. SoftBank, for example, invested in Mindtickle last year, valuing it at $500 Mn based on estimated revenue of $20 Mn — $25 Mn. Even SaaS companies in the United States, including Slack, Zoom, Snowflake, and Cloudflare, have gone public in recent years with great success. Sentiment in India often comes straight from the United States, particularly in related industries and from funds that invest in both nations, including several of India’s leading venture capital firms. Startup valuations are also affected by how publicly traded firms trade if retail investors are ready to pay high prices for loss-making companies, whether banks financing a share issue can find enough at a given price, and so on. There isn’t a single bubble across the board. Because of the vast quantity of money available in the market, investors are willing to pay a premium for good business. But that should be done judiciously.

Investors beware

For the first time in years, it’s possible to claim that private markets are more logical than public markets. If stock markets are the yardstick, select pricey companies may not be overvalued. A closer examination of what constitutes a bubble, as well as what Indian entrepreneurs are doing, reveals a more complete picture. Growth investing has been positive in industries that have recovered quickly from the epidemic, and there has been a lot of interest in a few market leaders. At such levels, one would expect some amount of rationalization. Investors must evaluate the prospects and the future road map of a company before investing. As more investments flow into a company without a proper business model or less revenue, it results in overvaluation creating a bubble. Investors can lose a colossal sum by not choosing the right company.

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This article has been co-authored by Sayan Mitra and  , who is in the Research and Insights team of Torre Capital.

Startup investing 101: The HNI’s guide to investments beyond the conventional asset class

by Sandeep Kumar

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Why invest in startups?

Investing in a startup is a high-risk, high reward game

Deciding the right opportunity and best practices for investing in a startup

Ways to invest in startups

Delaying the IPO comes with certain advantages for Startups

How startup investing really works

When can you expect a return or are you locked in forever?

Source: Pitchbook and CBInsights

Exits are what investors care about, but many founders dream of becoming a unicorn and avoid using the word “exit” until it’s too late. Despite this, M&As accounted for 97% of departures in 2020. And the majority of them occurred prior to Series B.

Exit or no exit: A fatal call

DiDi Chuxing IPO: The race to dominate the global ride-hailing pool besides stiff competition

by Sandeep Kumar

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DiDi Chuxing is a Chinese ride-hailing company headquartered in Beijing that was founded in 2012 by Cheng Wei. DiDi is China’s largest ride-hailing provider, with nearly 600 Mn riders and tens of millions of drivers. Didi Chuxing has the advantage of being a domestic player who is familiar with China and its clients. In China, the company’s app allows users to request trips from automobiles and taxis, as well as chauffeur services, minibusses, and ride-sharing services. If the IPO is successful, the company’s valuation could range between $70 Bn and $100 Bn. DiDi Chuxing, which is backed by SoftBank, plans to raise $1.5 Bn in debt financing through a revolving loan facility prior to its IPO. At a time when the Chinese government is cracking down on technology companies, Uber’s Chinese counterpart DiDi Chuxing may have filed for an IPO under the radar. Goldman Sachs and Morgan Stanley have been chosen to lead the company’s initial public offering (IPO).

Snapshot

  • Headquarters: Beijing, China
  • Founded: 2012
  • Notable Investors: SoftBank, Alibaba Capital Partners, and Ant Group.
  • Capital Raised: $24.9 Bn
  • Latest Valuation: $62 Bn
  • Exchange: NYSE
  • Ticker Symbol: DIDI
  • Founder: Cheng Wei

Cementing the position with its industry-leading services

DiDi-Chuxing allocates calls from customers within 3 kilometers, though this boundary is being widened now. However, DiDi-Chuxing recently added a destination basic allocation system in which DiDi drivers can announce a destination and escaping location. The DiDi-Chuxing allocating systems have two modes: selection mode, which began in July 2018, allows the DiDi driver to choose the destination, including long-distance; and allocation mode, which allocates calls to DiDi drivers nearby.

DiDi-Chuxing usually assigns DiDi-X to veterans and DiDi-pool to new drivers. Customers of DiDi use payment methods such as Wechat-Pay, AliPay, DiDi-Pay, and others. When paying for any DiDi-Chuxing usage, DiDi customers can change their payment methods. When a customer sends a DiDi-Chuxing car-sharing fee, the fee is transferred from the customer to DiDi. If the customer did not pay, he must pay the fee before using DiDi-Chuxing again. In the case of long-distance driving in Beijing, the DiDi system raises the fee by up to 30% to compensate the DiDi driver for financial loss.

In the case of DiDi-Premier, there are discrepancies between the announced payment amount in advance and the actual payment amount after driving. These two amounts, however, differed by only a few cents. Even though the customer’s money is directly allocated to the driver’s bank account, the money may be paid a little late after driving. Actual payment takes place two days after the customer’s payment, or one-time weekly payment is made.

Currently, DiDi-Premier is charged a distance fee, a low-speed fee, and a long-distance fee. DiDi-Luxury also receives a long-distance basic fee and a fast call allocation fee. Because of weak government regulations and medium-level public transportation conditions, DiDi-Chuxing has a 3 km base call allocation system, with a trend toward increasing the allocation distance from more than 3 km up to 10 km in the case of DiDi-Luxury.

Ride-Hailing App’s concentrated Revenue Model

The majority of the company’s revenue comes from its private ride-hailing app. DiDi-X drivers received 80% of the revenue paid to DiDi-Chuxing by the customer. DiDi drivers can drive the DiDi car for 12 hours per day, which is calculated based on the DiDi operating time.

DiDi-Premier drivers earn 74% of the revenue. DiDi-Premier fees are 20% higher than DiDi-X fees, and DiDi-Premier drivers earn 20% more than DiDi-X drivers. DiDi-Luxury is five times more expensive than DiDi-X and three times more expensive than DiDi-Premier. DiDi-Chuxing pays DiDi-owned luxury car drivers 10,000 yuan per month in one-time and weekly payments. The fee for DiDi-Pool is 10% less than the fee for DiDi-X. If customers pay with Alipay, Alipay provides a small incentive to the drivers as part of an Alipay promotion in DiDi-Chuxing. If a DiDi driver cancels the allocation more than four times, the driver must pay DiDi-Chuxing a fee.

