Valuation Is More Like An Art Than A Science, Says Tremis Capital’s Partner Pushkar Singh

For months now, Tremis Capital’s partner Pushkar Singh has been observing the spike in the valuation of start-ups, including unicorns, with trepidation. While ample capital still exists in the market, investors are now keen on backing founders with a clear path to profitability, which has led to a much-needed rationalisation in valuation.  

Today, early-stage founders must work harder to raise funding by showcasing their storytelling skills backed with drilled down numbers that they can deliver. Singh tells Outlook Business that he believes that the current valuation levels will broadly continue over the next two to three years and might even come down. 

Edited excerpts:  

What is your take on the rationalisation in valuation in the start-up ecosystem? 

The most basic rule of economics while setting the valuation of any asset is demand and supply. Times were unreal since 2019—central banks in countries like Japan, the US and European nations, which were already printing a lot of money, further increased this during the pandemic to pull their economies out of the crisis.  

Most of this money went into private equities and listed equities which cover start-ups, as well as real estate. Now, as central banks have increased the interest rates, core investors, venture capitalists (VCs) and private equity funds are pulling out money from VC funds and investing it into bonds. This is why start-up valuations have come down.  

Typically, an early-stage or late-stage start-up in India is valued on their revenue multiple. So, if their annual revenue is Rs 10 crore and the valuation multiple is 5, then the valuation is Rs 50 crore. These multiples have now come down.  

For example, multiples for direct-to-customer (D2C) start-ups in India were as high as 5 and 6. Today, companies with similar revenue and unit economics get multiples as low as 2. So, valuations have halved though the nature of the business has broadly remained the same globally and in India.  

We are also seeing new valuations at lower multiples given a capital glut and VCs know that they will be able to raise reduced money in the future. They are therefore asking start-ups now about their path to profitability.  

The past three to four years were unreal because there was so much capital that VCs were financing unprofitable companies and their valuations kept increasing. This was a typical bull market, which is now coming down. 

However, many investors currently do not see a visible path to profitability for many unicorns, be it Paytm or Nykaa. How will this impact early-stage or late-stage valuations?  

It is already impacting both early-stage and late-stage valuations. For instance, Byju’s was planning an initial public offering (IPO) at $29 billion valuation, but are reportedly raising capital at $7 billion, which means their valuation has come down to 25 per cent.  

One needs to understand how investors think. An angel investor backing an early-stage company knows that as the start-up grows, bigger investors will buy their stake. So, if they have invested Rs 25 lakh and the company succeeds, a VC will buy their stake at 10 times valuation. Hence, the angel investor is not so focused on profitability since it more the forte of mid or later-stage investors. 

When do you expect things to become more realistic?  

The kind of valuations currently underway is the kind of historical multiples we have seen in start-ups. Over the next two to three years, valuations will remain broadly same and might even come down as you can see globally and in India.  

However, the interest in start-ups will remain, at least in India, because most people understand that the start-up ecosystem will grow in the country. It is just that now they are not fine with paying 5x or 10x multiple and want better valuations.  

Which start-up sectors will have heightened interest amongst investors? 

Investors in the US and Europe and in India are optimistic about fintech and SaaS (software as a service) start-ups. In the US, over 100 SaaS companies have gone public in the past decade, because the road to profitability is very clear in this domain.   

The reason fintech is getting attention is because digital transactions are increasing. Incidentally, online payments are just a small part of fintech and a lot more is happening in the insurance, corporate and SME (small and medium-sized enterprises) lending, wealth management, etc.   

What can these growing sectors learn from edtech start-ups, which was once a shining star, but is struggling in current times? 

Both fintech and SaaS are not as concentrated as edtech as they have different models.  

India’s first wave of fintech began with online payments, and the government created a level playing field with UPI. We are unlikely to see many new companies in online payments since that market is very well served.  

However, the country is under-insured and small businesses struggle to get working capital because traditional banks don’t lend to them. So fintech will move more towards investments on the consumer side and lending on the business side.  

In their quest for growth at all costs, many early and early-growth start-ups often burn significant capital in customer acquisition without concentrating on monetisation and unit economics. Some say they are forced to do this by investors. How can founders avoid this death trap? 

I won't say that it is fair to mention only the investors, this involves both founders and investors. Founders were getting outrageous valuations and were making a lot of money. So, they just burnt money and increased revenue without caring for profitability because the assumption was that these companies will eventually become profitable. This is a good strategy as long as money is abundant.  

Since that scenario has changed, both investors and founders have realised that this model will not work. This is exactly what happened with Byju’s. They kept growing, reached a $29 billion valuation and then realised no one wants to invest at that valuation. They have brought it down to $7 billion now. Everyone lost money in the bargain; investors have seen their investment come down as has the founder’s equity.  

