Monthly Archives: June 2015

5 Things I Wish I Knew Before Starting My Startup In India: Finance & Financing

Think cashflow, not accounting expenses

For a startup, it usually hurts to think like an MBA or an accountant. While an MBA analysis (or typical big company analysis) would make you look at costs and revenues on an accrual basis and suggest ways to grow and maximize profitability, for a startup you need to always think cashflow. Money in, money out. So, a rental deposit is not an asset that can be excluded from your expenses (based on accounting values), it is an immediate cash outflow that must be recognized as such. To take this to an extreme, purchasing assets with periodic payments rather than a lumpsum upfront payment, may make sense even if the interest rate on the periodic payment is high. The (first) goal of a startup is to stay in business. As long as possible. Managing on a purely cash basis allows you to stay in business longer, which allows you more of a chance to validate your business plan.

Hire a Chartered Accountant, preferably with a part-time Company Secretary who is experienced in working with small businesses

The laws pertaining to company formation, company compliance and basic capital issuance for all companies (including startups) are quite complicated and are unfortunately wrapped in clouds of secrecy. I was not, and am still not, aware of any comprehensive sources or websites one can go to in order to figure out how to comply with laws related to company law and capital issuances. To highlight some simple points that most people don’t know – are you aware that shares issued by a startup to an investor at a price higher than par value (which is almost always the case) can be treated as taxable income in the hands of the Company, unless the Tax Assessing Officer is satisfied that the price is “fair”? It’s a strange rule, meant to curtail the use of private companies to funnel black money. But unfortunately, it serves as a painful rule for honest startups that would necessarily need early-stage capital to get off the ground. Most people don’t know these kinds of rules. Need a tax/accounting/company law professional to quickly advise you on these matters

“Be Indian, Buy Indian”

This is not a xenophobic comment, nor do I think that you need to be patriotic and shun foreign products. However, given that the biggest constraint for a startup is usually time and the fact that our foreign exchange laws in the country are extremely limiting, you are better off dealing only with locally-registered companies. Payments to foreign entities have a whole different set of rules which usually require professional advice and slow you down. For example, did you know that for a startup cannot just swipe a credit card and pay for Facebook For Business? Or LinkedIn? Both of those companies have foreign entities that are the contracting entity for Indian customers. As a corporate customer, you need to get a Chartered Accountant to issue you a tax document in advance (called a 15CB), you have to deposit TDS and then remit payment. Apart from the cost of getting a Chartered Accountant’s certificate (usually costs upwards of Rs.1500 per event), it’s the hassle of doing all this just to make what sometimes is a payment of a few thousand rupees.

If raising external capital, try to raise it domestically and not raise Foreign Direct Investment (FDI)

While the rules relating to FDI have been eased substantially over the years, there is still a lot of paperwork and bureaucracy in dealing with foreign investment. The RBI has delegated a large part of their exchange control roles to banks who serve as authorized dealers. This ought to be good, as it reduces the number of times you have to approach the RBI for approval. However, most banks (I have dealt with three till date) have internal rules and controls that are more stringent than what RBI specifies. That means you often end up with a situation where the bank’s compliance department will not process your payment even though you are compliant with RBI rules. I have once had to wait 2+ weeks (and go through a real run-around) after a wire was made to us for the funds to credit into our account. Tread carefully.

If raising external capital at an early stage, don’t worry too much about valuation

If your business needs external capital to survive and grow, it likely needs it in a relatively defined timeline. In that instance, you are better off trying to raise capital quickly on reasonable terms rather than slowly on great terms. Best to get fund-raising over and done with as quickly as possible. In the grand scheme of things, valuation levels at a startup are within some rough ranges anyways and time is your most valuable commodity so focus on getting your business off the ground and not squeezing the last bit of valuation out.

Asset Returns in India

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If you talk to folks and pick up anecdotal evidence, you would learn that a lot of money seems to have been made by investing in real estate in India. Those of us who live in India constantly bump into real estate brokers driving fancy cars and are regaled by stories of farmers selling their land for millions, and friends whose investment properties have quadrupled in 2 years! I had my team at Cians Analytics take a deeper look at the real data, and to compare and contrast what returns different asset classes have given in India over the last 23 years (since the economic liberalization of the country starting in 1991).