What is important is that the revenue of DiDi drivers is more than twice the minimum salary of university-graduated manpower under the weakness of China’s taxi industry and the automotive industry with the support of the Chinese government with limited regulatory power. The Chinese government regards DiDi-Chuxing as a kind of revenue-increasing engine for the people.

DiDi’s Business Timeline

 

A dominant strategic player in the Chinese Market with uncertain longevity

DiDi Chuxing has risen to the top of the online car-hailing market after merging with and acquiring Uber China. After driving Uber out of China in 2016, DiDi Chuxing quickly dominated the country’s massive ride-sharing market – but its position is far from secure, as more powerful rivals emerge to challenge its dominance. According to PwC, China’s shared travel market will reach $564 Bn by 2030, with a 32% annual growth rate. Many businesses have been drawn in by the massive shared travel dividend. China’s online car-hailing market exhibits a high level of market competition. Many players are still active, in addition to the dominant DiDi Chuxing. There is still room for a taxi-hailing market worth $100 Bn. The national average ride-hailing success rate is around 75%, and 25% of online ride-hailing demand remains unmet. This provides a lot of incentive for new entrants like Gaode Taxi, Meituan Taxi, Ruqi Travel, and other public online ride-hailing platforms.

DiDi Chuxing has approximately 554.7 Million orders, while the order volume of more than ten travel platforms such as T3 Travel, Cao Cao Travel, Wanshun Car-hailing, Xiangdao Travel, and Meituan Travel is less than 90 Mn, according to the calculation of the internal parameters of online car-hailing. As can be seen, DiDi Chuxing’s order volume far outnumbers that of other ride-hailing platforms. DiDi Chuxing, on the other hand, cannot sit back and relax. The company’s continued loss of market share has also planted a slew of hidden dangers for it. DiDi Chuxing’s market share accounted for 95% of the scale of online ride-hailing around 2016. Later, due to security incidents, DiDi Chuxing’s ride-hailing business was forced to go offline in the second half of 2018, and its market share also fell to 90%; according to calculations, DiDi Chuxing’s market share is only about 85% today.

How does DiDi fair over different regions and their market leaders?

 Source: PitchBook 

 Chinese Ride-Sharing Giant on the way to profitability 

DiDi Chuxing is dubbed “China’s Uber,” yet it really outperforms Uber and other competitors in the Chinese market. DiDi Chuxing, or DiDi, is a Chinese ride-hailing startup that has amassed over 550 Mn users and 31 Mn drivers since its launch nine years ago. DiDi claims to have a 99% market share in China’s taxi-hailing business and an 87% market share in private auto hailing, according to its own data. In comparison to Uber China’s 45 cities, it has a presence in over 400 cities across the country.

The company’s primary ride-hailing business is lucrative, and it has rebounded since the coronavirus outbreak in China, its home market. The corporation has 14 international markets, including Australia, Japan, Latin America, and Mexico, in addition to China. The business is more than just automobiles and cabs. DiDi also includes bus services and a chauffeur booking option, which might be beneficial if you’ve had too much to drink and need a designated driver to take both the car and the driver home.

DiDi’s financial performance is difficult to quantify because it is a privately held firm. In 2018, Chinese news outlets claimed losses of $1.6 Bn. While its primary ride-hailing company charged an average of 19% in commissions, overall expenses, which included tax payments and driver bonuses, were 21%, implying a 2% loss each journey. This pattern may be traced all the way back to the beginning.

Concerns Regarding the company

  • Massive expansion and competitive pressure: DiDi’s rapid expansion in China was fuelled by its fierce competition with Uber and lax government rules regarding ride-hailing services. DiDi created an army of drivers, which it bolstered with massive driver subsidies, allowing it to outrun Uber’s operations.
  • Regulation which limits driver’s work regions: China, unlike the United States, has rules that limit where residents can work. DiDi drivers from rural areas, in particular, are not allowed to work in larger cities unless they live there. Residency licenses come in a variety of levels, and cities vary in how aggressively they enforce them. However, many are tightening their belts. Many large cities are experiencing a driver shortage as a result of this, as many drivers do not want to risk paying fines for working where they do not live. It has also compelled DiDi to delete a large number of its drivers from its own app.
  • DiDi’s predicament is hardly exceptional: Regardless of size, all ride-sharing companies must choose between responsible expansion and safety. The murders that were reported exposed significant flaws in the DiDi app and its protocols. One major flaw was the company’s decision to outsource its passenger assistance system, which was chastised for failing to act on a previous complaint against one of the alleged murderers. Keeping an in-house customer support team would definitely strengthen the entire safety system, but it is a step that would have a negative influence on the company’s bottom line, which is already far from profitable.

Valuation analysis of the company

 Source: PitchBook 

Market sentiments surrounding the IPO

DiDi Chuxing is planning an initial public offering, with a capitalization of $60 Bn. Although no official date has been set, the company anticipates going public in the first half of 2021. When it comes to ride-hailing, you may only be familiar with Uber Technologies Inc. and Lyft Inc. DiDi, on the other hand, is one of the most well-known ride-hailing companies in the world. Even yet, the recent failures of ride-hailing IPOs are worth noting. Following their IPOs, both Uber and Lyft saw their stock prices plummet, trading as low as 70% below their IPO prices. DiDi, on the other hand, may have something the other businesses don’t.

DiDi has a 17.5% ownership in Uber, and DiDi has invested $1 Bn in Uber, so DiDi is essentially the Chinese Uber. But there’s a lot more to it. DiDi joined Kuaidi in 2015 to build a smartphone-based transportation services behemoth. Taxis, privately owned cars, carpooling, and buses would be summoned by users. This is in stark contrast to the Uber and Lyft models, which rely solely on scooters.

According to the sources, DiDi Chuxing chose New York because of a more predictable listing pace, the existence of comparable peers such as Uber Technologies Inc. and Lyft Inc., and a larger capital pool. The decision comes as the US Securities and Exchange Commission pushes forward with a plan to delist international companies from US stock exchanges if they fail to meet US auditing criteria.

