‘As Soon As You Raise Money, You Get Into The Rat Race’

Nithin Kamath, founder and CEO of Zerodha, does not mince words as he points out the excesses that led to the current situation in the India’s start-up ecosystem. He talks to Outlook Business about why founders must first understand the business and market they are getting into, refrain from joining the rat race of growth, focus on profitability and stay away from overdependence on VCs. Edited excerpts:

Zerodha was profitable even before it turned a unicorn. How important is it to think about the road to profitability?

I always thought businesses are set up to be profitable until I got introduced to the VC ecosystem. Today’s businesses are forced to grow fast because the VC knows that his investments will go up in value by quickly growing. The ecosystem has got into the idea of growing fast because everyone believes that it is the only way to get valued.

We did not get into that rat race and that is why profitability became the core focus for us. Once we became profitable, VCs began showing interest in us. By then, I had realised that there were two ways to build a business—join the race of who has the deepest pockets or grow organically without succumbing to the speed of growth. Also, without VCs at the cap table, I knew I could have more freedom to run the business.

Businesses will have to tone down their growth expectations and start doing the math around generating more revenue than spends on customer acquisition. The problem is when you become big, it is difficult to suddenly pivot into operating in a certain way and change focus from growth to profitability.

The current scenario has brought the focus back on overvaluation and excessive funding. Your comments.

What has happened is an eventuality. If you are a billion-dollar business, eventually you will have to make at least $100-$150 million in revenue. If you cannot, you can never justify the billion-dollar valuation. Once you have taken investors’ money, it is a marriage—you are obligated.

Today, if a start-up has an idea, it cannot get even a minimum viable product without raising a few million dollars at least at 4x valuation. As soon as you raise money at such a valuation, you get into the rat race. It is just the result of excess capital.

What kind of start-ups will survive this slowdown amid fund crunch and bleeding markets?

Any business needs to solve a problem for the consumers and the consumers should be willing to pay. Consumers cannot be using a product because they are being offered a discount. The businesses that will survive the current test of time will have to have some kind of a moat which allows them to charge a customer for a service.

How do you view the increase in mergers and acquisitions (M&As) happening in the ecosystem?

We have ended up creating a bunch of unsustainable businesses and M&As are a decent outcome of this. It was bound to happen. The only issue is that employees most likely will not get anything out of it.

Also, if an M&A is happening, you have to assume that the company is not in a great shape. So, VCs also might be taking a haircut on it. That way, it is not good, because wealth creation is not really happening. The other problem with M&As is that a lot of times, products do not get integrated in synergy.

How has the stock market and the economy not performing at the same pace affected the market size for start-ups in India?

Stock markets are always factoring in the future and not the present. The public market ecosystem is not very mature in India and does not understand growth stocks well. We have seen the performance of some start-ups which transitioned into public companies and how their stocks did not do very well.

When a start-up raises money, almost every term sheet will say that it will have an IPO in eight years. VC investors need an exit and the exit is to become a public company. The unicorns will have to list themselves in the next two-three years, though I do not how that is going to happen considering the times we are in now.

The other thing is, for the business to grow, either the customer needs to spend more or your margins have to go up—something that has not happened. Covid-19 has slowed the country down, so the economy has some catching up to do. Only when the economy does well will start-ups be able to generate revenue.

You recently said the actual number of fintech target users could be between 10 and 15 crore only. Will it result in the death of most fintech start-ups in the coming years?

If you, as a start-up with no idea, want to value yourself at $10 million, the only way to do that is by selling a story on how big your business can get. For that, you have to sell how big the market for your business is. Founders are forced to do it, because the cost of running a business has gone up. People are forced to think that India is a much larger market and value it like that.  

In all of this, the ones who are really making money are the big tech firms, as most money is spent on these platforms to acquire users. The money that comes into the start-up ecosystem is from the LPs who are investors in these companies.