[First published on 19th November 2014]

How about investing in a loss making company and getting return multiple folds?

I’m certainly not talking about trading penny stocks. Let me explain this to you.

Take company A, a startup in the online retail space as an example. The online store is a marketplace where company A displays products from sellers, takes care of the order fulfillment and at the end, pay the agreed amount to the seller.

Company A as a StartUp

Company A was set up with a modest capital of $100,000 and with good service, was able to build a large customer base in a short time. As the popularity of the e-commerce site increased, the order flows were more than expected which demanded a bigger and better infrastructure and staff. So, it was time that company A found investors to move forward.

First Investment

With a valuation of $10 million, Company A received a funding of $2 million. With the $2 million investment, Company A could afford good infrastructure and also had enough money to offer discounts to the customers. The new law of attraction goes like this:

The rate of attraction of customers towards an e-commerce site is directly proportional to the amount of discounts offered 

More discounts means that the company is loosing money and the good side is that the customer base is growing at a fast pace. This also resulted in many other competitors loosing the race in the Business and their customers didn’t have a choice other than joining Company A’s customer pool.

After an incredible Bull run, The size of the company and it’s customer base increased multiple folds, so did their losses. The interesting part is that despite the losses, value of the the company went up due to its brand popularity and the large customer base.

Second Investment

With a valuation of $500 million, Company A received a funding of $100 million. At this point, Investors who entered during the First round of investments have a choice to exit, of-course with almost 50 folds profit.

Now with many millions in the kitty, the business can be expanded, infrastructure can be improved, more discounts can be announced and more competitors can be killed.

At this point, Company A is still making losses (which is obvious from the discounts offered). But the size of the company is increasing and so is its value.

Third investment with $2 billion as valuation and the story goes on.

Who is loosing money?

If you look at this example,

  • The founders of the company are getting paid and also their share value is increasing.
  • Investors are getting multiple fold returns at exit.
  • Sellers are getting paid at their selling price and yes, they are doing good volumes.
  • Customers are happy that they could get products 40% less than the market price.

Everybody involved in this cycle is happy though the company’s financials show losses.

So who is loosing money? Nobody!

This is certainly a fascinating investment ‘Innovation’ that caught my attention in the recent days.

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