But even if DiDi was restricted to China alone, there would still be a case for the company. It serves a nation of 2 Billion people and has plenty of institutional backing. Tech investment giant and Uber-backer SoftBank Group Corp backs DiDi. Alibaba Group Holding Ltd. and Tencent Holdings ADR also back the company. Before its IPO, DiDi still expects to have another funding round to boost the valuation. Some of its shares are still trading below its 2017 peak valuation of $56 Bn.

Extensive product expansion and the road ahead

DiDi Chuxing, a Chinese app-based ride-hailing business, has unveiled a new three-year strategy for steady and sustainable growth. DiDi’s three-year plan, dubbed “0188,” moves away from its “all-in-safety” approach and toward longer-term safety capacity building and user value creation. The number 0 represents safety as a top concern, while the other three numbers represent DiDi’s strategy aims.

As of the beginning of 2020, DiDi has completed over 1 Bn international journeys. DiDi prioritizes its platform for integrated four-wheeler (ride-hailing, taxi, designated driving, and hitch) and two-wheeler (bike and e-bike) and public transportation solutions, as well as it’s subsidiary Xiaoju Automobile Solutions, autonomous driving, fintech services, and smart transportation businesses.

A customer-centric car leasing business has been unveiled by DiDi and its long-time partner BAIC, as well as a consortium of automotive industry enterprises and Chinese state-owned institutions. “In the next three years, the companies hope to have a fleet of 100,000 cars available for lease,” according to the agreement.

Should you invest?

The majority of initial public offerings (IPOs) are volatile at first. You have a large influx of early investors who buy into the hoopla and then fade away. As a result, many IPOs experience a drop in the period following the IPO. We’ve already listed Uber and Lyft, but we can think of a few more. JFrog Ltd. (NASDAQ: FROG) has dropped 33% since its first public offering in October. Snowflake Inc. (NYSE: SNOW), the largest software IPO in history, dropped 40% after rising 61% in the months afterward. This is how most initial public offerings (IPOs) go, which is why we constantly advise against investing in them immediately. You might want to get in as quickly as possible in some circumstances. But, in most cases, it’s better to wait for the euphoria to settle down and see whether the stock can return to a stable state i.e. the actual value. You should also be wary of the company’s particular industry.

It’s difficult to be positive about a ride-hailing service, using Uber and Lyft as examples. But, as we already stated, DiDi’s case may be different. As both Uber and Lyft have been embroiled in a price war across the United States, which has caused their stock prices to plummet.

DiDi has the advantage of having China almost entirely to themselves, as well as having infiltrated overseas markets. A user base seven times that of what many consider the industry’s biggest brand (Uber) might have a significant impact on DiDi’s stock performance following its IPO. As a result, the stock is more likely to be a buy than Uber or Lyft. However, because Uber is a shareholder, DiDi’s success might put money in Uber’s pocket, giving Uber an even bigger advantage in its struggle with Lyft. If you want to purchase Didi stock, it is advisable to get it at the right price

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This article has been co-authored by Sayan Mitra and Yogesh Lakhotia, who is in the Research and Insights team of Torre Capital.

Zomato IPO: Analysing the future of the Indian Foodtech giant

by Sandeep Kumar

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The future of Indian Foodtech is here

The food delivery and restaurant service tech giant, Zomato plans to go for an IPO this June or July. The IPO catches headlines, not just because of the amount being raised or the time when the IPO comes (both of which we discuss later), but also because Zomato could as well be the very first Indian Unicorn to go public. This shall be a momentous moment for not just the tech startup, but also for the entire startup community in India. The IPO could open doors to a new form of exit for the Indian founders and VC firms and cement India’s position as a startup friendly nation.

Zomato plans to raise over a billion dollars(!). This will be the biggest IPO since March 2020 after SBI Cards IPO at close to $1.3 Bn.

Business Model

Zomato was founded in 2008 as a simple restaurant reviews website. In 2015, Zomato entered a very crowded Indian food delivery space. Since then the landscape has changed completely. Out of the numerous startups (FoodPanda, TinyOwl, Scootsy, OlaCafe, UberEats) that were offering to deliver your food, chances are today you order food from one of these three: Zomato, Swiggy or Amazon (Amazon currently offers food delivery services in and around Bangalore). What happened to the rest? Well, most shut down, while the rest were acquired and then shut down. Barely a handful which were acquired by Zomato or Swiggy operate within, not independently.

Zomato acts as a restaurant discovery platform aggregating menus, dishes, user reviews and more. Zomato has nearly 3.5 lakh restaurants listings on its platform with more restaurants expected to join in as the pandemic and the induced lockdowns play a havoc on their dine in revenue streams. These restaurants pay Zomato a fee for greater exposure on the platform. The hope is, once a customer tried the food, chances are they will pay a visit to the restaurant. Now the pains and the faults in this premise make for a story for some other day. 

Zomato’s next line of revenue is the exclusive paid membership program very creatively titled “Zomato Pro”(earlier known as Zomato Gold), offering special discounts and/or free deliveries to is subscribed members. This membership model works how a gym does, take the membership fee and then hope the service is not utilised. Zomato has one advantage though, it can decide what discount to offer and/or what price to charge (dynamic pricing), based on traffic conditions, meal hours, order quantity etc. Zomato currently has 1.4 Million pro members and over 25k restaurants listed on Zomato Pro program.

Not all restaurants choose to be a part of the Zomato Pro program as these restaurants are also expected to offer discounts and offers on dine in options as well and maybe not all restaurants find themselves in such a position (again a story for some other day).

Zomato’s next stream of revenue comes from Hyperpure which supplies raw material to restaurants. This is a genius move in my opinion, at least theoretically. Zomato’s food delivery business allows it to forecast the raw material demands of a restaurant. Efficient buying practices and careful hedging (Zomato is in no position to carry out hedges against sharp commodity price movements, simply because it does not do enough volumes to justify this sort of a thing) can allow Zomato to up sell these raw materials, earning a constant cut.

If the hedging works, the restaurants are also set to benefit as they will receive a fixed price for their raw materials, allowing prior ordering. Zomato currently has 6000 restaurants on its Hyperpure platform in just two years.

