Let’s face it like many things in India, Indian business is also chaotic. The lack of order, ever changing tax laws and growing number of scams that plague our country make investing scary if not a fool hardy activity. Yet at 7.5% annual GDP growth, 600 million strong affluent class and soon to be the third largest economy, India is a country no investor can ignore. This is yet another demonstration of the paradox that is India.
Now if you can’t ignore it, where do you invest in India. Compared to other assets classes like stocks, mutual funds and fixed deposits, investments in startups give you potentially the highest returns. Of course, this comes with also with substantially higher risk. Risks for startups come in many shapes and sizes but a careful application of principles can substantially reduce this risk and make investing in startups apart from being exciting rewarding too.
When one evaluates a startup, two things one has to focus on. The team and the business. Business is the akin to the horse. The power of the business will allow the ‘jockey’ to drive it to the winning post. A limping horse can hardly make it in a marathon. Most conventional businesses are evaluated on their profits and future projections of profits. However, since a startup has to go through multiple stages of external funding to reach its target audiences, its valuation in the interim is more important. Valuations of startups are largely driven by revenues and not profitability in early stages. Hence in this case, profitability is not the best measure for potential success. A capital efficient startup will be able to increase sales with minimal amounts of capital.
If you find companies where revenue growth outpaces capital deployment those would be interesting companies to invest in as long as it can eventually turn profitable.
The other is the size of the market. Companies that operate in very niche markets such as pet salons in India would not make the grade. The other of course is gross margins. Companies who are selling below unit costs would need to operate in a very large market to be successful if ever. The size of market and capital efficiency are not the only measures of business attractiveness. The level of disruption and the unfair advantage a company has is another element necessary for success. Competitiveness being a dynamic element in the startups attributes, the timing of the startup and ability to innovate in future also need to be taken into account while evaluating a business.
The other element that needs a serious review is the founders. It is the founders who can take a good business to heights if they are both passionate and capable. Passion is required for them to be patient and persuade other people to join them. It is the same passion that will keep them faithful to cause and not look for short cuts to fame. On the other hand, their capability can only be tested by their past performance.
The last but not the least attribute of the entrepreneur is integrity. It is a necessary requirement in India. More often than not, Indians look at ways to speed up things by using dishonest means. In the short run, dishonesty make help a startup to grow quickly but investors run the risk of a smart entrepreneur shortchanging them on the returns. Given the lack of law enforceability there are only a few ways in which investors can handle a dishonest entrepreneur.