August 20, 2010

"Can Capital be a Curse?" - Article by Sanjay Anandaram

This article originally appeared in the Financial Express. Reproduced with the author's permission.

The CEO naturally looked downcast as he pondered the imminent shutting down of his company which had a well known brand and enjoyed a reputation as a maker of high quality, well designed products. The management team seemed energetic and enthusiastic. Yet why had things had come to such a pass?

“I think we had too much easy money,” said the CEO. I asked him to explain what he meant. “When we started the company, the team, the concept, the business model and the market opportunity were all very attractive to investors who, flush with capital from freshly raised funds, were eager to make investments. Given this interest, we raised funds at a very attractive valuation in less than 45 days and without having to answer too many questions. We believed we were unstoppable. We set up a great office in a not inexpensive part of town, created a very informal and casual culture with flexi-times, set up excellent infrastructure to enhance productivity and hired the best. It seemed like we were the darlings of the media as well. Our launch event was very well attended and our products were exceedingly well received – everyone appreciated the quality, the innovative design, the choices, the colours and our commitment to society. You see, we’d also promised to donate a certain percentage of our sales to the under-privileged. Soon we signed up distributors to sell our products as well.”

Then what happened?

“Well, the market started slowing down and we didn’t see it soon enough. We kept insisting that the market had yet to fully appreciate our products, business model and goals. That the market would soon learn to value high quality, top designs and the choices that were on offer. However, to keep sales ticking, we were forced to drop prices. To still keep making money with our cost structure, we convinced ourselves that we had to have higher volumes of sales. To achieve this, we had to go national – more distributors and retailers, more warehouses, more sales and support people, more procurement and manufacturing, more marketing, more investment in IT systems and the like. And of course, all this required more funds. We had no problem in raising this additional financing with no real questions being asked, yet again. Our story was so attractive! Board meetings were casual and friendly without too many questions being asked. I was essentially given a free hand.”

“But we hit a wall over the next 18 months. Actually, several walls. Our receivables position was becoming alarming as distributors and retailers were facing a credit crunch, our procurement costs were still very high, logistics and warehousing costs were not reducing, attrition in sales was increasing, only some designs were selling while we had a huge inventory of unsold designs, export orders had got rejected on account of damages in transit and some big retailers were very keen to renegotiate sales commissions and payment terms. Our board was getting concerned since we were also running low on cash. Existing investors provided additional funds, this time as a loan to be converted into equity when we raised more money later. This time they asked more questions and ensured that the loan had certain covenants attached. Unfortunately, this money too proved too little as we were unable to successfully negotiate the changed market circumstances. Investors were very upset and refused to provide any more capital. They were realizing how quickly the money had gone down the chute – they hadn’t bothered asking too many questions or trying to understand the costs, product, business model and pricing issues. We too were busy trying to build great products, designs and brand without worrying about fundamentals. There was too much money that came our way too easily. We didn’t have to work hard to justify our business plan. There was therefore no discipline and rigour. Investors were carried away as well with the team and plan and the promise.”

Easy come, easy go is an old saying. If something’s not been really earned but been almost handed over as an entitlement or a gift, its value tends to get undermined over time, sometimes very rapidly as in the above example. There are enough examples all around of all types of businesses that have lost their way because they came into too much money without being questioned and without having to really work hard in a disciplined and focused manner.

What do you think?

Sanjay Anandaram is a passionate advocate of entrepreneurship in India; He brings close to two decades of experience as an entrepreneur, corporate executive, venture investor, faculty member, advisor and mentor. He’s involved with Nasscom, TiE, IIM-Bangalore, and INSEAD business school in driving entrepreneurship. He can be reached at sanjay@jumpstartup.net. The views expressed here are his own.