And finally comes the last source of revenue (no need to be amazed, all this revenue does not trickle down to the bottom line), the delivery partners delivering your food. Here Zomato earns commission from the restaurants as well as the delivery charges from the customer (yes, all those extra delivery charges you paid and still these guys aren’t profitable…).

  Source: Zomato’s DRHP

Now Zomato does not give a breakup of how much revenue it makes from each segment, but nevertheless, most of the revenue comes from food delivery business, the ones you are the most aware of.

The not so straightforward Market Landscape

Food and restaurant Services is a competitive market in India comprising food delivery players like Zomato and Swiggy, cloud kitchens like Rebel Foods and branded Food Services players such as Dominos, McDonalds and Pizza Hut which. Food delivery players also compete with multiple other participants in the Food Services industry including restaurants which own and operate their own delivery fleets and both online and offline modes where restaurants place their advertisements to attract customers.

The food and restaurant industry in India is composed of three segments: delivery, take-away and dine in. Out of the three, the food delivery business is expected to grow most rapidly. While this was true even before the pandemic, the post pandemic has further cemented this.

 

Source: Zomato’s DRHP

During first half of 2020, the food delivery business contracted as India braced itself for the COVID lockdowns. However, once the lockdowns and the initial hysteria was over, a boost of business came to the food delivery business, not to the dine in or the drive way streams. This clearly is good for Zomato.

But things are not as straightforward for Zomato. This is because of how the food delivery business inherently is structured. Food delivery is more of ‘now pamper me’ kind of business and not ‘I don’t care what it is as long as it gets my thing done’ kind of business. Services such as Netflix or Zomato come in the former while services like Uber or Paytm which offer more of a commodity sort of service, come in the later.

One doesn’t really care who gets you from one place to the other or what app you used to pay someone, but one strongly cares what shows or movies a certain platform offers or which restaurant offers its dishes on which platform.

Source: Zomato’s DRHP

Zomato’s Financials

Let’s pore over the unit economics first. The number of orders placed on Zomato is largely driven by its customer base, restaurant partners and delivery partners. The number of orders is also subject to seasonal fluctuations and tend to be generally higher when customers may be less likely to dine-out as a result of unfavourable weather or during certain festival seasons and holidays when customers are more likely to order food for delivery.

Source: Zomato’s DRHP

The Average Order Value for Zomato has gone up over the last 7 quarters and stands at INR 407. The AOVs are higher for orders from premium restaurants. The orders have grown from 30.6 Million for 2018 to 403.1 Million for 2020. That’s a colossal 1200% jump in merely 2 years of time.

Source: Zomato’s DRHP

The change of heart and mind with increasing Unit Economics

Moving on to the unit economics of Zomato and we are welcomed by greener pastures: while last year Zomato lost INR 30.5 on every order made, this year Zomato managed to make a profit of INR 22.9 on each order. This has been achieved mostly on the back of.

  • increasing restaurant commission charges (remember the story for some other time 😉)
  • increasing delivery charges from the customer (sadly)
  • and cutting costs on deliveries and discounts (I swear I felt the last one pinch).

All this tight cost cutting and pressurising the restaurants for more commissions has led to this rather phenomenal turnaround.

And like most things in life, if it looks too good to be true, it probably is; many think such commission structure is rather unsustainable and Zomato won’t be able to sustain this for long. Whether or not Zomato manages to sustain this or not, the IPO, pre-IPO funding and special stake sale from Naukri.com is bound to flush Zomato with tons and tons and tons of sweet cash.

Source: Zomato’s DRHP

All this positive unit economics (whether or not sustainable) is yet to impact its bottom line (which continues to dive deep in red), Zomato seems to be right at the verge of hitting profitability. While the market is in no way saturated, as more and more people start making digital payments, internet becomes cheaper and smart phones penetrate the society even more, online food ordering is bound to keep increasing.

The increasing Turnaround of Customer Cohort

As the number of customers to acquire rises, it would prove to be a challenge to monetise each customer so well that each order’s unit economics turns in the green. Acquiring customers takes cash, and that too loads of it. What matters is whether or not Zomato manages to make money from its customers, which gets us to our next metric: Customer Cohorts.

Source: Zomato’s DRHP

Acquiring customers comes with a cost and that cost needs to be redeemed from each customer. This directly implies that the customer must spend on the platform, more than what the platform spent on acquiring him. The above chart shows that once the customer is acquired, he continues to stick to the platform. The bunch (cohort) of customers acquired in 2017 now spend 3X of what they did in 2017. This is pretty impressive given a lot of customers must also have churned.

So, with the unit economics turning positive, the question that still lingers is, why does Zomato still operate in loss?

For that we switch over to the financial statements.

Source: Zomato’s DRHP

Well, there are two ways to explain the huge losses. Firstly, the huge amounts of cash spent to acquire customers and the time lag between CAC and LTV of each customer. Customers take some time to monetise once acquired. The costs have already been paid, even before the customer start generating any revenue. All those acquisition costs get added up as we see in Other Expenses line item.

 

These Other Expenses are not really “Other”, they are the marketing spends and all the discounts that Zomato offers on its platform. This line item accounts for most of the customer acquisition spends.

The other major source of expense is the Employee Expenses. Well, maybe because Zomato pays its peeps well, who knows…

All of this requires cash, which Zomato happens to have truckloads of. The latest pre-IPO round got Zomato over $680 Mn. If the IPO goes as planned, Zomato may end up with $1.00 – 1.14 Bn more. A war chest of $1.7 Bn!

The shares of the company are going to be listed on National Stock Exchange of India. We expect that the shares will be listed at prices upwards of INR 60 per share. Previously the shares of the company were converted at a price of INR 58 per share.

Zomato plans to use most of its IPO crop in organic as well as inorganic expansion, offering discounts (yayy!), sales promotions, cementing its delivery network and thus acquiring more and more of both customer and restaurants.

That’s what $2 Bn is capable of. I would not want my competitors to have a $2 Bn advantage over me.

Which gets me to Zomato’s rivals…

Peer Group Analysis

The pre-IPO funding round in February 2021 valued the company at $5.40 Bn. Within the expected price range the IPO would value the company at $6.50 – $7.00 Bn. Taking EV/Revenue multiple into account and weighted average calculation of the comparable companies, we arrive at an NTM multiple of 8.76x which gives us an intrinsic valuation of 2.07Bn.

