Karthik Prabhakar has risen the ranks in venture capital (VC), starting as an intern with Chiratae Ventures (earlier called IDG Ventures India) in 2010 to becoming an executive director (partner) and global head of fundraising at the firm, which has about $750 million in assets under management. Prabhakar has invested in the likes of Nestaway, Playsimple Games, and Earlysalary, among others.
In a freewheeling conversation with Fortune India, Prabhakar talks about the impact of a slowdown in fundraising in the wake of Covid-19 outbreak and why entrepreneurs with cash in the bank will find the scale tilted in their favour. Edited excerpts:
How do you evaluate startups’ preparedness to sail through the current slowdown in funding as well as business?
Every community, startups or otherwise, have been hit with this unpreparedness. I don’t think we can just single out the startups. This event has really questioned the fundamental business continuity planning, exercised across all spectrums. You can see that from the supply chain disruption that everyone is talking about, which is the first principles that we are taught in MBA, i.e, you need to ensure your supply chain is robust, that you have dependencies and how do you mitigate that.
Like others, almost everyone in the startup community has been hit by the current situation. However, I think there are two exceptions. One set of companies are those who hit the market to raise funds, in say 2019. They actually got responses on how they need to do a few things in a corrective way, otherwise, it can impact their overall fundraising plans. The warning signals for them in terms of being prepared from a cash conservation basis started back then. Also, the SoftBank situation rang an alarm bell for many. Startups started seeing that larger pools of capital will probably go slow, consequently, many companies started conserving cash and seriously evaluating profitability in 2019. This set of companies are to some extent prepared.
The second set of companies are those who have always charted the path of profitable growth, purely because of the nature of the business. For instance, enterprise businesses fundamentally are not cash guzzlers. Similarly, you can look at gaming companies. Such companies will sustain because they were anyway sustaining.
These two sets of companies were somewhat prepared.
What are these corrective measures?
It goes back to unit economics and questioning the fundamentals of capital utilisation towards profitability. There is one set of companies which fundamentally require a lot of capital to build up the market. This is because they are investing in building a market. But, there is a phase where there is a reasonable market built and in traditional norms, you will look at the proof of the pudding in terms of profitability. If you are one company with X capital, there is probably another with 2X capital, which is probably burning its way through and growing. To that extent, the first company is always thinking, should I be burning more or should I be turning profitable? Because, if I turn profitable, then probably I lose the game on growth. In today's environment, the ones that are burning their way through will have to reassess the right path. It may be the right path for some, but not for all.
In that case, do you apprehend market expansion will slow down? Won’t it also impact the businesses?
These are blips and also an opportunity for corrective action, irrespective of the sector. If one were to extrapolate the consumer behaviour on digital consumption, it is going to increase, based on what you can see around. The grocery guy is actually very comfortable taking orders digitally and delivering, which means that the trust factor on the digital way of life is increasing. Obviously, there are questions around cybersecurity and hacking, etc. Assuming all of those are taken care of, digital will start increasing, which means the market definitely expands without a prod in terms of incentives to customers. I believe this is an inflexion point for digital to pickup in a big way, but the qualifier will be cybersecurity and customer security. If these things are prevalent and customers fall for it, then this is a challenge for digital scale-up.
Startups, which mostly have three-six months’ runway, are being advised to expand it to 12-18 months. The intrinsic nature of the business has to change suddenly. How do they cope with it?
It is actually a tough ask and I completely empathise with the founders on that. Being a VC, it is very easy for me to say that extend the runway. Unfortunately, that is the hard reality. One can either fight that or adapt to it. The question is really about ensuring that the power of the entrepreneur remains strong. If you are in a powerful position, with money in the bank, then there is a lot more that comes to you.
The thing about 12-18 months runway doesn’t necessarily mean that there is not going to be any funding for the next 12-18 months. All it means is that the startups will be better prepared. Most of the VCs and PEs have dry powder and everyone is looking for opportunities because we have to do business as well.
Do most people have enough cash, and if not, what can they do to get there?
There are two parts to that. Do most people have that kind of cash in the bank? The answer will be no. But, the good part is many will also have capital because they have raised some or the other money in the past six-eight months. They will possibly re-look at every line item in their expenses with a very strong scrutiny and rationalise.
