BackThe end of ‘topi’ investing
More old-world companies are waking up, smelling the coffee and investing in the right start-ups in disruptive areas
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Last week, automobile maker Mahindra and Mahindra Ltd announced a wide-ranging strategic partnership with cab-hailing company Ola spanning fleet expansion, vehicle financing, insurance and sales. A few weeks prior, Tata Motors Ltd had announced a similar partnership with Uber. Now, what do these moves mean?
Some of the large corporate entities have not only realized but have also admitted that they are vulnerable to disruption. So it’s better to ride with the tiger than resist and be on the sidelines.
Announcing the partnership, Mahindra chairman Anand Mahindra said, “I have recognized a new reality and Mahindra is poised to play a significant role in the new world. We have two categories of people—those who buy vehicles for objects of desire, while others focus on the shared economy. And we will be a part of both. Being one of the largest automobile groups in the world, we are providing Bhavish (Ola CEO Bhavish Aggarwal) and his team an offer they cannot refuse."
“An offer they cannot refuse" holds significance as more such compelling offers will come in the life cycle of these tech start-ups. And it means venture capital investors backing such companies—unicorns, in some cases—are probably poised to make huge returns. (A unicorn is a start-up with a valuation from private investors of $1 billion or more.)
This phenomenon is happening across the globe and in sectors where companies are buying into the wave of the future. This is the reason Unilever bought Dollar Shave Club for $1 billion. This is why Wal-Mart Stores Inc. is buying Jet.com for $3 billion. This is why General Motors Corp. bought Cruise for $1 billion, and also why it invested $500 million in Uber’s rival Lyft.
Dave McClure of 500 Startups, the leading Silicon Valley-based early-stage investment firm, has an explanation for this. According to him, “This phenomenon of hedging your public company stock by buying potentially disruptive unicorns for only 5-10% of your market cap may be one of the simplest ways to defuse the start-up threat and keep on trucking... this is the Unicorn Hedge."
Venture capital investors would do well backing those companies defining the wave of the future. Except that the past three to four years have been largely driven by “topi (hat) investing", where an investor has invested in a company—which is now proving to be ridiculously valued—thinking that another investor will buy it again at a higher valuation, eventually leading to a game of passing the hat where everyone now is waiting for the last fool standing who will be the ultimate owner of that hat.
Some investors have labelled this phenomenon “topi investing".
Now, when that last fool is nowhere to be seen, venture capital firms are worried about the house of cards that they themselves built.
Unilever-Dollar Shave, GM-Lyft, Wal-Mart-Jet and so on point out that there could be potential acquirers in large companies only. The idea is to build something for disruption and not necessarily look at everything from the lens of Ctrl+C and Ctrl+V—such as we are investing in Amazon of India, Zillow of India or Zappos of India, the time for which has come and gone.
There have been motivations to build such companies for Nasdaq or NYSE initial public offerings by pumping in huge amounts of money which have attracted investors of all hues. The dot-com bust of 2000 proved that if access to capital becomes too easy and cheap, it is not valued and often contributes to reckless spending and wishful business models that lead to failures.
Going forward, there will be huge merit in measuring success primarily driven by standards of tech companies that can go public in India, which are far less forgiving, or can have an Indian base, or are huge brands in this country—as these would likely prove to be disruptors of the incumbents.
This is the right time to be investing as the mood is softer—in the right start-ups in disruptive areas. More old-world companies will wake up and smell the coffee and find themselves on the back foot, compensating by paying outsize, sometimes incredulous sums for breakthrough competitors or the new set of unicorns!
Shrija Agrawal is Mint’s deals editor. Due Diligence will run every week and cover issues in India’s venture capital, private equity and deals space.
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