The Indian Food Delivery space is Duopoly: Zomato and Swiggy. Under the shiny apps, things twist and turn very differently.

For starters, the business approach of Swiggy is vastly different from Zomato. While Zomato wishes to service the entire restaurant supply chain, right from raw materials, to getting it delivered to your home, Swiggy assumes a different role.

Swiggy sees itself purely as a delivery aggregator. A delivery aggregator, that will deliver groceries, books, meat, alcohol, medicine, pretty much anything that fits into that Swiggy rider’s bag. Food fits, so it delivers.

This is important. Viewing from this angle, Swiggy becomes a delivery player, mimicking Delhivery in its business approach than Zomato! 

Food just happens to be what shot Swiggy to fame. Swiggy runs not a restaurant service business, but “I’ll find someone to deliver your stuff” business – a low cost, low capex, low overhead last mile delivery business, something which most players struggle to deal with.

Be reminded though, most of Swiggy’s revenue still stems from food. The IPO for Zomato is a big deal for Zomato, but an even bigger deal for Swiggy, which will force it to act. Acted Swiggy already has, raising a new funding round, but that’s no match for the $1 billion Zomato IPO. The IPO sets the scene for not just Zomato but Swiggy as well. A bombed IPO may as well hurt Swiggy’s IPO prospects.

There’s also a new kid in town, Amazon Food. Amazon Food, is like that rich kid whose mere presence threatens Swiggy and Zomato’s dominance. Things seem quite for now. Amazon only operates in Bengaluru, offers very low delivery fees and no packaging fees; and if you happen to be a prime member, you don’t pay that even.

And I get it. Maybe Amazon is not so much of a threat that I call it to be, but my fears are based on two reasons: firstly, Amazon. Yes. That’s it. Second, just as the dust from the numerous players undercutting each other settled, a new player enters the scene. Now it isn’t as if Indian market can’t accommodate these new entrants. The market’s expanding. But what all previous tech businesses have taught is, whoever lands first gets the bucks. Amazon with its existing, robust delivery network can very easily undercut its peers offering cheaper delivery and deeper discounts, as it seemingly has already started.

Will the IPO deliver in the same way Zomato does?

Zomato’s IPO is one the most awaited IPOs. The listing has come at a time when the Indian economy is going through crisis. However, being true to its foodtech giant status, the company has used tech extensively in operations, sales, marketing and automation, which has excellent operational leverage in the longer term, and tech company values tend to get a fillip.

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This article has been co-authored by Khubaib Abdullah and Ayush Dugar, who are in the Research and Insights team of Torre Capital.

 

Asset allocation for new age investing: The key to reaching a higher financial altitude

by Sandeep Kumar

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Perhaps you keep telling yourself that you’ll invest when you have more money or that you’ll do it “someday.” Or perhaps you’re concerned that the markets are now fragile, so you’re sitting on the side-lines, waiting for a “better time” to invest. Alternatively, you may believe that you must become a hard-core specialist before you can accomplish anything with your money that approaches investing.

But here’s the thing: delaying it may cost you more than you realise. Experts estimate that 40% of people have lost money due to procrastination. If you wait to invest, you may miss out on some extremely significant financial advantages. In the long term, the sooner you put your money to work, the better off you’ll be.

Long-term economic growth forecasts are crucial for global investors. Equity prices are based on forecasts of future earnings, which are in turn based on forecasts of future economic activity. This dynamic implies that the same variables that drive economic growth will also boost equity values in the long run. Similarly, the predicted long-run real income growth rate is a crucial predictor of the economy’s average real interest rate level, and thus the level of real returns in general. The link between actual and prospective growth (i.e., the degree of slack in the economy) is a fundamental driver of fixed-income returns in the short run.

Asset Allocation: An inevitable step for successful investments

The asset allocation that is appropriate for you at any particular stage in your life is mostly determined by your time horizon and risk tolerance.

  • Risk ToleranceRisk tolerance refers to your readiness to risk losing some or all of your initial investment in exchange for higher prospective returns. An aggressive investor, or one who is willing to take on a high level of risk, is more inclined to risk losing money in order to achieve greater outcomes. A cautious investor, or one who has a limited risk tolerance, prefers investments that will allow him or her to keep their original investment. Conservative investors preserve a “bird in the hand,” while adventurous investors pursue “two in the bush,” as the classic phrase goes.
  • Time Horizon – Your time horizon refers to how many months, years, or decades you intend to invest to reach a specific financial goal. Because he or she can wait out slow economic cycles and the inevitable ups and downs of our markets, an investor with a longer time horizon may feel more comfortable taking on a riskier, or more volatile, investment. Because he or she has a shorter time horizon, an investor saving for a teenager’s college education will likely take on less risk.

Letting go of traditional investments

Traditional investments like FDs already have seen starving interest rates. It will not be unrealistic to assume that soon there will be a time when instead of the bank paying interest on FDs the investors will have to pay the bank to keep their FD being in negative interest rates. Similarly, Mutual funds in maximum cases fail to give a hefty return, the way it is presumed. If we talk about stocks majority of the investors tend to lose money as the act of investing in stocks, bonds, etc. is driven by human psychology and not by numbers. Often investors tend to ignore macroeconomic factors like GDP, Unemployment, etc. We profoundly find investors to have an attitude of going with the flow resulting in over-valuation of a stock and at the end when the bubble bursts there are only tears.

Let’s say if you did run the numbers very carefully but the hardest fact to digest is that the stock market prices don’t only depend on the company’s performance. As we have discussed a number of times that macroeconomic factors are not in the control of any individual investor.  Let us take a glance at the returns that the traditional asset classes have generated through a graph.

Traditional investments were the investors’ favourite since they appeared to provide security and comfort. However, they have a significant and generally noticed secondary effect: a tiny increase in wealth. The rate at which prices rise is referred to as inflation. According to the most recent estimates, India’s inflation rate is around 5% – 6%. This indicates that money loses 5% – 6% of its worth each year. After accounting for inflation, a 4.5% after-tax return on traditional assets will result in negative real returns.The falling interest regime that on for the last few years, drove quite a few of these investors towards Mutual Funds which still fails to provide an optimum return for investors.Following the recent market downturns, interest rate reduction, and the resulting impact on fixed deposit rates, many investors are now questioning if traditional investments are still a smart investment option.

