- Cockroaches are startups that can survive long periods of
winter fundingsuch as pests that can survive through nuclear war.
- Most startups go through the cockroach phase at least once, gaining experience and knowledge as well as strategizing their business, experts say.
- For startups that cannot survive without external funds, the future is bleak leading to mergers, acquisitions and in worse cases even shutdowns, experts say.
The Indian startup ecosystem is maturing but it is also getting a shiver in the start of winter funding. In these situations, venture capitalists (VCs) turn their focus from unicorns – companies valued at $1 billion, to cockroaches – companies that will survive the test of time. The name is a reference to the fact that cockroaches have been known to survive even a nuclear war.
Anirudh A Damani, CEO of Artha Group defines a cockroach as a startup that does not need external support to survive. “It can run forever on the cash it generates from selling its products or services at a profit — something a loss-making startup can’t do because its biggest customer is the venture capital investor,” he said.
The struggle for funds is not an unknown challenge for most startups starting at the pre-seed level. However, this time around a long funding winter has arrived and is expected to last anywhere between 6-18 months according to many experts. And funding began to dry up six months ago – falling to $2.7 billion in the quarter ending September 2022 from a peak of $15.9 billion the previous quarter, according to a report by Venture Pulse.
A good startup can survive through dynamic changes, experts say. “Startups that follow the cockroach strategy persist despite changing market conditions, environments, and investment scenarios. Most startups go through the cockroach phase at least once, gaining experience and knowledge as well as strategizing their business despite changing market conditions,” says Mitesh Shah, partner at Physics Capital.
To ensure that a startup becomes a cockroach, businesses need to make difficult changes to their models – founders need to pivot the focus from valuations to cash flows.
“Unicorns sitting on cash always live but those at the end of their runway struggle. However, the good thing is that because of these times, companies have started to focus on businesses in terms of unit economics and the path to profitability rather than just looking at fundraising and vanity valuations,” said Bhaskar Majumdar, managing partner, Unicorn India Ventures.
Sustainable unit economics is key
For the VC ecosystem, which has seen hits and misses in great measure, the funding winter was an acid test. “In these winter times, businesses that solve a basic human problem thrive at the expense of companies that buy profits under the guise of deep discounts that lead to unsustainable unit economics,” Damani said.
For startups that cannot survive without external funds, the future sadly leads to mergers, acquisitions and in worse cases even shutdowns.
“In the current environment, where funding parameters have become tighter and valuations are under pressure, startups (their founders and investors) are looking at alternative survival strategies. Some startups that heavily dependent on funding for survival and growth often do a distress sale or shut ship,” says Majumdar.
Sectors like edtech, which have raised a lot of funding during the pandemic, are also in trouble due to overestimating the TAM or the total addressable market. Consumer-facing sectors that show the ‘need’ to spend money to acquire customers can also reduce a startup’s ability to become a cockroach.
“Because their marketing spend is key for customer onboarding and a huge contributor to burnout, unless they are able to pivot to models that can sustain current business operations without discretionary marketing spend, there is a huge chances are such businesses are in most trouble,” said Ankur Bansal, co-founder and director of BlackSoil.
Late-stage startups in most trouble
Cockroaches who want to survive will also have to lower their valuation expectations, experts say. This is especially true of late-stage startups, which will require more funding, and also need to show a path to generate cash.
According to Shah, late-stage startups will face the most trouble getting additional capital, as valuations reset and there is a renewed emphasis on profitability. There also needs to be a moderation in valuation expectations, in line with changing market dynamics.
“Good companies can certainly get access to capital but they need to be more accepting of valuation multiples. Some correction in multiples is necessary for good markets, from time to time. But yes, many companies have and should be open to strategic outcomes from larger peers or established corporations,” said Apoorva Sharma, partner at Stride Ventures.
How to become a cockroach?
Sharma believes that Indian startup founders will channel their strong survival instincts. “These are pruning costs to ensure they have a longer runway. Some companies have actually shown improved unit economics,” he told Business Insider India.
According to Shah, many of those who may fail the exam are those who have utopian visions that exceed their abilities. Cockroaches must have sound fundamentals such as product demand, a short product development cycle, and controlled capital expenditures.
“An important part of a successful cockroach startup is focusing on a specific niche or target market, even early in its journey. A targeted, long-term business concept and a captive market are necessary for be a successful cockroach startup. A value-based proposition is essential if an organization wants to reach its target clients. A company needs a unique business selling proposition to get investors to reach out their pockets,” Shah said.
Bansal believes that a strong focus on fundamentals and cash flow is the essence – cockroaches are the startups that can eschew the concept of growth at all costs and focus on capital efficiencies. Most VCs also say that it is the founders who have to go through a mindset change with the startup.
Majumdar lists the qualities of a good cockroach that can thrive when funding is slow –“Survival instinct of the founders, ability to make the business clear on a clear profitable path, low key nature and not in the business of building a profile for for its sake.”
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