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Founders are choosing respawning over resistance
The Nutgraf is a 10-min newsletter sent at 10 AM IST every Saturday. It connects the dots and synthesizes one big event in business, technology and finance that happened over the week in India. In a way you’ll never forget.
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Just 10 mins longSynthesis not analysisSometimes memes
27 May, 2023
Companies may take years to regain their lofty valuations, so founders are quitting and starting up again.
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Good Morning Dear Reader,
Imagine it’s early 2021. You are wondering if you should become an entrepreneur. It sounds exciting, and all around you, everyone seems to be doing exactly that. You’re still not sure, but there’s one message that you’re hearing again and again—there’s never been a better time than now to start up. There seem to be few barriers, and it’s easier to find early-stage funding for a startup than it is to get cabs in Bengaluru.
So you jump in. You’ve listened to enough venture capitalists (VCs) on podcasts who say you need to pick a problem you’re passionate about. Something that drives you, makes you want to solve for in the long-run. So you pick something. Maybe you start a fintech company that does something before it decides to do lending. Or you start a YouTube channel and call it an edtech company. Or an AI company that uses AI to write short-form posts about how AI will change everything. Doesn’t matter.
Boom. As word of your startup gets out, you raise seed funding from a prominent investor at a valuation of US$5 million. It was surprisingly easy. The deal closes over a couple of cappuccinos and a five-slide presentation at Third Wave. You write a thread on Twitter. Two weeks later, someone else approaches you asking if you’re planning to raise Series A funding. You have enough money for now, but you remember that it’s good to be well-capitalised. So you decide to raise again, but on your terms. You raise another US$10 million, but now you say your company is now valued at US$50 million. The investor says yes immediately, and sends you a term sheet the following week. You start to believe maybe you are destined for greatness.
Then, a couple of months later, you decide to secure the future of the company. There’s no revenue yet, but that’s fine. That’ll come later. Everyone knows that valuation is everything. Even the news outlets seem to just care about who just turned a unicorn and when. So you raise a Series B round. This time, you raise US$80 million, at a valuation of US$500 million.
You are on your way. You dream of startup awards, of podcast interviews, and wonder what it’d be like to be a LinkedIn thought leader. Unicorn status awaits you.
Cut to today.
You’ve decided to quit your company.
And there’s never been a better time to start up again.
In today’s edition of The Nutgraf, I’m going to write about a key trend that we’re going to see more frequently in 2023—founders quitting their existing companies. As the realisation dawns that many companies will never go back to the valuations they received in the last couple of years, founders will choose to respawn rather than resist. In video game parlance, a respawn happens when your character reenters the game after being killed or removed from play.
Usually, respawns happen against your will, but in this case, founders are actively choosing to restart and build something new while abandoning what they’ve built earlier, which is often worth tens or even hundreds of millions of dollars. As a result, several companies right now are zombies—they are dead, and yet alive.
But I haven’t even come to the strangest part of the story.
This is not a question of money in the bank. Most of these companies are well-capitalised. In the words of one of the founders I spoke to, “I know people who are sitting on five or six years of runway.”
Founders aren’t walking away because they’ve run out of money.
While most founders are still sticking to resistance, the early signs of founders quitting startups they’ve founded has already begun. Aditya Kothari, who founded the short-video app Chingari, recently announced his decision to move on from the company. Around the same time, Anshuman Kumar, who founded the edtech company Teachmint, also walked away to start something else entirely from scratch.
Edtech startup Teachmint 's co-founder and chief technology officer, Anshuman Kumar, has quit after a three-year stint to pursue a new venture. Kumar will now lead Duolop, a modern relationship management app, as the founder.
"As someone who is passionate about using technology to enhance relationships, I am excited to lead the charge in creating a platform that offers a variety of services and goods to help couples navigate life's journey together," Kumar wrote in a LinkedIn post on Friday.
Kumar led Teachmint, the Lightspeed India-backed edtech startup, for more than three years and played a pivotal role in shaping its technology capabilities. Founded in 2020 by Kumar, Mihir Gupta, Payoj Jain, and Divyansh Bordia, Teachmint focuses on digitising classrooms and helping educators manage lessons through its free, SaaS-based mobile platform.
Teachmint co-founder and CTO Anshuman Kumar quits to pursue new venture, YourStory
I asked a second founder for a heuristic that could tell if a company was a zombie company. He suggested that companies that raised more than US$5 million in the last couple of years as part of their pre-seed to series A would fall in the consideration set. One consequence of having crazy liquidity in the market was that unlike earlier times, product-market-fit (PMF) stopped becoming a criteria to raise series A rounds. “In fact, Series B was also make-believe PMF, but that’s a different debate,” said the founder.
So I tried to find out how big this was. To do this, I got in touch with Traxcn, a startup data platform, and asked for a list of companies that raised more than US$5 million in 2021 and 2022 as part of their pre-seed, seed, or series A stage.
Soon enough, I had my answer. There were close to 270 deals in 2021, and almost the same number in 2022.
I’m not the first person to make the observation that valuations went so out-of-whack over the last two years that it no longer became viable for founders to stick on. Nithin Kamath, founder and CEO of Zerodha, noticed it last month and even wrote a brief thread about it. In his thread, he attributed the cause to something specific, i.e., liquidation preferences, and suggested that this would happen with late-stage startups.
Here’s Kamath’s argument in a nutshell: all startup investors are in the game of waiting for a big payout, which is more or less how things work. However, what also matters is who’s ahead of the queue to receive it when it happens, either through a funding round or an acquisition. And right now, because they raised multiple times at ridiculous valuations, founders are at the back of the line. Normally, this wouldn’t be a big deal as long as a company continually grows in valuation. Everyone gets a slice, and the queue order wouldn’t matter much. But when funding becomes scarce, liquidation preferences matter considerably.
And right now, founders are realising that their companies will take years (if ever) to return to the valuations they claimed in 2021 and 2022. There’s little chance of this happening.
I went back to the founder I mentioned earlier to figure out if there was a better way to identify zombie companies. He said, “If we say founder motivation is a function of the value of the founder’s stake, and if the current value of the company is lower than total funds raised, then the founder has effectively no skin in the game.” After some quick maths, he suggested that since the valuation of companies have dropped by 50% from when their last funding happened, if total funds raised by the company were more than 25% of last valuation, well, that would be a dangerous sign.
In early 2021, Teachmint raised US$20 million as part of its Series A round at a valuation of around US$175 million. A few months later, it raised US$78 million at a valuation of US$500 million. Overall, Teachmint has raised US$118 million since inception, which pushes it well over the 25% threshold.
There are dozens and dozens of companies in the same boat. All sitting on money, but without any incentives to move forward.
In some cases, VCs are asking for part of the money to be returned. But others are quietly counselling founders to kill the companies and walk away, because they’d prefer to write-off their investments. For many founders, they are stuck between a rock and a hard place. They don’t have enough money to last long enough to get back to an era where capital is as free-flowing as it was last year. Nor do they have enough to get their companies to profitability and free cash-flow. As one founder told me, profitability would at least give a framework to value the company.
Right now, it’s all running on, as the kids would say, vibes.
So several founders are choosing the option to burn out than to fade away.
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Correction: In last week’s edition on India’s 20% tax collected at source on overseas credit-card spending, I wrote, “How many people do you know who own credit cards with limits exceeding two crores?” Some astute readers (who own credit cards presumably) pointed out that you don’t need a credit limit of Rs 2 crore to exceed LRS since the credit limit resets every month, and so credit cards with limits of Rs 20 lakh would do. I don’t think this changes my argument significantly, but factually, this is correct, and I apologise for the error.
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