Several years ago, I came across an interesting piece of research (by the then-Merrill Lynch). They had analysed long term market behaviour of investors, performance of key asset classes in public markets, and had correlated it with the stage of the economic cycle, and then summarised all this analysis into a neat cycle.
Fast forward to today, I just read an interesting article at techcrunch - Fundraising Acceleration Is The New VC Investment Thesis. The job of a VC, as with any other, exposes one to several kinds of biases and groupthink phenomena that, at times, get trotted around as gospel truth. All this got me thinking. Is there a similar way to characterise the sentiment cycles in venture capital? The more I thought about it, the clearer it became that the picture should look something like this:
Of course, this is all a bit tongue in cheek.
Now juxtapose this model (its validity having just been proven rigorously) onto the India startup ecosystem, and it becomes clear we are in Quadrant III. There have been talks of a frothy investment environment, a bubble even, especially in sectors like e-commerce. Larger investors are visibly concentrating their exposure to the top 2-3 companies in each category (Flipkart, Snapdeal).
But like any framework, this one is simplistic. And this is precisely the reason why at least half the bubbles ‘called’ have not eventually turned out to the bubbles (even a broken clock is correct twice a day?). The more sensible way to view this, I suppose, is that when a large new opportunity,i.e. a ‘white space’ opens up, one, despite years of conditioning, needs to stop thinking in terms of cycles.
Economic/business cycles are artefacts of a mature system. Nascent sectors and opportunities are marked by secular growth, not cyclical growth; and risks that are structural, again not cyclical. Of course, in the final analysis, everything – sales, funding, traction, valuation – is influenced to some extent by the general economic cycle, but, in the context of early stage investing, these factors pale in comparison to technology risk, competitive pressure, regulatory hurdles and various other structural risks that a start-up deals with.
Arguably valuations will rise and fall with the prevalent sentiment, but can anyone credibly argue against the fact that e-commerce in India is currently barely scratching the surface of its potential today? There will be a variety of different kinds of companies that will inevitably crop up in the next 10 years to cater to this opportunity, not only horizontals like Flipkart, Snapdeal and Amazon, but verticals with well-defined niches as well, and many more we cannot imagine sitting where we are today. This argument, in my view, holds true for a wide spectrum of technology related businesses that are still at an early stage in India.
To answer the crazy e-commerce valuation part of the title, given we are in Quadrant III, there is a definite concentration of capital as the ‘winners’ of the e-commerce horizontals space appear to be emerging. Which implies they will likely be the first to achieve a successful exit for their investors. Depending on their risk-return appetite, many investors have taken a calculated call that they are willing to settle for lower returns (i.e. ‘crazy valuations’) with the expectation of shorter-term and surer exit.
(Norbert Fernandes is Co-founder & Principal at IvyCap Ventures . Views expressed are personal.)
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