Profitability: The new benchmark for startups seeking investor approval

A pandemic-led funding boom has collapsed and uncertain macroeconomic conditions have dampened investor sentiments, forcing founders and investors to become more prudent in their business decisions. (Image: Pixabay)
A pandemic-led funding boom has collapsed and uncertain macroeconomic conditions have dampened investor sentiments, forcing founders and investors to become more prudent in their business decisions. (Image: Pixabay)

Summary

  • Investors across stages now expect positive unit economics and efficiency from even a Series B round

Bengaluru: A rise in profit visibility of listed startups has made investors demand that unlisted startups, too, show a path to profitability or a product-market fit early enough if they want to receive funding.

Investors across stages, even in Series B rounds, now expect positive unit economics and efficiency, said Alteria Capital's managing partner Vinod Murali. The only exceptions would be startups operating in very deep markets where there is a lot of demand and a longer path to profitability.

“Almost all entrepreneurs have been pulled up by their existing investors that until they show a perpetual path to profitability, it is unlikely that anybody is going to give you money," India Quotient's partner Madhukar Sinha said. "And that is exactly the reason why a lot of companies at a smaller size have started turning profitable."

Even early-stage businesses that are more growth-oriented need to get their unit economics right in order to strike a balance and grow at a sustainable pace. "Essentially, a lot of the end game for companies is driven by whether you can do an IPO and the public market only values companies if they are profitable or have a path to profitability," Fireside Ventures' partner Dipanjan Basu said.

The change in sentiment has happened even as many late-stage startups and unicorns that went public recently have begun to show profits.

Groww, Physics Wallah, InCred and Digit Insurance were among the startups that turned in profits in FY23, as per data sourced by Tracxn. Shares of Zomato and Policy Bazaar (PB Fintech), which have posted profits, have rallied. While the Zomato stock is up three-fold in the past one year, PB Fintech has more than doubled.

The link between profits and share prices was noted by Sanjeev Bikhchandani, whose Info Edge India has invested in both Zomato and PB Fintech. "Maybe there's a causal effect there," Bikhchandani said at Info Edge's earnings call on 13 February.

The sentiment is filtering down to unlisted companies as well, albeit as Sinha pointed out, this means longer wait times to close deals, as there is no longer the same kind of eagerness to invest as before.

Companies such as Frnd, a social discovery app, and coding platform Masai School, are expected to turn profitable soon, Sinha said, joining a growing list of companies such as Niyo, BigBasket, Wakefit and LEAD Group that have outlined their path to profitability.

There has been significant overhaul on go-to-market architecture such as the channels companies use and improving sales focus, refining products and solutions that do not make sense, and revisiting price and margin structures, Shaleen Sinha, head of growth tech at BCG India said. "These fundamental pieces are now resulting in much better unit economics and companies are either achieving or being close to Ebitda breakeven," BCG's Sinha said. Ebitda is short for earnings before interest, tax, depreciation and amortization.

These comments come as the pandemic-led funding boom collapsed and valuations for companies fell after higher interest rates, uncertain macroeconomic conditions and other geopolitical tensions dampened investor sentiments. This has resulted in a shift in mindset for both founders and investors to become more prudent in their business decisions due to limited availability of capital.

"There is now an understanding on both sides (founders and investors) that once the company has raised a certain threshold of, say, 700-800 crore, it's high time it becomes profitable. It has a spiralling effect where the limited partners are not rewarding such fund managers and fund managers are not rewarding such founders who freely spend money," Ashish Fafadia, partner at Blume Ventures said.

"Investors have moved on from market share development at all costs to gaining market share in a more sustainable manner. The expectation is that companies generate profits within 4-7 years or by their Series B round. The profits can be modest but not a token amount and should not be adjusted for any expenses. The zero interest rate playbook is dead, " 3one4 Capital's founding partner Siddarth Pai, said.

Even bigger companies like Swiggy that are yet to generate overall profits will at least need to shrink losses in the quarters ahead of IPO and have a near-term plan for profitability for the markets to value them, Pai said.

(With inputs from Samiksha Goel)

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