What SoftBank’s new vision means for Indian industry

When Freshworks, one of India’s largest software as a service (SaaS) companies, was raising a new funding round last year, it had an unlikely suitor in SoftBank. Until that moment, the Japanese investment giant’s Vision Fund was known more for investments in consumer-facing technology firms such as online retailer Flipkart and payments major Paytm in India, and players like China’s e-commerce behemoth Alibaba and ride-hailing operator Uber globally. SaaS firms like Freshworks may not match consumer internet companies in terms of valuations, but they have a clearer path to profitability and predictable growth.

For the Chennai and California-based company, which was launched in 2010 and valued at $1.5 billion in 2018, the round is meant to be a precursor to an eventual public offering in 2021. It was led by internal backers, including Sequoia and Accel, while public market-focused fund Fidelity was among the new investors.

“The deal (with SoftBank) did not go through because of valuation. Also, it wanted a bigger stake than what Freshworks wanted to sell,” said a source briefed on the matter.

A SoftBank executive, who didn’t want to be named, admitted the valuation was too high. “We were probably a year too late in trying to invest in the company,” the executive said.

A Freshworks spokesperson declined to comment.

SoftBank’s restrained approach, in this case, shows how the investment juggernaut, famous for its aggressive deal-making, is changing strategy as it prepares for a smaller and more disciplined version of Vision Fund. The move could have a huge impact on the Indian startup ecosystem — SoftBank is an investor in half of 24 homegrown unicorns.

How it changed the game
SoftBank made a big-bang entry in the industry in 2014, when it announced three investments totalling $1 billion. The biggest cheque was written for India’s second-largest online marketplace Snapdeal. Ride-hailing firm Ola and realty classifieds player Housing were the other two bets.

At the time, SoftBank founder Masayoshi Son said he wanted to back Indian founders at Snapdeal and Ola against Amazon and Uber.

Snapdeal tried to become the market leader in 2015 by beating Flipkart, but it slipped to the third spot behind Amazon India in 2016 as price wars intensified. So, when Vision Fund became active in 2017, SoftBank wanted to back the market leaders in two key segments of the Indian internet economy — Flipkart in online retail and Paytm in mobile payments. Both had competed with Snapdeal and its payments unit, Freecharge.

This sent a clear signal across the startup ecosystem, changing the incentives of founders when the market was just emerging from a funding winter in 2016. “Many people were trying to do business thinking: ‘Let me get SoftBank and we will figure out unit economics later’,” said a venture capital investor. “Basically, ‘Mera paas Masa hai’, the industry version of the famous Deewar dialogue, became a full-time strategy.” Even companies which were market leaders feared that if SoftBank injected massive capital in a rival, it could distort the market dynamics.

Sectors in which SoftBank has reportedly showed interest — food delivery, e-pharmacy and scooter sharing, for instance — have seen aggressive battles for market share. Last year, Swiggy and Zomato saw losses pile up to $50 million-$60 million a month. But they have now brought these numbers down amid uncertainty over which player Soft-Bank will back.

“The dial, which had moved very much towards capital-led growth, is moving back towards unit economics, especially on the consumer side. Growth at any cost is not accepted anymore or advocated at board meetings,” said Parag Dhol, MD at venture firm Inventus Capital India, which has backed Policybazaar and redBus.

SoftBank has tweaked its approach over the past 18 months and is now backing companies that have a dominant market presence, a clear path to profitability and will be ready for a public offering. These include online financial services portal Policybazaar, logistics startup Delhivery, and omnichannel retailers Firstcry and Lenskart.

While announcing a $285-million SoftBank investment last month, Lenskart CEO Peyush Bansal told STOI that though the company’s board debated going public, “staying private for a bit longer is not bad and those who wanted exits have got them”. Lenskart’s early investors have mopped up $250 million in secondary sales since 2016. “We would have gone public, but we wanted to grow aggressively and make some longterm bets before getting into the daily dynamics of being a listed company,” Bansal said, adding that he planned to use the fresh capital for capacity building and not for “price wars and advertising”.

Another likely impact of SoftBank slowing down will be on liquidity generated through secondary share sales by early investors and employees. In 2017, it collectively invested about $4 billion in Flipkart and Ola, of which $1.5 billion was used for exits by investors like Tiger Global Management, SAIF Partners and Accel India. Recently, Lightspeed and Sequoia cashed out of Oyo after founder Ritesh Agarwal bought their shares for $1.3 billion to $1.5 billion by taking a loan. Agarwal has denied any direct SoftBank involvement in the loan, but reports have suggested an implicit backing by the Japanese firm for the deal.

Much-needed reckoning
SoftBank Vision Fund CEO Rajeev Misra had told STOI last month that going forward, the firm would be “slower and more deliberate with our due diligence”. Investment pace is expected to halve and Vision Fund 2 is likely to be half the size of $108 billion that was announced earlier. In November, SoftBank’s Son said the key criteria for bets would now be the ability to generate free cash flows. “I want to make it clear… firms that accept SoftBank’s investments must be self-sustaining. We do not make investments for the purpose of rescuing companies,” Son said, in the context of the $9.7-billion bailout of WeWork after a failed IPO.

This has caused a ripple effect, as large companies are making changes in the drive towards profitability and an eventual public offering within four years. Paytm’s parent, One97 Communications, which is backed by SoftBank, is looking to cut operational losses by a third to $350 million-$400 million this fiscal. Oyo and Ola have started laying off staff, reducing fixed costs, despite raising capital.

“The companies that were supposed to have escape velocity and market leadership in large segments got more capital than they probably deserved. If you give any management team more money, it shows up in the P&L [profit and loss statement],” said Dhol of Inventus.

A less aggressive Soft-Bank is likely to change the dynamics of late-stage investment market, where Chinese internet giants Tencent and Alibaba and Prosus (spin-off from Naspers) are also active. Along with these investors and PE firms, which are getting active in backing mid and late-stage startups, local venture firms have also raised enough dry powder for the activity to continue.

SoftBank will continue to be a dominant player, but many believe the days of dealmaking driven by the fear of missing out are gone.

“Large cheques will continue to come to the market, but they will be more metricsdriven and not testosteronedriven,” said TCM Sundaram, MD at Chiratae Ventures, which has backed Lenskart, Firstcry and Curefit. “There will be sanity and focus, at least on profitable growth in 2020. It’s good for the ecosystem; new segments will have to think of unit economics.”

However, many think a lot will depend on how quickly firms in some high cash burn segments can calibrate their losses and find a way to grow in a profitable way. While companies like Snapdeal have stopped chasing growth at any cost, adopting an approach of good unit economics instead, the transition has not been easy. “SoftBank has left a hole in the market in terms of how companies are built. The reckoning is going to be worse compared to 2016 and it’s good that it will be worse,” said a venture capital investor.