Chiratae News

Would you rather have a small stake in a big firm or other way round?


March 26, 2015

It’s not the percentage of stake owned by a founder but the absolute value of the stake that has more importance, say experts

Do you know Jack Ma’s stake in the Chinese e-commerce marketplace Alibaba is valued at around US$13 billion? What about the equity stake of Travis Kalanick, Founder of San Francisco-based Uber, which is valued at US$4 billion? It is surprising to know that these mammoths own below 10 per cent of stake in their own companies after several tranches of funding by investors.

This trend of diluting stakes by founders to a minority after each investment has been witnessed globally for many years. And, this trend is catching up with Indian founders. They have little choice because it is important to raise capital regularly to drive growth resulting in dilution of stakes.

Despite this, what drives their passion to create something new every day? According to a recent report by Economic Times, less is more rewarding for founders of high-growth Indian startups. It states that a number of founders who diluted their stakes to a minority for boosting valuations are now worth millions of dollars. This is because it’s not the percentage of stake owned by a founder, but the absolute value of the stake that has more importance.

Sachin Bansal and Binny Bansal each hold a 7.5 percent stake in Flipkart, with their individual holdings at more than US$800 million in the e-commerce player.

Ashish Gupta, Senior Managing Director and Co-founder of Helion Venture Partners said, “If someone is looking for control, then ownership is important. However, if one is looking for value alone, then absolute ownership is important.” Helion has invested in property search portal

Massive growth in tech investments

Tech investments are booming in India with e-commerce and taxi-hailing companies such as Flipkart, Snapdeal and Ola leading the charge. According to a report by CB Insights, in 2014, 71 different VC investors (VC and corporate VC) have made investments in Indian tech companies, which is more than the last four years put together, and 22 per cent higher than 2013.

The burgeoning growth in the number of tech startups is due to the increase in the number of Internet users driven by rapid adoption of smartphones and affordable data tariffs. According to NASSCOM, about 800 new tech startups were set up in the fiscal year 2014, and this is predicted to rise to 11,500 by 2020.

The positive economic sentiment after the change in the government is driving more venture capital firms into the country. There has been a growing interest not only from the West but also from Eastern giants such as Alibaba, Temasek and SoftBank (which plans to pour US$10 billion into India over the next few years).

Race for market dominance

Fundraising cycles in the country have condensed as Indian startups want to stay ahead of the competition. Snapdeal raised two rounds of investment from Ratan Tata and SoftBank in a matter of two months. Kunal Bahl, Co-founder of Snapdeal owns less than five per cent stake which is worth US$100 million. Ola, valued at US$1.4 billion, raised its Series C and D funding within four months. Bhavish Aggarwal, Co-founder and CEO of Ola has a 12 per cent stake, which is worth US$168 million.

“In most cases the founders have diluted their stake to raise appropriate amount of funds to win against the competition and not just as a trade-off to boost the valuations, which is more a result than a driver. Any founder who just wants to secure large amount of capital to raise valuations, without strong underlying business traction, is generally not backed by investors at all stages,” TCM Sundaram, Founder and Managing Director, IDG Ventures explained to e27.

Larger companies with a significant share of the market have a better chance of survival than smaller players. Samir Kumar, Managing Director of Inventus said, “It is better for an entrepreneur to own a smaller percentage of a bigger pie, compared to a larger percetage of the pie. This is because a larger entity is inherently more stable than a smaller entity, and chances of failure reduce significantly with size.”

Don’t worry about dilution

In the early stages, founders have large ownerships in their startups but in order to fuel growth, there is a need for continuous investment leading to dilution in stakes. Indian founders have started diluting stakes for amplifying valuations because in the end it is the absolute value that matters.

“It is more important to have a reasonable percentage of ownership in a rapidly growing company with a large market opportunity than a significant/large ownership in a slow growing company. So, our recommendation to all founders has been to raise money when available and use it to grow the company rapidly along with its valuation, and not worry about dilution,” explained Sundaram.