<p>A couple of years ago, a senior editor at a web-based publication approached an angel investor to seek funding for a new entrepreneurial venture that he had conceived. Admittedly, it was a unique concept but something that came with abnormal levels of uncertainties on whether it could be pulled off. The business was valued by some consultant at Rs 10 crores. The basis of valuation these days is not on tangibles that you can see and touch but rather on some airy notions of what future cash flows might look like. In the case of our editor, all that he had to show for this extraordinary asset value was a piece of paper, supposedly a business plan of sorts.</p><p>The valuation game has over the course of the last decade changed completely. One reason for this stems from the fact that cheap – literally free – money was available, an outcome of low or in fact negative interest rates. Investors, family offices and hedge funds looking for higher returns took punts on all sorts of fancy business ideas. True, some of them worked and in a few cases created the giant behemoths of the internet age that dominate and enrich our lives. But truthfully most of them actually failed to make the cut. The venture capitalists still profited as the value enhancement in the 10% of their portfolio was so enormous that the write off in the balance 90% was more than catered for. </p><p>There are now hundreds of start-ups called ‘Unicorns’ that have a notional value of over USD 1 billion. This value is calculated, not on a public platform such as a stock exchange that allows free trade and is consequently market driven, but on the basis of the price at which new shares are exchanged. Here again a consultant, one compensated with a substantial fee by the management and existing shareholders, is called upon to provide a figure. The basis of these calculations is subject to dozens of variable inputs and therefore circumstantial. If and when such companies are listed on a stock exchange, they see a market rout within a few weeks with a sizeable loss of value and investor wealth. In some cases, the original investors previously cash out – conveniently – and the new ones are left licking their wounds. We have several high-profile examples in India where common retail punters have lost their shirts. But in a free market they have no one to blame but themselves. Get-rich-quick ideas rarely work. Ask a betting man that has for years played the horse races. </p><p>More recently, some of this exuberance is moderating. For a start, free money has gone for a toss with US interest rates jumping from near nothing to about 4.5%. Other central banks have quickly toed this line. Hence the attractiveness of seeking higher returns is fraying. Second, angel financiers too have burnt their fingers in silly ideas of what will work or become the next big thing. They have become cautious. Third, exit options are now much harder to come by and people have become smarter, having faced the consequences of reality and huge losses.</p><p>This saga of excitement and apathy will continue just as the markets go up and down. Memories fade and then what appears to be a brilliant investment opportunity, one that promises boisterous returns, pops up and the cycle begins again. This is not to say that investors should not take risk. But rather that they go into something with thought and full acceptance of the fact that they might lose the bulk of what they had put in. Success with a smile and failure with a sigh, should be the moto!</p>
<p>A couple of years ago, a senior editor at a web-based publication approached an angel investor to seek funding for a new entrepreneurial venture that he had conceived. Admittedly, it was a unique concept but something that came with abnormal levels of uncertainties on whether it could be pulled off. The business was valued by some consultant at Rs 10 crores. The basis of valuation these days is not on tangibles that you can see and touch but rather on some airy notions of what future cash flows might look like. In the case of our editor, all that he had to show for this extraordinary asset value was a piece of paper, supposedly a business plan of sorts.</p><p>The valuation game has over the course of the last decade changed completely. One reason for this stems from the fact that cheap – literally free – money was available, an outcome of low or in fact negative interest rates. Investors, family offices and hedge funds looking for higher returns took punts on all sorts of fancy business ideas. True, some of them worked and in a few cases created the giant behemoths of the internet age that dominate and enrich our lives. But truthfully most of them actually failed to make the cut. The venture capitalists still profited as the value enhancement in the 10% of their portfolio was so enormous that the write off in the balance 90% was more than catered for. </p><p>There are now hundreds of start-ups called ‘Unicorns’ that have a notional value of over USD 1 billion. This value is calculated, not on a public platform such as a stock exchange that allows free trade and is consequently market driven, but on the basis of the price at which new shares are exchanged. Here again a consultant, one compensated with a substantial fee by the management and existing shareholders, is called upon to provide a figure. The basis of these calculations is subject to dozens of variable inputs and therefore circumstantial. If and when such companies are listed on a stock exchange, they see a market rout within a few weeks with a sizeable loss of value and investor wealth. In some cases, the original investors previously cash out – conveniently – and the new ones are left licking their wounds. We have several high-profile examples in India where common retail punters have lost their shirts. But in a free market they have no one to blame but themselves. Get-rich-quick ideas rarely work. Ask a betting man that has for years played the horse races. </p><p>More recently, some of this exuberance is moderating. For a start, free money has gone for a toss with US interest rates jumping from near nothing to about 4.5%. Other central banks have quickly toed this line. Hence the attractiveness of seeking higher returns is fraying. Second, angel financiers too have burnt their fingers in silly ideas of what will work or become the next big thing. They have become cautious. Third, exit options are now much harder to come by and people have become smarter, having faced the consequences of reality and huge losses.</p><p>This saga of excitement and apathy will continue just as the markets go up and down. Memories fade and then what appears to be a brilliant investment opportunity, one that promises boisterous returns, pops up and the cycle begins again. This is not to say that investors should not take risk. But rather that they go into something with thought and full acceptance of the fact that they might lose the bulk of what they had put in. Success with a smile and failure with a sigh, should be the moto!</p>