Asset Returns in India (1991-2013)

The results are presented in the attached paper (above), but I am summarizing the key points below:

Unlike in the US, where a Robert Shiller (arguably the most knowledgeable commentator on the real estate markets) has posited that real estate is at best an asset that barely covers inflation, in India the data looks quite different. In fact, in India, it appears that real estate returns have comfortably exceeded all other asset classes. That being said, our view is that one should be very careful about how one invests in the real estate sector. While real estate returns seem to have been high on average, as an asset class it is highly illiquid and in India comes with a substantial amount of credit risk (if buying real estate from a developer) and is plagued by substantial black/grey market dealing. Honest investors are at a disadvantage and usually can’t exact full value and returns.
The stock market has given a healthy return on an absolute basis (~15.5 % per annum), however if you factor in inflation, the real return is only ~7.1% p.a.
That also begs the question of whether investors are getting adequately compensated for their risk by investing in India. If the real return in Indian equities is only 7.1% per annum, does it make sense for a foreign investor (for example a US investor) to take on the additional risk of investing in India rather than investing in their local markets. During the period of possibly the highest growth in the Indian economy, the Indian equity market returned only 7.1% on a real basis, while the US equity market returned 7.3% — basically implying that investors who chose to invest in India got no benefit for the extra risk they took on by investing in India (note that this holds true without even factoring in currency devaluation which would have made Indian returns seem even more unattractive)
Obviously, investment decisions are not made by looking in the rear-view mirror, but history can provide pointers for how asset classes react to different external conditions and stimuli

Aman Chowdhury. May 2014.

Startup stress: margin of error

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I was having a drink with a family friend the other day, and he asked me how becoming an entrepreneur compares to the job I had before (my prior roles have broadly been P&L-running roles in large/mid-size companies). My initial response was that a) at one level, there were a lot of similarities as my prior experiences had also required a high degree of accountability and ownership but b) while running anything and managing people always comes with a high degree of pressure, the stress levels in a startup environment are even higher.

I have been thinking about this more subsequently and here’s what I really think — Startups are infinitely more stressful to run then larger companies.

I’ve been trying to identify exactly why that is, given my experience in going through the process of building a startup not too long ago.

I think it has to do with the fact that there are a very large number of items that can be business-ending. Things just matter more for a startup. Its that simple.

Its often one slipup and you are done. And I don’t just mean a slipup related to cash and cashflow, which I think is an obvious one. Its more broadbased. Margins of error are very thin, and so EVERYTHING matters more.

To wit:

If you are Microsoft and you lose your largest client unexpectedly. That’s bad. But you’ll get over it. Quickly. If you are startup, its probably curtains for you. You probably won’t get through it (though you might depending on things like whether you are really well capitalized)
If you are Reliance and a few of your largest clients pay you 3 months late, your AR looks bad and Dalal Street will not be happy with you. If you are a startup, you probably won’t get through it
If the tax department sticks you with a big tax bill (valid or not) and you are Vodafone, you will get through it. If you are a startup, you probably won’t be able to pay the bill. Even if you can pay the bill (and herein lies the rub) you probably don’t have the time/bandwidth to even go through the process of contesting a tax bill (your 1 person Finance team will spend his entire time dealing with audit queries and thus won’t have the time to do regular work like invoicing/financial reporting/etc) . When you are small, time is probably an even bigger constraint than money. That’s the part one doesn’t normally realize going into it. One assumes that the playing field is reasonably level if the rules are the same for all competitors. But the reality is that the impact of shocks on the system is significantly greater when you are small.

For those who are visually minded, here is my simplistic depiction of the difference between startup stress vs large company stress:

Quick Math: Rule of 72

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Most people who have an interest in investing understand the power of compounding — putting something away today at a certain rate of interest, will reap a significant benefit tomorrow simply due to the power of compound interest.

One can use a shortcut method to figure out exactly how much return you would make due to compounding by utilizing the rule of 72:

Simply put, if you earn 6% per year and let it compound, your investment would double in 12 years (72/6=12).
If you earn 8% per year, it would double in 9 years and so on.

By using the rule of 72, you can solve for 1 of the 2 variables — if you know return per year, you can figure out the duration taken to double the investment. If you know the duration to double, you can figure out the % rate.