Alternative asset classes for investments an opportunistic future

Alternative assets are less traditional and more unexpected investment options. Alternative asset classes include commodities, real estate, NFT (Digital Art), venture capital, private equity.

  1. Alternative Investments
  • Venture Funds: It is money put into start-ups and small enterprises that have the potential to grow over time. It is a high-risk, high-reward investment that is often made by relatively wealthy people. Even more intriguing is the fact that most traditional venture capital funds are limited partnerships. This means that the money can only be invested once by the fund managers. They must refund the principle and gains to the venture capital fund’s investors if they make an investment and leave for a 3 to 4x return.
  • Private Equity Funds: It is made up of investments made privately and not publicly traded. These investments are made directly into private enterprises by investors. Typically, this funding is raised to fund innovative technology or acquisitions. Success in the private equity markets necessitates a high level of risk tolerance and the capacity to deal with significant illiquidity.
  • Unicorns: Unicorns were formerly depicted by ancient Greeks and Romans as being very quick and light on their hooves, with a horn treasured by merchants and investors. It’s a description that may also be used to today’s unicorn businesses. Investing in unicorns makes sense given low interest rates, continuous technological advancements, and new regulatory benefits. However, there is a contradiction to investing in unicorns: the availability of private equity makes them less likely to go public, yet their aversion to public markets makes their shares difficult to come by.

We have the expertise you need and the service that you deserve at Torre Capital, a VC-funded Singapore-based Financial Technology company. We are creating a fully digital Wealthtech to connect family offices and HNI investors with global opportunities, including alternative assets like Private Equity, Venture Capital, Real Estate Funds, and Hedge Funds.The table below consists of some of the PE/VC Funds with their IRR and Fund size.

  1. Real Estate

Commercial and residential properties, as well as REITs, are all examples of real estate. Real estate consists of land and anything permanently attached to it. REITs, or real estate investment trusts, are businesses that own and operate income-producing real properties. REITs provide investors with the chance to invest in real estate as a kind of financial stability. Transacting in REITs is substantially less expensive and time-consuming than transacting on properties. REITs make a lot more sense as an investing vehicle. Second, it provides investors with a new asset class outside of traditional stock, debt, cash, and gold, so helping to diversify risk. The returns generated by REITs are depicted in the graph below.

Collectibles / NFTs

NFTs are digital works of art that exist on the blockchain network and can take a variety of forms. Memes, video clips, images, music, and even tweets are some of the most popular forms of digital art. When you buy these tokens, just like any other investment, there’s always the possibility of your money growing in value. These digital treasures are non-fungible, which means they can’t be replaced. At the moment, blockchain technology is generating a lot of buzz. Some predict the technology will have the same impact on consumer behaviour as the Internet did. Now let us come to the prime question that is how much to invest in NFTs?

Honestly answering these NFTs (especially Digital Art) revolves around the concept that beauty lies in the eyes of the beholder. Hence when you buy something unique and the other person sees the same value in it and the demand increases the prices also shoot up. It will be wise to say that an investor can always explore this option with extra wealth.

 

  1. Cryptocurrencies

In the last five years (ending 31 December 2020), the S&P 500 index of large-cap US equities has compounded at an annualized growth rate of 14.5% (in USD, net dividends reinvested); over the same time period, the price of bitcoin in USD has compounded at an annualized growth rate of 131.5%. Now if we consider Etherium it also has given a hefty return of 500% in 1 Year. If this still feels normal, then let’s talk about some astronomical figures like in the case of Dogecoin or Meme coin as it was named earlier has given a return of around 20000% in a year.

Apologies if you felt a minor heart attack after seeing these return figures.

It is also very important to note that the market is highly volatile and very unprecedented due to a lack of regulation. We are not unaware of the current scenario of Bitcoin and the way Elon Musk is affecting the market sentiments and indirectly controlling the prices, even the astronomical values that Dogecoin gave was also due to the SNL tweet by Elon Musk. You might still be wondering if you should invest in cryptocurrency or not!If we consider simple lottery tickets where nearly 1 lac people buy the tickets and the probability of winning the competition is 1/100000. Now If I ask you do you put all your savings to buy lottery tickets? The obvious answer is No. The reason it is has no backing and the uncertainty is infinite. We just intend to justify the psychology behind the investment by bringing in the example of a lottery. You should invest your money in crypto according to your risk appetite. The graph below shows the returns generated by Bitcoin and Ethereum.

  1. Digital Gold

Buying physical gold certainly has its downsides. There are issues of identifying its legitimacy and purity, then there are problems of safekeeping and storage. One more issue is that we are in the midst of a pandemic. It is not quite ideal to go out to gold dealers or jewellery stores. Digital gold, on the other hand, can be bought online and is stored in insured vaults by the seller on behalf of the customer. All you require is Internet/mobile banking and you can invest in gold digitally anytime, anywhere. You can take physical delivery of the gold at your doorstep. You can invest an amount as low as Re.1. Digital Gold can be used as collateral for online loans. Digital Gold is genuine and the purity is 24K, 99.5% for SafeGold and 999.9 in the case of MMTC PAMP purchases.

Your purchase is stored safely and is also 100% insured. You can exchange digital gold for physical jewellery or gold coins and bullion.Trading volumes of digital gold in India totalled four to five tonnes last year in India and have proved to be a new way of investing in gold. Let us take a glance at the returns that the gold market has generated through a graph.

The magic wand of diversification to minimize risk

Diversification is the process of dispersing money among several investments in order to lessen risk. You may be able to limit your losses and lessen investment return variations by selecting the correct set of investments without losing too much potential gain.

