Monday, November 10, 2014

Why investors give money to Flipkart or Whatsapp even when they are in losses?

Students are now learning more outside classrooms than inside them! In last 5 years, I have seen increased coverage of stories of entrepreneurs in media but the lack of analysis in most of the "news" leaves many questions unanswered. One of the most strange or simply intriguing question that I face in all colleges from young graduates is "Why investors give money to Flipkart or Whatsapp even when they are in losses?"

While I prefer giving answers, in this case I prefer asking a counter-question - "How much money did you make in 1st year of your college?" Answer is usually 0 - except for cases involving scholarship, internship, part-time, prize moneys or merit cum means cases! Now the next question - "How much money did you spend in 1st year of your college?" Taking usual suspects like tuition fees, hostel fees, food charges, travel fees, university fees and some extras like entertainment or boyfriend/girlfriend charges (for few cases this is more than the study expenses ;-), let us say the average comes to 1 lakh a year.

Let us now use what we learnt in our Std V Mathematics classes => SP - CP = P, that is, selling price less cost price equals profit. Which means for 2, 3, or 4 years you will be making a loss in your education. So why should someone invest in your education? And then come the real answers: this money is not an "expense", it is an investment and we will be earning after we pass out.

Lets say you are an engineer with 4 years of degree course - and in 5th year you get a job of 6 lakhs and expenses become 2 lakhs in 5th year. With negative 4 lakhs during studies and 2 lakhs in 5th year you would have made 6 lakhs revenue and 6 lakhs expenses - which means zero profit and zero loss in 5 years. And this is where the game begins - you may get a promotion in 6th year and salary becomes 8 lakhs, though expense may also go up to 4 lakhs - profit = 4 lakhs! 7th year it may be 5 lakhs, 8th year it may be 6 lakhs, and 10th year it may be 10 lakhs, and touch a crore by the team you retire. Let us assume no income tax or other major changes in life - your father (the investor) is set to make many times return on investment.

Of course, this is a purely financial consideration not taking in account the social or emotional factors. While on the same argument, let us answer another important question - how much money you need for starting a venture? If we take example of our degree course, then the answer is obviously 4 lakhs as 5th year you will be having positive cash flows. Now try to draw a parallel between your business plan and your education/career. The money you need from an investor should cover all the negatives you are expected to generate till you start becoming positive and sustainable.

Now you know why investors are putting money behind Flipkart or any other loss making venture? They are giving money for them to complete their education (or customer education) before they get a salary (customer money).

Hope you have a simple answer to a complex question that was troubling you? For more such discussions in future, do visit this blog and share with your friends.