We’re 12-18 months away from a reckoning for Indian startups: Chamath Palihapitiya

Top Silicon Valley VC, Chamath Palihapitiya of Social Capital flags quality of startup capital, business models and nature of money that came into Indian startups.
We’re 12-18 months away from a reckoning for Indian startups: Chamath PalihapitiyaChamath Palihapitiya, co-founder of venture fund Social Capital, is known for being voluble and outspoken on many hot-button issues unlike most of his VC brethren housed in Silicon Valley.

Among the new breed of investors, this second-generation Sri Lankan immigrant made his mark with a hugely successful stint at Facebook, which he joined in its early days back in 2007. Having led the social networking site’s growth in mobile and international markets, Palihapitiya, 39, scooped up millions when Facebook went public.

In 2011, he got together with Ted Maidenberg and Mamoon Hamid to start Social Capital, and has since backed workplace collaboration platform Slack, online file-sharing platform Box, among many other startups, managing more than $1 billion in assets.

In India, the Valley fund has its solo bet on mobile-based payments company Ezetap, besides backing seed-stage investor Prime Venture Partners.

In an interview at the Social Capital’s office in Palo Alto, Palihapitiya, who owns the NBA team Golden State Warriors, tells Samidha Sharma why he didn't take a bet on Flipkart, where the Indian tech startups went wrong in the past few years, and the bubble in the venture ecosystem.

Excerpts from an extended chat...

Your only investment in India is in Ezetap, how’s it turned out?

India will not achieve its potential and succeed at scale unless there’s a massive expansion of its middle class. Right now, there’s no real consumer credit system but you have a large, young population that’s starting to earn.

India needs a low-cost system that can enable consumption to increase, which will then cause credit to go up. This is where Ezetap comes in, it’s built the simplest and most useful transaction and payment processing platform for collecting and making payments from any financial source, including bank accounts, mobile wallets and everything in between.

Why aren’t you doing more in markets like India?

At Social Capital, we have an ambitious world view, but we have been clear from day one that we won’t be in a position to make our world view viable unless we are also one of the most profitable funds in the world.

Profit comes from being a really good manager of risk. We have to ensure that when the opportunities exist we make the most of them, and when there is a lot of “bad” risk we avoid those areas so we lose the least possible. That’s the broad strategic overlay we take to all investments, which is why we did not invest in the e-commerce space in India.

On future India investments…

We have looked at every investable category in India. Unfortunately, many of the startups we’ve seen are just really hard businesses to make work. We want to invest $1 billion in India over the next few years, but we need credible ideas, the right support infrastructure, and high-quality entrepreneurs who are Indian born and bred. And all of this takes time.

As a result of our experiences, it’s increasingly likely that we find 4-5 companies over the next 10 years and put $50-100-plus million into each of them, than putting $20 million in 40 companies.

How would you evaluate the e-commerce business in India?

If gross merchandise value (GMV) is healthy, then the long-term issues are around fraud and true demand generation. When you look at GMV, the critical question is if that GMV gross margin is positive or negative? If it’s gross margin positive, then you can focus on the difficult job of scaling the infrastructure so you can be a viable company. But when it’s gross margin negative GMV, then it’s critical to spend time securing the capital to support this unprofitability until it’s profitable.

The risk is that this behaviour creates a long-term negative cycle that ultimately causes a company to implode.

On Flipkart Vs Amazon...

Being a really good risk manager isn’t about judging what’s obvious or known, but trying to find out what’s under the waterline and see around corners. For us, we made a decision that owning Amazon stock not only gave us ownership in the clear e-commerce winner in the US and many parts of Europe, but it gave us a free option in India.

This seemed like the right risk/reward trade-off for us. Amazon is a highly concentrated holding of ours and we are extremely optimistic about their long-term prospects globally and especially in India.

You’re an Amazon bull..

When you look at Amazon, the powerful thing they have is that they generate huge amounts of free cash flow in the US and can thus send it to India at effectively no cost of capital (no dilution, no interest rate). But if you are a local competitor that doesn’t have a multi-billion-dollar cash cow business somewhere else, you have to raise money from traditional investors.

These investors have a very different duration and risk tolerance than Jeff Bezos and Amazon. This seems like an important aspect of the e-commerce business in India that many seem to gloss over. You can’t overcome free capital and Amazon India has free capital from Amazon. Every other company is at a structural disadvantage as a result.

Your assessment of the India’s tech ecosystem...

There are fundamental issues and business problems in India that won’t be overcome with money alone. India needs the intellectual flexibility for local people to suggest local solutions, and for those solutions to be available for adoption. American investors who made money in the US and China have now deployed an unbelievable amount of capital in India.

But the Indian startup ecosystem is largely in a worse shape compared to Silicon Valley with respect to hiring, talent and support infrastructure. Companies in India have raised capital, bumbled around without proper talent, governance and mentoring, and when it’s time to raise the next round of capital, investors wonder why these companies make no sense.

Where is it headed?

I think we are 12-18 months away from a reckoning of sorts in India. The reckoning will be about the quality of capital, the amount of the capital, and the quality of the resulting businesses. Too much money came in too early and the resulting businesses that got built can’t independently exist and they can’t go public. So when you put all of that together, this will immediately change investor sentiment.

Hasn’t it already happened?

Not yet, but it’s in the offing. The same three things happened in China but with the opposite result: success. That’s because the infrastructure was more established there.

How different is India tech market from that in China?

In China, there were fewer firms trying to invest in the early days, and there was a relatively contained ecosystem that ran its own playbook. Companies in China, maybe with the exception of Baidu, didn’t have an American playbook. It took a Chinese person to come up with the idea of WeChat for example.

The point is that India is in a different state. The influence of the investor class has been too strong, and as a result companies have tried to copycat American businesses to make the American investors feel comfortable. Founders have gone sideways or they’ve created businesses that are fragile and brittle and ultimately not sustainable.

You recently tweeted that India is a perfect microcosm of the rest of the venture landscape but cycles there will be faster, so it’s important to pay attention — what did you mean?

What’s happening in India is eventually going to happen in Silicon Valley, but will take much longer because there is a lot more money and investors here. For better or for worse, I was talking to someone at a competing VC fund, he said, “What I like about Social Capital is that you are very disciplined.”

The problem with being disciplined is that there is zero emotional payback in the moment and you feel like an idiot. We had an opportunity to invest in Flipkart at a billion-dollar valuation. Do you know how it feels when you pass on a company at a billion dollars and it rips to $15 billion? You feel stupid.

Why did you pass on Flipkart?

Because I did not understand the business. There was too much operational complexity that no one understood and I was afraid of Amazon. Although at the time there was no Amazon. That didn’t matter because it wasn’t clear that the winner wouldn’t just be a function of capital vs technology or some trade secret. I was concerned that over the fullness of time, a few years of head start didn’t mean much.

What would mean a lot would be capital, expertise and patience. As a result, I believed, and still believe, that certain markets aren’t well suited to startups but rather to incumbents with limitless time, patience and capital. I view e-commerce as the canonical example of such a market.


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