The other part is, ones where there may not be money, there are pools of capital, including existing investors, who will look at how do you make sure that the companies have that kind of runway. Obviously, you can’t do it in every company. That is the hard reality of the business as well. You also have limited reserves. As long as the product offering continues to be very strong, there will be financing that comes their way to help them overcome this hurdle, but that will be super selective.
In that case, will companies which might have a shot at survival otherwise fall by the wayside now?
The unfortunate truth is yes, but that is the nature of the ecosystem. The risk factor is always high; events like this exacerbate that. The silver lining there is, the startup community has wonderful founders who will hopefully find their way through.
Profitability has become the yardstick now, but can you really wish away cash burn?
I don’t think profitability is the be all or end all because, at the end of the day, the real reason why somebody is investing in early-stage, be it in terms of time from an entrepreneur or an employee perspective, or money from an investor's perspective, is because of exponential returns. How will that exponential happen? By taking some extraordinary steps, which will take the path of burning money. You can't wish that away.
The idea is, in the short term, to hunker down and sustain, leaving that money in your bank, to again come back to a growth path once the dust settles down. Today, even if you want to grow, do you have consumers who are ready to buy from you? The answer is, no. It's okay if the revenue comes down a little bit, just sustain for now.
How will the dynamics of fundraising change going forward?
Sectoral frenzy will fall away for some time. Let’s go back to the first principles. People will just not look at how large the market is, but will also start looking at what is the differentiation of the product and how quickly can this become a viable business.
I would bucket investments into two categories, one is a category where the market to some extent is established and you are trying to build in efficiencies and create better ways of solving the problem. In that case, you may not be a high capital guzzler. Then, there are market creators, who may actually need tons of capital to create that market. For a short period, I think, there will be some limited capital available for the market creators, but, at the end of the day, they are the ones that create very big outcomes.
Coming out of the pandemic, with a focus on building sustainable businesses, will startups turn conservative in investing in new ideas or experimenting with non-core verticals?
Entrepreneurs are eternal optimists. Some adapt by saying let me be profitable and sustain. Anyway, I am a clear market leader and I will be profitable and then look at how do I create new opportunities adjacent to my business. Others will think whether this is a great time to ramp up their digital offering. Can I begin new products? My earlier plan was to grow X. May be that will be subdued for the next six-eight months, but how do I prepare myself in the next six-eight months to evolve. My guess is: startups will not be sceptical. Definitely, there is a lot of stress, but in six months’ time, we will actually see the startups shining.
How will the money flow in early stages vis-à-vis late stages?
That is hard to predict. There are two-three proxies to see where it can end up. One is to ask a fundamental question: Is there money available in the global system for the alternatives? The answer is, yes. In terms of late-stage, since there is not much of resident capital in India—the most of it comes from outside—there could be a change in the nature of that pool of capital. Today, it is A, B, C and tomorrow, it could be X, Y, Z. Their behaviour patterns, the way they look at an opportunity, could be different.
In the early stage, given that the VC industry has developed over the past decade, and there are now many funds, you will have diversity within the VC community, as well where some may take a cautious approach and some may be looking at the silver lining. Funding will happen, I don’t see that stopping.
However, a reassessment of valuations will definitely happen. Under the present circumstances what you can achieve is different. Ten years ago, if somebody said I am investing in an Indian company because this can be an unicorn, people would have lots of questions. Once say a Flipkart and a Snapdeal happened, the believability of something hitting a billion-dollar in a certain timeframe began increasing. Earlier, people would, for instance, say such an outcome could take three-four years. Today, the mindset is, for a company to hit a billion dollars, one may think it could take seven years, because of which the entry valuations will definitely see some suppression. Ultimately, you have to look at outcomes
With valuations rationalising, how do you think a founder’s perspective on dilution change?
That is a case-dependent discussion. That is the reason why extending the cash reserves for a longer period gives that ability to think through because you don’t need to rush into something just to ensure that there is cash reserves in the bank. If you have enough reserve, there is simply enough time to think through all the pros and cons to decide on the right path forward.
How are investors reacting to this inadvertent shift in exit timelines?
Even investors have to adapt. It’s not that they are protected. There is this risk for investors as well; which means that return expectations are going for a toss which is a hard reality. Just like startups have to accept the situation and take a lot of cost-cutting measures, investors have to accept their returns are going to be impacted. There is no short cut to it.