Try it. It works. Its an approximation but an effective tool. As they say, better to be approximately right than precisely wrong!

Management tips – startup to scale-up

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Here is an email I sent internally to the senior managers at my firm to capture my (current) thoughts on how to manage people. Captures my view on what is required from a Company’s managers when a Company gets past the start-up stage and needs to start focusing on how to build systems, processes and really starting to focus on building lasting value.

Caveat: the points captured I am sure are not original (even though I can’t recall where precisely each came from, either real experiences or imbibed knowledge) but they do reflect what I consider useful management traits, attributes and techniques:

xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx

Hi,

As we have discussed this topic at various points and have discussed ways to supplement and enhance the managerial skillsets at the firm, I thought I would pen down some of my thoughts based on what I have learnt over the years and also based on things I have read in various books and consider useful and practical. So, here are a few key management tips that are worth considering as you choose to define your own unique managerial style:

Management is not a popularity contest

In order to do your job, you need to inspire the respect of your team members. People need to look up to you, otherwise it will be hard to get anything done. You have to get along with your team. But have to tread a thin line. You should be personable and friendly but if you get too friendly it becomes hard to have the tough conversations and drive the team when needed. A lot of people I have seen in my career, have struggled with this and tend to have 2 types of manager-employee relationships – some are too firm and standoff-ish and often don’t manage to connect with their team members and earn their respect. Others, are too relaxed. They want to be every employee’s best buddy. Makes it very hard to execute, and usually ends badly as they struggle to make things work when people get busy.

People work for people, not companies

A lot of research into company behavior indicates that a person’s longevity and happiness at a place of work is most heavily influenced by his relationship with his/her boss. This ranks higher than a host of other factors that include compensation, company stature, policies, etc. The evidence is clear – if you have a good relationship and respect your boss, you want to stay in the Company. If not, you don’t.

Communicate bad news early and good news late

If there is a problem, communicate quickly. Get support to resolve quickly. Risks need to be addressed as quickly as possible. They can have dire consequences. Good news deserves praise, but there is normally no urgency to address this kind of news. It deserves its place but doesn’t require speed. Our natural inclination is to showcase and highlight good news and bury bad news. What separates great companies from moderate companies is how they handle both types of news. What is the speed with which they communicate and address the news?

Praise in public. Admonish in private

This is a standard piece of advice for all managers as taught in business school. Publicly humiliating someone doesn’t solve anything. It just results in people feeling slighted and ashamed. On the other hand, praise is often best handed out in public so that everyone can appreciate the positive behavior. All of us are guilty of losing our cool and saying things we probably shouldn’t have in a public setting, but we should strive to control this to the extent possible.

Make your boss’ job easier

Everybody in an organization has a role dictated by their position and responsibilities. A defined hierarchy and reporting lines, allow everyone to leverage their skills and time, and defines clear accountability. Making your boss’ job easier means potentially doing some of his work. This demonstrates that you CAN do more of his work, and also frees up more of the boss’ time. If everyone in a Company does this well, the Company is highly productive and can execute well. Execution is the key to success of every organization.

Hire for attributes, not for skills

In most professions, you can train a person to pick up skills. You can teach them how to do a comp, a PPT deck, a model. But attributes are very hard to change. If a person is lazy or stubborn, for example, it is very hard to change that. When interviewing, one should always try and gauge that.

Play the hand you are dealt

While you should always strive to hire the best, you will usually have to deal with a mixed bag of employees — some A Players, some B Players, some C Players. This could be because you inherit some employees who you haven’t hired yourself, or could be because your hiring isn’t foolproof. The job of a manager is to bring out the best in the team that they have. That means making every employee perform at the best of his/her abilities. Your job as a manager is to turn C Players into B Players, and B Players into A Players, while creating an environment that retains and motivates A Players. You often don’t choose your cards. But you have to learn to play the hand you are dealt

The client is not always right. But he (or she) is always the client

In a service business, you are constantly engaging with multiple clients. Clients can be relaxed and friendly, or tough-as-nails. You won’t always agree with the client’s point of view. The client may sometimes not be polite when providing feedback or demanding work. On top of that, sometimes you will know the client is wrong. You have to suck it up and deal with it. The client is the client.

