Wisdom of First Principles

By Meenakshi Shivram

Entrepreneur. Board Advisor. CEO. Investment Banker. Skanda Jayaraman has seen it all, and he’s here to spill the beans. Read on for edited excerpts from our interview as we go back to basics and understand the recipe for a startup’s success, the role working capital optimization plays in it, his outlook for funding this coming year and how technology is revolutionising the landscape.

Meenakshi: You’ve been an investment banker, an entrepreneur, an advisor – basically a Jack of all trades. Can you tell us a bit more about what got you here?

Skanda: You know, the second part of Jack-of-all-trades is also me: Master-of-none! (laughs) But no, I’ve had a pretty enriching journey across twenty years in financial services. I started off in retail finance, worked in risk management making credit scoring models in retail and wholesale banking in India and Singapore for 6 years. The next 13 odd years were all about deal-making in India. There were some cross-border transactions as well, but largely worked with Spark Capital where I started off in 2008, and finished in 2021 as Head of Investment Banking for about 7 years. Post that, I wanted to try something a bit non-linear and that’s when I got involved with a fintech company Qapita, where I joined as the CEO of the marketplace. They were trying to create a digital stock-exchange for private markets,and I was the one who was trying to put it together. Along the way, I realised that maybe my entrepreneurial aspirations were pushing me to take control of things – I wanted to do things in a different way, so…here I am! I’ve been an entrepreneur for the past 6 months, dabbling with several things. I wear multiple hats as an entrepreneur, consultant to a couple of companies and I sit on the board of a few of them as well. But yes, it’s certainly been an enriching journey right from being a modeller, to a deal-maker to an entrepreneur right now. I’ve seen the full 9 yards, if you would want to call it that.

Meenakshi: That’s an interesting journey! Thank you for sharing. Now, I’ve personally always been biased to those who can break complex concepts down to the basics. So I was delighted to read the line on your Linkedin bio that spoke about building a sustainable business using first principles. Tell us, how would you define first principles?

Skanda: Having done and seen a lot of companies and a lot of transactions through my days in investment banking – across Series-A to IPOs – I’ve developed some mental models on what successful companies did right to get there. So, as a caveat, remember that these models are – to some extent – biased by these experiences. But basically, the mental model goes in to understand why there exists such a high mortality rate amongst startups. There’s enough literature to corroborate this, so while it may not be an original line of thought, it is my fresh perspective. I’ve come to learn that the reason why startups fail is because founders rush into raising VC or external capital too soon in their journey without establishing a product-market fit! Without genuinely understanding if the product will be paid for by the customer, it’s tough for them to understand if it is a need-to-solve problem or a must-solve problem. There is a close identity associated with the customer at the problem statement state itself. And because of the cyclicality of funding, due to the large amounts of capital available in the last boom, many founders who were able to demonstrate at least some amount of credibility or a deck managed to get funded! 6 months later, many developed some form of an MVP, but were not able to get the customers! There were many cases where they were struggling to get even 2 customers resulting in a dilemma – how do they deliver returns on the money they’ve raised from investors? People think they need to have a very complex, esoteric-sounding idea to build a successful business, so they try to imagine addressable market sizes of billions of dollars to secure VC or family office funding. 

What I’m trying to do is slightly different. I have built a prototype, I have gone to 25 customers / prospective customers, I’ve sat with them to understand whether the product would be useful to them and whether they’d pay for it. The reason I’m doing this is to understand if my business would sustain with or without external financing. That means that if we grow it at a certain rate, and if we allow it to compound, then cash flow should basically take care of a large part of the expansion requirement. I’m looking to build a B2B product, so if I can get to – say, 50 customers, I know that proof of concept is no longer a problem. There is utility, and evidence, to tell myself (more than anybody else!) that usage cohorts & other metrics are looking good. It’s only when I need to go from 50 to 500 or 5000 that I need to raise additional capital. So, a simple rule of thumb that I’ve told my clients as a banker and I keep telling myself is this: If my rate of growth can be funded by internal cash flows, then I don’t need to go and dilute equity. The day I feel that money is the only constraint for me to not grow at 100% and return cash at 25%, that’s the time to dilute equity. Equity is an expensive form of capital! Suddenly, we’ve made it so accessible, we think it’s cheap – it’s not cheap at all! Return expectations are 30-35% IRR at early stages, 25-30% at growth stages, and is a very expensive form of capital. It should be taken only when you absolutely need it for expansion, and not just because there’s an ego gratification that comes from it.

 Meenakshi: I agree! Over time, raising funds has a marketing/PR quality to it, just to get your name out there.

Skanda: Absolutely. And then you’re just chasing one fund after another from round to round.

Meenakshi: Speaking of funding – what are some upcoming trends you’re seeing from a funding perspective? Do you think your sentiment will largely be echoed by other founders? And the drumroll question…Will the funding winter continue?

