On two models of entrepreneurship

images

Image link

The models of entrepreneurship vary from being venture capital backed to being bootstrapped. There are other models in between but for the sake of simplicity let us consider these two polar opposite models.

The first model is that of venture capital backed big bang startups. These are the current fad. They are all over the media. Most of these companies in India are less than 10 years old. Take the case of Ola – they are all over the news having raised $500m in a Series F funding. Ola was founded just 5 years ago and is currently operating in close to 100 cities in India. They are not profitable and don’t look to make any profits in the near future. The plan probably is to grow and grow and suddenly one day when they have become big enough they decide to turn profitable.

Ola is currently valued in excess of $5bn. Valuation, I believe is more a matter of belief than of science. Valuation of a company is what everyone (the investors) believes its valuation to be. Anyone who has tried his hand at DCF valuation of a company realizes the power of assumptions and the uncertainty of the future. Now, these companies won’t pay dividend as they are growth companies. So, the only way you can make profit from your share is by selling the share. The share price will continue to grow till the time all the investors continue to believe that it should grow.

In future, if there is any disruption, the investors’ belief might just shake and valuations will then plummet. There are a number of things that can happen in future which can start a vicious downward spiral of the share price. A new technology might come up, there might be an incident triggering regulations or even something happening to the founder..

Now, there is another model which is not all that glamorous but is time-tested. The model where you set a viable business model and keep investing the profits back into the business. You bootstrap and raise debts  to add to the capex. Zoho is doing just that. They refused a $200m valuation from a VC way back in 2000. They have a 15 million user base and have been always profitable. The founders have rejected the VC model for their company. It is difficult to put a valuation to Zoho as they don’t disclose their revenues and there is no investor group to form a belief about their value.

It is difficult to say which model is better. Among other things the approach does depend on the founder’s definition of success. So, what thought is pushing you to take the plunge..

Advertisements