Is There a Big Bubble Lurking in Startups?

To talk up valuations, startups junking conventional accounting norms
Ask fast-growing Indian startups about revenue and you’re likely to get a variety of answers ranging from annualised sales run rates to numbers that have exorbitant growth built into them. These will range from volume of bookings and number of taxi rides to the often-misused term, gross merchandise value (GMV). Anything but real revenue.In a bid to talk up valuations and portray a larger-than-life image, startups are touting metrics that don’t comply with conventional accounting norms. The Numbers Game Indian ecommerce Ecommerce firms’ gross firms need to merchandise value raise another (GMV) excludes value $20 billion, of goods returned and according to discounts offered Goldman Sachs GMV equivalent in taxi Flipkart will Revenue run rate app market is number need another of hundreds of of rides, which is being $2 billion millions of dollars manipulated by drivers before going pub is not actually a lic, estimates say reliable metric

More importantly , loosely defined terms used interchangeably with `revenue’ are bandied about. “Many terms are unconventional but startups use them in PR and public communication to highlight growth,“ said Rutvik Doshi, director at Inventus Capital Partners. By signalling big growth numbers, startups drum up more investor interest and pump up valuations.

“These metrics signal these companies are in a hyper-growth phase,“ said Doshi.With more investors wanting in on highgrowth firms, valuations tend to get pushed upwards. “Valuation is a function of supply and demand,“ said Doshi.

“There is also a fair bit of pressure on entrepreneurs to showboat in public and talk up their numbers to lay a claim to being the forerunner,“ said Sumanth Raghavendra, co-founder of Deck App Technologies. Because of the premium placed by investors on category leaders, entrepreneurs are also pressured into talking about bigger numbers. “The day a startup raises funding by an institutional investor is the day it is signing up for continuously demonstrating progressively bigger numbers,“ he said.

INVESTORS AWARE

Investors know the truth behind the numbers but choose to play along. “If these companies are using forward numbers or GMV to pump up their valuations, it is only because their investors are willing participants in the process,“ said Aswath Damodaran, professor of finance at the Stern School of Business, New York.

“Unconventional numbers are used as a proxy for growth, but investors do dig and are aware of real financial numbers hidden beneath,“ said Doshi.

GMV , or the total value of goods sold on a platform, is a number that can be easily gamed. For instance, the sale of items with a high price tag can push up GMV dramatically. Not just that, critics have questioned the discounted sale of expensive items that encourages the practice of sellers buying goods themselves under other names.

“As these are high-ticket items, they can significantly bolster the GMV metric but in real revenue terms, the actual addition is zero or even negative,“ Raghavendra said.

CLARITY AT AMAZON

Among ecommerce companies, Ama zon is an example of accounting clarity. The company does not talk about GMV but revenue that it earns by selling its own inventory, cloud services and commissions its gets from selling third-party goods.

As an investor backing one of the top two Indian ecommerce giants pointed out, comparisons with Amazon or Alibaba don’t apply here. “The reason Amazon is ahead of others in revenue multiples is because of its web services business, which is profitable,“ he added. In the quarter ended March, Amazon posted $1.57 billion, or 7% of revenue, from Amazon Web Service.

Alibaba has a market capitalisation of $243.3 billion while GMV for 2014 was $370 billion.

“Why would somebody buy Flipkart when Alibaba is trading 0.7x of its GMV?“ an investor said. To be sure, new age companies are often valued on the basis of growth potential. Some key questions Damodaran asks while valuing a company: What are the cash flows from existing investments?
What is the value that the company will create in the future? How risky are these cash flows and when will the company become a mature business? Investors are often enthused by the Indian Internet market, which according to a Morgan Stanley report in February, could rise to $137 billion by 2020.“There is no fraud here, just greed on both sides. If you don’t like the way the game is played, don’t play it,“ Damodaran said.

VALUATION BUBBLE

Sharad Sharma, an angel investor and the co-founder of software products think tank iSPIRT, places the blame for the bubble squarely on investors.

“In a transaction, buyer determines the ceiling, seller controls the floor.Since VCs (venture capital funds) buy equity, they are responsible for the bubbles,“ he said.

A bigger danger, as flagged by Sharma, is that this valuation bubble could potentially even affect startups outside the ecommerce sector, especially those building software products and enterprise solutions.

“This can’t sustain too long, maybe another 12-18 months. We must insulate the pockets that are not in a bubble.Otherwise collateral damage can happen and bring everything to a halt,“ he said.

Source: The Economic Times

Advertisements

Author:

Neeraj; an entrepreneur & a visionary in the field of Railway, Defense & Automobiles, is a graduate in commerce and a Harvard Business School Alumni. He’s an expert in govt. liasoning & contracting and has an exceptional network & connections at both local as well as global level. He’s an expert in Market Strategy & Planning and has served number of overseas companies as an advisor/consultant. He takes a profound interest in upcoming startups & is very receptive towards ground-breaking ideas & innovations. He likes to brainstorm those ideas and if the values & philosophies matches; he is even ready to invest his resources, serve as a mentor or act as an incubator to futuristic businesses.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s