Profits are no doubt vital to the growth of any company, but some of the biggest names in business are yet to make money. This being the backdrop, does profit still matter? Well, it does, then why do investors invest in a loss-making company? Chinmay Ananda has elucidated on this question in MentorED, our weekly live 30-minute workshop where industry veterans share their knowledge and experience and discuss topics that are apt and relevant to the start-up and small business fraternity.
Chinmay Ananda is a Financial Educator, Business Storyteller, Speaker, Author and Investor. He has trained and consulted over 950 business owners in Australia, India, China and Indonesia, and teaches in top business schools like the Royal Melbourne Institute of Technology (RMIT), Torrens University, University of New England and Insight Academy of Entrepreneurship in Australia. Ananda also conducts monthly webinars for indianstartups.com that has 100,000+ members. He also mentors start-ups and is active in the Venture Capital ecosystem. In 2016, he was awarded the prestigious Kerrie Nairn Scholarship for his public speaking skills.
Playing the high-risk game
Chinmay Ananda initiated the workshop by asking a question to the audience, “Why do you think investors invest?” Although many may opine different views altogether, it is worthwhile to have a measurable answer. Thereafter from his illustrious story of purchasing his motorcycle which later proved to change his own mindset in investment, he answered, “Investors invest if you make them believe that you can help them make more money with their money than they would have done with their own money.”
Investors invest if you make them believe that you can help them make more money with their money than they would have done with their own money.
For any investor, there are multiple avenues to invest in order to get a profit in return. Most frequently, when someone invests, they look for a future prospect even more than considering the present status of the company or sector. They look at startups as a high-risk game. “If at all I have got ten crores to invest, I would probably choose ten startups and invest one crore in each one of them. They know for sure five to six of them might fail miserably which means they may not even get back the money that they have invested. One or two might give them one and a half to two times a return and there might be another that might give two to three times but there might be that one startup that might end up becoming a unicorn which might give them even a hundred times the return.”
Investors are also interested to make sure that the startup eventually passes into the subsequent stages of funding and thereby expanding into similar markets. “They also want to prepare to make sure that they can take you to the next round of funding series B where the big players like the venture capitalists also known as vulture capitalists emerge because they do not just come after the share in the company they also come after the management. So, this is one of the main reasons why investors invest even if a startup is not making profit because they want to make sure that startup is valuable for the next investor who would like to invest.”
Newbie investors can invest in a loss making company. Don’t you think it is risky for them?
The newbie investors should be asking themselves what is their risk appetite. This is where I usually tell people, please do not take the gambler’s approach. Please do not do it with your own money unless and until you know that you can take that risk for many people. Yes, startups are very risky. As I said, out of ten, they know five, six, seven of them will miserably fail but one has to take that risk. Higher the risk, higher the return, lower the risk, lower the return.
The investor has that mindset that it does not matter even if the company is burning cash – I will invest because when we take that company to the next stage, we know to a great extent that it is going to be valued at least three to four times the money that they have invested.
When a profit-making company merges with a loss making company will there be any benefit in the portfolio of investors of both the companies?
Sometimes it might be a strategy with regards to buying a competitor or it might be simply because they want to create more monopoly. For example, Ola, when they launched, there were many other players who were offering very similar services.
Two founders of two such companies, they were techies. I had met one of the founders so I was listening to their story and they said, we knew Ola was one of our competitors and then it is like – you are playing a cricket match against each other and you really hate them but all of a sudden in IPL you have to play next to them. You have to share the same dressing room, so even the same thing happens in the investment world. When our investors in Ola decided that let’s buy them out, they bought TaxiForSure.
Of course, even Taxi (TaxiForSure) was making a loss for 200 crores, the main reason behind the strategy was to make sure that they are capturing the market and they are kind of creating a monopoly. So, with that perspective, yes, it was definitely a success. Now that does not mean that we can apply the same strategy to every business or industry.
The investor has that mindset that it does not matter even if the company is burning cash - I will invest because when we take that company to the next stage, we know to a great extent that it is going to be valued at least three to four times the money that they have invested.
The first customer is the key
For any startup, the difference begins to happen with the first customer. As the mentor opined, “The moment they have that first customer that is like the proof that someone is there to exchange money for the service or the product that they are offering. So, someone is seeing value and they are ready to give money and if more people are giving money because they see value in the problem that the startup is solving then yes you will have more people who will be buying it and if at all it is repetitive, it is going to be even more valuable.” This repetition can create all the difference as the company will now have the monopoly that investors would love to catalyse.