'Software is one area where you cannot buy customers'

Software companies have started attracting a significant amount of funds from investors like Tiger Global Management and Steadview Capital, which, until now, primarily betted on consumer internet space. The flow comes amid a financing boom in India's startup industry, the first since 2014-15.
It mirrors a change in investment trend in the US, where software companies such as videoconferencing player Zoom, cybersecurity firm Crowdstrike and analytics company Datadog have had successful public offerings because of a clearer path to profits compared to heavy loss-making consumer-focused WeWork and Uber. But the flow of capital has also created fears of overvaluation and a bubble.

TOI spoke to Naren Gupta (NG), the Silicon Valley-based co-founder of Nexus Venture Partners, about these overvaluation concerns in the software market, challenges in building in SaaS (software as a service) companies and the fallout of WeWork's failed IPO. Nexus, which has $1.5 billion in assets under management, has backed companies like Druva, Postman and Delhivery.

Gupta, an IIT-Delhi graduate and a PhD from Stanford University, has about 20 years of experience in investing, especially in software firms. The 71-year-old had co-founded software company ISI in the US and took it public in 1990.

TOI: The boom in venture funding this time is being led by software firms as much as consumer internet companies. What's your view on valuations?
NG: In Silicon Valley, software company valuations have gone up dramatically, particularly when you have predictable annual revenue rate (ARR) models. And everybody's sort of wondering if those valuations are really justifiable. Now, I mean, one thing I would say that's very important in the US and India to some extent is that in the past five years, software is having a bigger and bigger impact on non-technology industries. I think this is where the perceived market has become larger. If you look at Salesforce 10 years ago, it was used primarily by technology companies. And today, they have expanded way beyond that to traditional industries. I would say the valuations are on the high side. Will that change? It is very hard to tell. Interest rates are low. These companies, even with $200 million to $300 million revenue, are growing at 25-30% a year.

But on the other hand, I would say consumer companies in the US have even more ridiculous valuation in areas like food delivery. The economy is booming in the US and unemployment is at a 50-year low. So, the Valley is in a full-fledged boom.

TOI: After WeWork there's a lot of talk of profitability. How has the mood changed over the last few weeks?
NG: I would say it's been changing under the surface in the last six months, even before the WeWork fiasco. For a long time, the mood was growth at any cost. Money was cheap. There is definitely a swing towards growth at a reasonable cost.

You are seeing that profitable companies going public are getting multiples which are 2-3 times higher than companies with losses. So, there is talk that companies need to become profitable someday and I believe that is a trend you are going to see getting stronger over the next twothree years.

TOI: Last time the initial signals were markdowns by mutual funds. What do you see as the signal this time? How do you think it will be different?
NG: Firms like Fidelity were investing from their public funds, where they have a small allocation for private companies. They are required to mark it every quarter, so it became visible. This time, the funding is not coming from those funds. So, the problem is sort of hidden under the surface.

I think the markdowns this time will not be uniform with every company at 25%. Some companies will be marked down 80%, while others will be just fine. I think it's going to be pretty non-uniform. I think the write-downs will be mostly by hedge funds. I don't think it will be a bloodbath like the dotcom era as all of them are real companies.

TOI: In case of companies attracting capital, going forward, do you see the bulk of money shifting from consumer internet companies to software ones in India and the US?
NG: I think consumer companies are changing perhaps, as areas like net banking have emerged. I don't think the money is moving dramatically. In India, it is a bit of a lag with whatever is happening around the world. So, every VC in India, whether they know software or not, wants to invest in software, whereas five years ago, they wanted to be in the internet space.

Software requires a fairly deep understanding of customer needs and what technology makes sense. SaaS is just a segment of the software market. Some of our best companies in India are very deep tech SaaS firms, which are unlike mostly application SaaS companies.

TOI: How do you see the funding bubble playing out in India this time compared to what we saw in 2014-15, which was led mostly by consumer tech?
NG: The bubble seems to get bigger and bigger. The round sizes are larger, burn rates are significantly more and 14-15 was a blip compared to what is happening today. Some companies would succeed, and most will fail, but India will come out ahead.

TOI: There's a lot of talk about the future of Vision Fund 2. If it doesn't happen, what do you think will be the impact on the startup ecosystem, including India?
NG: I don't know the status of Vision Fund 2. If it doesn't close, I think it's going to have a big impact on high cash-burning companies. Entrepreneurs are smart and they would have to cut down the burn earlier in their growth cycle, even before they reach the stage of going to Softbank. Profitable companies will be valued even more highly, and profitability will become important for venture returns. We have already seen some Silicon Valley investors talk about profitability in the past six months.

TOI: How much of it could trickle down in India?
NG: I don't see any impact right now. I believe whatever happens in the US, it takes six-eight months to impact India. There's pressure on Indian consumer companies to become profitable, given what is happening at Uber. The problem in the US, once you go public, is that you cannot have the stock price drop that much not because of shareholders but because of employees. Our thesis in the consumer space is that big cash burners are not sustainable long term.

TOI: Some overvaluation is now coming into software startups. We saw after 2014-15 that consumer internet had to grow into valuations. How tough will this cycle be for software companies?
NG: The key is growth. Software companies must be product-led. The product must address a significant problem in the way that customers want. The biggest challenge is that the gestation period is quite longer compared to consumer internet companies.

It might take one year to come up with a product and building customer confidence another year. The real proof and the growth of the company comes in maybe three, four years. From then, it's just such a good fit for the market and you have a unique positioning that revenue would at least and triple every year for the next few years.

Indian companies tend to have higher churn in customers. Software is really one area where you really can't buy customers. When you are selling software to a company it's the relationship and commitment for not just a year or two, but for 10 years. It is not just a transaction business, and Indian companies sometimes tend to have some kind of a trading mentality.

TOI: Nexus has been an early backer of Snapdeal and two years ago it seemed like that investment will be a write-off. Do you think you will make money on Snapdeal?
NG: Yes. We were the few people who stood up two years and backed Snapdeal, saying it will be okay and will come out of this mess. We will not make as much as we would have liked to. The company has come around quite a bit.