For the next couple of years, people will try to grow profitably and not burn a lot of capital. One side effect of this is the mass layoffs taking place globally and in India. They had hired people in the expectation of future growth but for any start-up the biggest cost component is tech salaries. This is their way of cutting cost and making the start-up profitable.

How can early-stage startups have a clear route to cash-flow break-even or at least a major bankable inflection point as fear of recession spreads and the demand for non-essential services declines? 

Most early-stage founders have realised this and no one is hiring tech resources at high salaries. Because the market has also come down.

These things are all market dependent. Founders were getting outrageous valuation because money was there. Now, salaries were so high in India because start-ups were hiring people and they could afford hiring people at Rs 1 crore salary. But a non-funded start-up just could not afford to hire people at these rates.  

Now, since the quantum of funding is coming down, salaries are also coming down as founders want to preserve cash. It is a function of bull market: when money is cheap, people splurge on things that are not necessary. Early-stage founders have realised that they can do this, but their company will die.  

How does Tremis Capital help start-up founders build businesses based on time-tested principles of compelling value propositions, sound unit economics, and a clear path to profitability? 

We don’t tell early-stage founders how to run their business. Because in early stage, when the competition is low, the business is unproven and the company has achieved very little product market fit. We are backing smart founders and hope that they know what they are doing.  

We have a simple investment thesis at Tremis Capital. There are two kinds of VCs in India. The first is the operator VC, who helps the founders in a lot on business decisions, strategies and sales. The second is a traditional VC who helps raise the money and then the founders decide how best to utilise it.  

We want to back smart founders and help them wherever they ask us to, since we are not operators. We can assist them in raising the next funding round, reaching out to more investors and hiring key people. But we don’t tell them how to run the business or make robust unit economics because the founders know that better than us.  

Do you help in understanding how to reach a larger Total Addressable Market (TAM) or evaluate the size of their potential customer base? 

We don’t invest in very early-stage start-ups. Our investment thesis is to invest only when the company has a product ready and is making some revenue. By that time, the founder has already figured out a lot of things like which is their target audience and how to build the product. We started in 2019 to help founders raise larger funding rounds and we started investing last year.  

Whenever we are helping a start-up raise capital, we work in a very detailed manner with the founders. Because then we have to establish TAM, prepare a deck and build their financial credentials, so that they can explain to an investor why they need the funds. They also have to list how they will utilise the funds, specifically salary and marketing, their growth plans, who their competitors are and how to tackle them, etc.  

Times are challenging. It is not so easy to raise capital as it was last year or in 2020. Founders have to reach out to more VCs. But that is still better than raising no capital.  

When we help start-ups raise capital, we tell them that they need to bring down their expectation on valuations. There is still a lot money in India as VCs had raised their capital in the past couple of years, which needs to go to good start-ups. But you will not get 5X funding like what your competitors got last year. Markets have changed and it is all about demand and supply and the current competitive set.  

We help founders to understand valuation which is a lot more about negotiation. Valuation is more of an art than science. It boils down to how comfortable the investor is with your company, how good your team is, your revenue over the past few months vis-à-vis growth and the current market value. Only then, you arrive at your multiple.  

Does that not mean that valuation is a very subjective activity? 

Yes, there is a lot of subjectivity involved. For instance, two similar companies with similar products, assuming both have similar revenue and operate in a similar industry, might get two very different valuations. Because one investor might like the deal from company A more than company B.  

In the early stages, a lot of rides on how confident you are about the founder and how good you think the founding team is. Also, how can they build a business. Since most VCs understand that 80 per cent of their investments won’t pay off, they want to back founders who can create billion-dollar businesses and help them make money at the portfolio level.  

Story telling is very important while raising capital and this is something we actively work with our start-up founders. Help them form a core story backed by numbers.  

How does Tremis' current portfolio look like and what is your portfolio Internal Rate of Return (IRR)? 

We have done seven investments with one exit and are presently evaluating five. Also, we have given term sheets to six more.  

The IRR is very high because there is a lot of beginner’s luck. We started last year and got good deals and valuations have held up. Right now, the IRR is around 70 per cent but this must come down because it is not possible to keep that portfolio IRR.  

Our internal target is 26 per cent IRR that makes your investor’s investment double within three years.  

There are some who say that they give 50 per cent IRR but you must look at the period. During that period, the valuation went 10x. In the long term, no asset class or industry can give 70 per cent IRR, unless it is crypto where in one year you get 70 per cent and the next year you could get zero.