Investing in start-ups? Forget FOMO, join JOMO: R Venkataraman

Start-ups and unicorns seem to be getting synonymous these days with record number reaching billion-dollar valuation this calendar year.

The Business Standard, on November 28, 2021, carried two interesting lines on its front page.

First: The headline - Hail a new breed of angel investors, start-up employees using their fat pay-checks and ESOPs as Angel investments.

Second: An interview of SEBI Chairman, Ajay Tyagi who said - New investors must realise that any investment is prone to risk.

This is a study of contrasts – on one hand money is pouring into start-ups like never and on the other, words of caution from the regulator.

In the recent past, I have met so many friends, who have now taken into start up in a big way. In WhatsApp groups, messages pour in where such deals are floated. Hunt for the next unicorn is the new game in town. In fact, this segment is so hot, that deals get closed in record time. The presentations are slick, and the promoters are young and very confident and at least appear to be out to change the world. This is good because young entrepreneurial energy is getting unleased in India. Many start-up founders have become choosy and prefer angel investors who can “add value”. The balance of power has shifted from the investors to target investment companies.

My words of caution are for investors because start-up investing is very risky, to state the least. I have personally lived through Internet frenzy of 2000. That was the last start-up funding boom cycle, we saw in India dominated by the technology or IT space. Post the dotcom crash, this market did not have a happy ending. History seems to be getting repeated. Media is writing about the pace of unicorn creation. We had blockbuster listings of tech start-ups and suddenly everyone wants a piece of the action. Nothing attracts capital like returns. Surplus liquidity has driven valuations haywire; this is what is sucking in a whole new breed of investors wanting to invest in start-ups.

Everyone wants a unicorn in their portfolio, including me. But they can be difficult to spot at an early stage. Bragging rights of spotting the next Zomato is huge, but these bragging rights come with huge risks.

Here is my advice to start-up investors:

1) Start-up investing is very risky: This is the biggest understatement because historical data shows that more than 99% of start-ups fail. Most of the start-ups will fail within the first 2-3 years of existence or they chug along in what Ajit calls “liquid oxygen.” i.e. they neither die nor scale up. This is very frustrating for both the investor and the company.

2) Real life rarely imitates power point slides: Every presentation looks very appealing. Every start-up looks like the next Google. Real life rarely imitates power point slides.

3) Risk and returns are joined at hip: The moment you want high returns, you should be willing to take high risks and be willing to write off the entire investment. For every Zomato there are 999 or more tomatoes and potatoes which nobody talks about.

4) Assume your portfolio could become zero: If you want to enter the high-octane world of start-up funding, start with the premise that your investments will become zero. If you are still fine, then go ahead. Invest in a portfolio rather than one start-up, to improve your odds. Some wealth managers have fund of funds which captures such unicorns and possibly successful start-ups.

5) Take ownership, take blame: If your investment turns bad, tell yourself – I gambled, and I lost. Do not blame the broker, advisor, friend and regulator for your greed.

The kind of investing frenzy we are witnessing now usually happens at the fag end of the cycle. My fear is that we might be towards the end of the cycle. None can predict the exact timing. Corrections will happen and that can be painful. Some of the IPOs are trading below IPO price, and already, a section of media and some investors are starting to question SEBI and giving advice to SEBI to bring back price controls. They will be better served by following Sebi chairman’s advice on risk.

During the dot com boom bust cycle, many of the dotcom billionaires, used unrealised profits in ESOP valuations to change their lifestyle, and fund investments. This hurt them badly when markets crashed. Hence, my advice would be - be careful while taking loans against ESOPs or start-up shares; when the market turns, value of investments will fall, and the value of the collateral will fall even further. And debt will literally rip you apart. Trust history on this.

My advice to start-up investors is to manage your risks and invest safely and not because of FOMO (Fear of Missing Out). If you invest in start-ups because of FOMO, then you will also lose out on JOMO (Joy of Missing Out) when markets correct.

The author is Chairman, IIFL Securities Ltd.