Every employee thinks he (or she) is under-paid

In my 18 years of working in companies, I have come across only 3 people who thought they were over-paid. Generally, everyone wants more. Its human nature. As a manager, you have to learn to live with it. Compensation must be commensurate with the value each person delivers. That should be the goal post you use in calibrating compensation. Otherwise, you will end up just paying people based on how vocal they are about their compensation.

Execution is key

A manager has to have the ability to “get it done”. Execution is a mind-set and like a muscle if you stretch and exercise the muscle, it gets stronger. So too with the ability to execute. Your teams efforts, ideas and feedback should always be solution-oriented.

Actions have consequences. Think through both short-term and long-term implications of your actions

As Type-A individuals, we all have a habit of focusing on solving the problem, at hand. We want to fix bad quality work, we want to spend extra time to do something right, etc. While these are an integral part of our functioning and is absolutely required, we should always also be aware of longer-term implications of what we do. So, for example – we can have people work 120 hours to get something out the door quickly and well this week. But, that stretch will have longer-term effects if not addressed or curtailed. Stretching the team to get something solved in the near-term obviously needs to be also balanced against the longer-term good. This potential dichotomy between short-term and long-term good has to continually be balanced, in order for us to stay stable and be a successful employer.

Judge others on their intentions, and yourself on your outcomes

It’s a human tendency to judge others more harshly than ourselves. We need to fight that urge. We should give our employees the benefit of doubt – if they have the right intentions. Sometimes, people cannot live up to their expectations because of items outside their control. We should try to judge them on their intentions, in those cases (as long it is not a recurring phenomenon)

Take inputs. Then decide. Live with your decisions

As a manager, you cannot run away from making decisions. You, more than anyone else, has to live with those decisions. As a part of your decision-making process, you can and should take inputs from your team. The best ideas often come bottom-up so this is very important. Once you have received feedback, the final decision is always yours. The buck stops there

Respect is not conferred by titles. You have to earn it

People assume that fancy titles automatically command respect. That’s true in the very short term. People will respect their boss in the short-term because they have no choice. But, I think the correct representation of that is that they obey (not respect) their boss, in the short-term. Eventually, if your team doesn’t believe you are capable and worthy of respect, they will show it. And, most likely, leave

You always pay for pain

There is no free lunch in management as in life. The more pain your employees bear, the more you will have to pay (in compensation, attrition rates, morale and quality). There are firms (and industries) that work people 100+ hours a week, or keep their employees on the road 4-5 days a week. Not surprisingly, they pay people more. Balance has to be restored. The best you can usually do as a manager is not to contribute to the pain that arises from poor management, lack of direction, lack of respect for each person as an individual, and lack of alignment of personal and company goals.

Am sure you have read about, heard of, or experienced some of these pointers during your careers. Hopefully, it can serve as a refresher and can help you with refining your own management style.

Thanks,

Aman

Beggar Thy Neighbour

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It’s all relative.

Unfortunately, that’s what our perception of most things boil down to. We have a very weak compass for evaluating absolutes. That applies to money, wealth, prices, jobs, nearly everything else around us.

Let’s imagine a situation:

You open the mail one Monday morning, and discover (to your immense pleasure!) that you have won a $1 million prize. Complete windfall. You are ecstatic. Pause and imagine what that feels like.
The next day, with a spring in your step, you walk out of your house on Tuesday morning imagining all the things you would do with your new-found wealth. You meet your neighbour in the elevator and start talking about your windfall. The neighbour listens to you patiently but soon cuts you off and says, “Wow, what a coincidence. I also got a windfall prize in the mail yesterday. Oh, and it was for a $5 million prize”

The question is: How do you think you would be feeling after you received the $1 million windfall in Point 1 above? And how do you think you would be feeling after you heard about your neighbour’s windfall? The reality is that you are $1 million up in both cases. You ought to be ecstatic. But most people would be significantly affected by the second piece of information that you received on Tuesday.

That’s the reality of how we perceive windfalls, or evaluate new information. It’s wins and losses, relative to where we were before. And it’s relative position compared to others (other people who we think are relevant).