Furthermore, asset allocation is critical since it has a significant impact on whether you will reach your financial objectives. Your investments may not produce a significant enough return to fulfil your goal if you don’t include enough risk in your portfolio. For example, most financial experts believe that if you’re saving for a long-term goal like retirement or college, you’ll need to incorporate at least some stock or stock mutual funds in your portfolio. However, if you take on too much risk in your portfolio, the money you need to achieve your goal may not be available when you need it. For a short-term aim, such as saving for a family’s summer vacation, a portfolio strongly weighted in stocks or stock mutual funds would be improper. You may feel comfortable building your asset allocation model if you know your time horizon and risk tolerance, as well as if you have some investment expertise.

The art of rebalancing

Rebalancing is the process of returning your portfolio to its original asset allocation balance. This is crucial since some of your investments may drift away from your investment objectives over time. Some of your investments will increase at a higher rate than others. Rebalancing your portfolio ensures that one or more asset categories are not overemphasised, and it returns your portfolio to a reasonable level of risk. Let’s say you’ve determined that alternative investments account for 70% of your portfolio. Alternative investments, on the other hand, now account for 90% of your portfolio, thanks to a recent spike in returns. To re-establish your original asset allocation mix, you’ll need to sell some of your stock assets or buy investments from an under-weighted asset category.

Your portfolio can be rebalanced based on the calendar or your investments. Investors should rebalance their portfolios on a regular basis, such as every six or twelve months, according to several financial gurus. The advantage of this strategy is that it uses a calendar to notify you when it’s time to rebalance.

Others advise rebalancing only when an asset class’s relative weight grows or lowers by more than a particular percentage that you’ve determined ahead of time. The benefit of this approach is that your investments will alert you when it’s time to rebalance. Rebalancing, in either instance, works best when done on a somewhat occasional basis.

Never put all your eggs in one basket

Many people are hesitant to invest because they are afraid of losing money. A novice investor’s first question is frequently, “What if I lose everything?” While all investing has some risk, the fear of losing “everything” is unfounded if you choose wisely where to invest your “eggs.” A well-diversified portfolio should have two degrees of diversification: between asset categories and within asset categories. You’ll need to spread out your assets within each asset group, in addition to arranging your investments across stocks, bonds, cash equivalents, and maybe additional asset categories. Naturally, when you add more investments to your portfolio, you’ll incur higher fees and expenses, lowering your investment returns. As a result, while considering how to diversify your portfolio, you’ll need to factor in these fees.The idea is to find investments in parts of each asset class that may perform differently depending on market conditions. So Happy Investing!

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This article has been co-authored by Sayan Mitra and Ayush Dugar, who is in the Research and Insights team of Torre Capital.

Popular SaaS metrics to consider while investing in a Tech Venture

by Sandeep Kumar

SaaS metrics can answer important questions about your venture: Do I have the right business model? Is this the time to accelerate growth or to hit the brakes? Do I need to add new customers or focus on the existing ones? Should I add that new pricing level the products guy has been pestering me about? Is there really a limit to how much my venture can grow? Can it be changed?

With all the jargon and metrics whizzing around, it can be hard to keep track of what really matters. Today we break down what is that needs to be measured to unlock explosive growth! This article focusses on:

  • What are the most crucial metrics to measure at each stage of the startup?
  • Why are SaaS businesses different and how are the challenges they face different from other software startups?
  • And finally, is your SaaS business model viable?

Here goes…

So, what makes building a SaaS business so tough?

In one word.

Subscriptions.

Think about it. The revenues from a customer do not come instantly, like how it does when you sell a product. The revenues come over a period of time. If your subscriber is happy with your product and sees no reason to change it, they will stick with it for longer. And the longer they stick, the more money you pull out of them (on second thoughts, that sounds so pervert!). The longer a customer stays with you, the more you profit.

If on the other hand the customer signs up but ends up finding a better product or cheaper pricing or whatever, the customer will hit that CANCEL button and leave (churn). If this happens before you recover the money you spent in acquiring them, then, my friend you just made a loss. (Ouch!)

So, let’s get it straight. SaaS is not just about selling some piece of software to a customer. It has more to it. There is not just one but two sales you have to make. That’s right, two!

  • Getting your customer. Well, because, you need someone to buy your subscriptions.
  • Retaining that customer. So that you can increase the revenues generated from that customer. The longer the customer stays, the more revenues you get.

There is one last and final aspect to the two sales above. That is monetizing your customer.

Let’s look more into each one by one.

Getting those Customers (Acquisition)

Now, what do you think happens to your P&L while you are acquiring your customers? (Hint: Nothing good)

If ‘you bleed cash’ seems too hard a way to put it, then let’s just settle on, ‘you suffer significant losses’ Your server costs, employee wages, office rents, and all other costs don’t go on a pause magically.

And to add to your sorrows you also have to spend a bomb to woo your customers to your product.

A newbie SaaS business spends 92% of its revenues to acquire customers.

All this takes cash. Loads of it.

But wait, it gets worse.

The faster you try to grow, the more you bleed. (Ouch again!)

This naturally will extend to a cash flow problem as your customers will pay you only at the end of the year or month.

If you spend 1000 bucks to acquire a customer and bill them for $50 pm, you’ll need 20 months to break even on just one customer. Even worse, the customer may leave just after one year. Before you could recover your $1000.

But it’s not all blood and tears. The humble J curve is here to help you.

The horror story I just told you, well that applies only to the trough you see above in the J curve (the hockey stick head).

Once you hit breakeven on the individual customers, you’re off to the races!

So how do I know if I have hit the breakeven? Well, we have two metrics that help you do just that.

The first one is the Customer Acquisition Cost or the CAC, the horrors of which we discussed above. The CAC has been dubbed as the killer of startups. This is the amount you spend to get each customer. This of course varies from business to business.

Some businesses find a way to hack their way through the miseries of CAC. They build an audience first and then offer a solution to them. This way you get access to a ready-made audience that most probably will throw their money at you. You won’t have to spend (or spend not much) anything to get your customers.

The accompanying metric to CAC is the Long-Term Value or the LTV of a customer. Loosely, this is the total revenue you expect to get from each customer.

Using these two, you can find out if your business model works or not.  There are two rules of thumb to keep in mind:

  • Make sure your LTV > 3x CAC. Even higher LTV is better. Some startups have LTV at 4, 5, 6 even 7x to their CAC. While such a high ratio may seem good, just make sure that you are spending enough on marketing. Chances are you could do with putting in more money.
  • Make sure the months to recover CAC is less than a year. Basically, you should hit break-even within one year of acquiring your customer. Good startups have has this figure at just 10, 8, even 5 months.

