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The perils of unicornism

Were you of the idea that the number of unicorns that a country promotes is the greatest measure of its economic health?

The raising of capital seems to have become the primary goal of business. Everyone talks about how much a business has raised and what their valuation is. And when I say everyone, I do mean everyone - founders, large investors, small investors, employees, high government functionaries, and even regulators are obsessed with this.

Once upon a time, articles in serious business publications would always mention the revenue and profits of companies that they were writing about. It helped readers get an immediate sense of the scale and the success of the business. Now, readers are often expected to get by with just the valuation. And what is this valuation? At best, it will be the total valuation at which the company last raised money. More often it will be something even worse - the total valuation at which the company is trying to raise money, or even what the founders claim it is worth. In effect, it's a meaningless number. In fact, it brings to mind Charlie Munger's famous statement that "Every time you hear 'EBITDA earnings' substitute it with 'bullsh*t earnings". Investors' attitude towards these valuations should be the same. The greatest measure of the country's economic well-being seems to be the number of 'unicorns' that have been created, which is probably the most bullsh*t economic metric that has ever been created.

The problem has gone far beyond investors. Recently, there have been a number of news stories of mass sackings in a number of high profile startups, specially in the education sector. Many of these articles narrate first hand experiences of teachers and others who joined these companies and now, just months later, have been sacked. Some of the quotes from these ex-employees show how far this valuation illusion has spread. Someone says that he found an alternative job a few months ago but his manager persuaded him to stay saying that 'company has USD 20 billion valuation so why are you worried?' The man stayed on and has now been sacked over a zoom call along with hundreds of others.

It sounds like a joke and I wish it was. The fact that these bullsh*t valuations are being used by vulnerable employees to make job decisions is a terrible outcome of this focus on valuations and the raising of capital as the ultimate measure of business success. In fact, historically, regardless of the industry, raising too much capital has always been a red flag for investors. If you look at the companies that have been great wealth creators for the Indian equity investors, none of them needed a gigantic amount of capital to succeed. This is true of companies in low-asset technology and services businesses as well as those in asset-heavy businesses. Even though large amounts of funding was needed for the latter, these were sourced in a well-accepted framework of debt and equity. Most importantly, the centrepiece of the business plan was always a predictable path to profitability.

Profits are central to a business; without profits, there is no survival and there is no way to evaluate a business. I've been analysing stocks since 1991, and I find it unbelievable that in 2022 I have had to actually write that previous sentence. It's like a doctor explaining that if someone stops breathing, they will die. For as long as people have done any kind of business and invested in them, the following statements have been self-evidently true: Profits are a must for survival. More profits with fewer inputs (capital and other resources) are better. Growing profits is better. The sooner a business becomes profitable, the better it is.

Unless it contributes to a defined path to profitability, raising more capital is a negative indicator for a business. However, what is most damaging to the entire business and economic environment is the wholesale obsession with valuations and raising money that has now overtaken us. If a business makes good profits and grows then the result will automatically be a higher valuation and a greater ability to raise capital. What we are seeing is an artificial reversal of this relationship.

Unicornism is a dangerous belief system. Whether as an investor or an employee or a business founder, stay clear of it.

Suggested read: Profits are profits

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