Skanda: See, I think when we say “funding winter”, it may seem a little stark. It’s not like the funds are not available, right?. There are so many PE funds that have raised capital in 2021-22, and a lot of that has not been deployed yet. So, there’s a lot of money available and there’s no two ways about that. Why is there a lot of money available? The India story in the next 10-15 years is going to be very healthy, robust & there is a lot of excitement still left in this market for good businesses to be built. However, there is still a funding winter because there is a bit of a denial in the entrepreneurial segment to realise that what has gone wrong is a structural mistake in terms of initial cap tables, the way the initial rounds were raised and models were promised. So, there is an element of reluctance amongst a lot of people to course correct. Granted, it’s difficult to course correct – it’s easy to say, but not easy to pivot a business from a high-growth model where the teams have been built in a certain direction, to cutting that growth and going back to profitability-focus. A lot of unicorns & mature startups are starting to make noise about this and I think it’s about time. A lot of them have raised 800+ million dollars to realise their first dollar of profit! Don’t ask me what the return on capital is! (laughs). 

It had to come to this stage for them to realise. So somewhere, I think, entrepreneurs glamorised this concept of saying “Oh, I raised so much money and therefore I should be successful.” I think the definition of success is changing, the definition of a successful business is changing, and rightly so! I just hope this is not a phase where people are playing to the gallery, because there is a bit of a bearish outlook out there. I hope they’ve matured from this whole cyclical experience, to realise that businesses are built over a much longer term rather than the next 2-3 years. A lot of pain is yet to be fully realised and undertaken, and so there is still more pain left in the market. But from an investor standpoint, this is a great opportunity.

Meenakshi: What sectors do you think will attract the lion’s share of funding in the coming years in India?

Skanda: I don’t think sectorally things need to change a whole lot. If we look at it historically, financial services has been one of the most successful value creators, especially lending using an NBFC licence. Along came the way fintech, where they said that this would change, it’ll be all about the number of users, and so cash was burnt for marketing – but ultimately, everyone got into lending since the more sustainable returns came from there. I’m a big bull for the long run on lending. Anything, therefore, which is domestic consumption based – especially rural, tier-2, tier-3 consumption based, I’m a big fan. Any ancillary themes that go along with that – agritech, more value associated consumer products & services, healthcare, domestic consumption…I’ve seen the disposable income change drastically in the country in the last ten years, it will continue to change even more in the next ten. People will be able to afford more and ask more of the quality of products and services they consume, so therefore any theme that rides on it – be it financial services, healthcare, consumer products – will absolutely do well.

In terms of tech & software, I still think that enterprise-grade SAAS has a lot of potential. A lot of change has happened in GPT4 in the recent past, and I think that’s going to really onboard a flurry of new developers & creators wanting to build on top of that to solve some small sachet like tools and sachet like use-cases, in India & globally. Therefore, building in India for the globe on the software side is a theme I’m interested in, and I think will do well and attract funding. 

Cash is King. If the unit level economics are not doing well from a cash flow / operating cash flow standpoint, those businesses are not likely to get funded again, at least in the next couple of years.

Meenakshi: In your experience, how important a role does working capital optimization play, especially for a startup or a small business?

Skanda: I think it plays a tremendously important role, irrespective of the size or segment of the business. I would like to double underline or stress on “Cash is King”. Are you throwing cash from your basic unit level? Yes or No? That’s what they need to answer. And the reason people don’t answer that is they know they want to book the revenue, and the revenue is all sitting in receivables. Or they believe that just because they have inventory, it’ll fly off the shelf. I’ve seen enough businesses across consumer, retail, apparels and even healthcare – a lot of thse businesses don’t do well even at a substantial scale. They may have a 300-400Cr Revenue, EBITDA of 40-50Cr, but they will still be in the market because they don’t have even 10Cr to pay off their employees or expenses. These are random numbers, just an illustration, of course. The reason this happens can be because of long repayment cycles, and expenses don’t stop anyway. So there’s revenue, there’s profit…but where’s the cash? Irrespective of EBITDA, who is calculating the cost of that capital? That financial awareness is centred in my own mental model – are you seeing cash in or cash out? Are you struggling for cash at the end of the month or is cash rotating itself well? Simple question, but nto so simple when it comes to running a business. Working Capital, therefore, is not understood very well when operationalizing it. 

Meenakshi: How important is a robust governance, risk & compliance framework? What role does technology play in it?

Skanda: Risk & Governance is painful to implement on a day-to-day basis, but it’s the absolute bedrock on which you will build for the future. This comes back to first principles – the way to build a sustainable business. A sustainable business is not just about having a P&L, unit level economics, working capital, cash flow…it is also ensuring that your stakeholders are made aware of what the risks & governance protocols are in a business. If technology can be used to leverage that, then it absolutely should be a day zero investment! What we don’t realise is that a blip on your reputation, it doesn’t impact only the investor ecosystem but also to the customers! People will pull away as customers because they don’t want to associate themselves with bad names. We want to avoid this. Most businesses make this mistake of not hiring a CFO till Series B. I don’t understand why! It is an integral part, not an optionality – that’s what creates a lot of problems when they scale up too soon.