This second rule can also be inverted and used to get a rough idea of how much you should price your product. Remember that $1000 spending to get your customer to pay you $50 pm? Well maybe you should bump your subscription cost to $83 (= 1000/12) or reduce your CAC.

Once you have these two rules nailed down, you can really step on the gas and expand like crazy. The LTV > CAC shows that your business model is viable and the CAC within 12 months shows that you can do hit profitability without going bankrupt. You have these two working in your favor, most VCs will be ready to fund you. (Nice!) Otherwise, maybe you need to change your business model somehow.

Based on Unity’s disclosure in its S-1 about the number of >$100,000 customers, adjusted with a bit of extrapolation for a single quarter we arrive at the numbers for the beginning of 2018. We are no able to judge that Unity added approximately 116 new and increasing >$100,000 customers in 2018 and approximately 111 new and increasing <=$100,000 customers back in 2019.$1.6 Mn per customer might seem huge, however, these are a large token of customers who are willing to spend more than $100,000 per year.

You can also combine them with segmentation (another qualitative metric of sorts) to see what segments of your customer base seem to be most promising. Alternatively, you can also use LTV: CAC to gauge what ad streams offer you the best returns and then heavy down on the ones that offer the most customers for the cheapest.

Making those Customer stick with you (Retaining)

So, you have a proven business model that has LTV > 3x CAC and time to LTV < 12 months. You’ve also secured funding now and have also expanded the team. Now you just scale the business and very soon you’ll make a bank!

You begin with 100 customers. At the end of the month, you find that 3 of them are no longer with you (not dead, they canceled subscription). 3 fewer participants on the platform. Big difference. You simply shrug it off and keep expanding rapidly.

A year passes and now you are acquiring customers by thousands. One fine month you acquire 10000 customers. At the end of the month, you notice 300 of this cohort (the group of customers acquired this month) have left.

Maybe losing 3 customers a month was okay, but 300 is big!

My friend, you’ve just run into customer churn

The churn is the % of customers you lose from a cohort each month. And this isn’t just another number in the spreadsheet. These are the number of people that tried your product but did not want to continue with it. You can only guess the reasons. Maybe they found a better product or maybe they found something cheaper. Either way, this sheds light on if your product is lacking.

The appropriate churn for a medium-stage startup is less than 5%. Great companies like Salesforce have kept it to less than 3%. This means that out of the 100 customers that signed up, 97 stayed on. Now as the scale of your business goes up, the goal must be to keep the churn numbers lower. As low as possible.

Now for all those who run a B2B SaaS. Let’s say you lose 5 customers out of the 100 you have. No big deal maybe. But what if these were your 10 biggest clients, responsible for a substantial churn of your MRR (Monthly Recurring Revenue)? Well, now you’re trouble. (again)

This kind of churn is called revenue churn. Again, there isn’t a clear way to get out of this, maybe you need to reiterate on your product or maybe you need to get a better sales team. There is however one trick to hack your way out of it.

Advance Subscriptions!

You just ask your customers to pay upfront and provide them access to your platform or app or whatever that you have. There are two benefits of doing this:

  • You get good cash flow, even before the sale is officially recognized. This increases your capital efficiency.
  • The customer is also less likely to churn as they have already parted with their money, they must as well use your product.

You may keep a track of this using the ‘Months up Front’ metric. The more months upfront you have, the lesser are the chances of cash flow issues and customer churn.

One has to be careful in asking for upfront payments though. A lot of the customers will not be happy paying for the product before they use it. (did I ask you to get a better sales team…?)

There is another superpower that only a few startups have. And that is the negative churn. Negative churn is when you increase your revenue from existing customers such that it offsets any revenue you lost from the churned customers. There are two ways to get to this coveted stage:

  • Up-sell your existing customers. Maybe sell premium versions or cross-sell other subscriptions.
  • Add a variable to your product. Maybe keep a variable number of accounts allowed/leads tracked/seats used. As the customer expands usage, the more you get paid.

Now as your startup expands to new customer segments or other markets, you may wonder if there was a way to know beforehand if the churn would trouble you or not. To counter that, we suggest startups use a Customer Engagement Score and Net Promoter Score.

Customer Engagement Score is a startup-specific metric that tracks how likely is a customer to continue using the product based on the features of the product they use and the frequency with which they use it. You basically assign points to each feature of your product (or to each product, if you have multiple products). Allocate more points for features/products you think would be more engaging.

You can verify your points allocation by using your historical churn data to see if the features/products you used actually predicted that churn.

You can also use this to find out which are the best features/products so that you can double down on improving that feature or up/cross-selling those products.

To put things into perspective Unity grew by 33% without taking into account any new customers and its actual growth was 42% because it added new customers. A growing base of customers that spends more every year is the reason behind the stellar growth numbers of Unity. Organic growth is much easier when you have a niche product.

The other metric worth tracking is the Net Promoter Score. This is a startup agnostic score, making it useful to compare across startups. You can learn more about NPS here.

The range lies between -100 to 100. Anything above zero is considered ‘good’, 50 above is ‘excellent’, and 70 above is ‘world-class. Any score above 71 is rarely attained.

For Unity, the score is between 41-50 among various platforms, which makes it number one amongst its competitors. Even the best of the companies like Amazon (54) and Apple (47) haven’t attained a score beyond 70.

There are a lot of additional factors to consider as well. The market has changed slightly, with many VCs now prioritizing profitability over crazily high growth. Companies that have both are ideal, but they are quite rare. Financial indicators are an excellent method to measure the health of a firm if it has more than a million ARR, but we also take a lot of qualitative aspects like the addressable market size, its demography, management and the team, and other factors into account.  The majority of traditional SaaS businesses aren’t like that. In order to push the expansion forward, the business must cautiously look at the health of its metrics mentioned above and invest money in sales, marketing, and its team.

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This article has been co-authored by Khubaib Abdullah, who is in the Research and Insights team of Torre Capital.

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