There are many other instances that point to the same factors. One obvious one is the interesting correlation that seems to exist between countries that are consistently ranked as the Happiest nations and those that have high suicide rates. (see International Business Times article http://www.ibtimes.com/happiest-countries-have-highest-suicide-rates-280921). It seems that unhappy people in generally happier countries may be more driven to take their own lives because they think of themselves as relatively worse off.

On a less morbid note, there is also quite a bit of research on the fact that an individual’s happiness could increase by staying in the company of people that are less attractive, rich and/or intelligent than them. It makes them feel relatively more attractive, rich and intelligent and could thus improve their sense of happiness. Better to be the richest guy in a poor neighbourhood than the poorest guy in a rich neighbourhood. Beggar Thy Neighbour.

Seriously? Foreign Direct Investment (FDI) rules

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Having had some experience with dealing with raising FDI capital over the course of the last several years, I was somewhat perplexed with some of the strange rules.

Explain this:

India’s FDI rules have an interesting provision related to valuation of a private company. The rule basically states that an Indian resident (including a Company) cannot sell shares to a foreign resident at a price below its fair value.

Ok, fair enough. The government wants to protect Indian residents from potentially unfair foreign investors (don’t agree with the premise, but I guess I can understand that some could).

Now, here is where it gets interesting. In order to determine the fair value of the shares, a Discounted Cash Flow (DCF) analysis must be conducted, and the price arrived at based on the DCF is said to be “fair”.

Then, the foreign investor MUST invest at a price equal to or higher than the fair value, as determined by the DCF.

Obviously, from the Investor’s point-of-view, the DCF value is the fair value. In order for any investor to invest in an asset, they must believe that they are buying the asset at less than the fair value. However, the FDI rules pretty much guarantees that one cannot buy at less than the fair value. That basically means that either the Investor has a completely different valuation approach that somehow justifies paying more than the DCF valuation, or that the Investor is looking at a completely different set of projections than what is submitted to the Reserve Bank of India by the Investee Company.

Quite a bizarre rule. Pretty much forcing firms to fudge numbers. Hope better sense prevails when the new government revisits some of the existing laws.

Aman Chowdhury

March 2014

www.amanchowdhury.com

Growth vs. Profitability. Startup Dilemma

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I remember one of my first classes of Finance in business school (Darden Business School)…”Growth creates a funding need”. Nowhere is this more true than in a startup.

Most early stage firms are torn between trying to grow as fast as they possibly can, and conserving cash so that they can achieve and sustain profitability. Which one is more important? Unfortunately, the answer is….it depends.

The objectives of an early stage company are manifold:

Achieve profitability to get out of the “valley of death” so that you are a self-sustaining business not dependent on external funding/fuel
Increase in size to get benefits of scale, make a bigger splash with potential clients, and provide investors with a good return and an exit

Most often a company has to trade-off #1 vs. #2. Do you spend on the expensive sales guy or do you keep the money in the bank to harvest cash? Do you spend to improve or enhance your product (product company) or add headcount (service company) to be ready for more demand, or do you hunker down and wait for demand to unfold. Never easy to choose.

To some extent, i think some of the critical factors are the type of company you are (product vs. service), and the kind of investors you have (institutional vs. non-institutional/self-funded). If you are a startup who has raised money from institutional investors, the expectation most often is for you to deliver outsize returns — most often funding rounds are precisely so that you can take the bigger size risks to shoot for the outsized returns. To some extent, you are being given the financial backing precisely so that you can swing for the fences, and not for you to focus on stealing bases (go for sixes, not hit leg-glances for a single if you prefer the cricket metaphors).

From my own experience, having largely been involved in service businesses, i have always steered more towards the profitability than the growth axis. Think that is largely driven by the fact that service business don’t have the same low variable-cost dynamic as a product or especially an e-commerce business does. To (over) simplify, service business = high variable cost, low fixed cost. Product/internet business = low variable cost, high fixed cost. Nor are they typically as skewed in terms of winner-takes-all competitive landscapes (service industries aren’t typically as concentrated as product industries). Thus, investing significantly in revenue growth is more appealing in the case of product/internet businesses. Magnitude of potential success (think massive profit potential if your online business becomes a winner) is much higher in the case of successful product/internet businesses (even though likelihood of being successful is much lower)

Aman Chowdhury. May 2014.