Discover more from Boring Money, by Shreedhar
CarTrade takes its own sweet time to buy GoMechanic
Or how a failed startup might make its founders very rich
The idea goes that startups are valued not based on their potential for profit, but their potential to sell stories. If you’re a startup that isn’t profitable, you really have no money of your own, so your stories better be good to impress your investors to continue to give you money.
What makes for bad storytelling is lying about your business numbers and financials to your investors. I’ve written before that investors don’t care too much about fraud against the public, government, etc., but they definitely care about fraud against themselves. Accounting fraud is fraud against your investors so they care about it a lot.1
Two months ago, GoMechanic’s founders admitted to some accounting fraud and investors weren’t super happy. GoMechanic is in the business of aggregating car-service garages on their platform (like Oyo does for hotels) and their accounting fraud was to say they had more garages on their platform than they actually did, and hence more revenue. In early 2022, the founders had great storytelling abilities and were looking to value the company at $1.2 billion. After this fraud stuff became public, their storytelling took a hit and now they’re looking to sell off the company at $30 million.2
I want to emphasise that between early 2022 and early 2023, nothing particularly changed in how the company did business. Yes, the founders had exaggerated some numbers, and the overall startup funding market is down, but the GoMechanic business in 2022 wasn’t very different from the GoMechanic business in 2023. If GoMechanic has exaggerated its revenue by, say, 20%, the “rational” way to look at it would be to discount the valuation by around the same figure.
But that’s definitely not how startup valuations work. If you’re a startup founder that lies to investors, it makes for a bad story, and that makes your company worth much less than it would be otherwise.
CarTrade gets a better deal the longer it waits
The Morning Context reported earlier this month that CarTrade, a second-hand car marketplace, was going to buy GoMechanic, for $30 million. CarTrade denies that any decision has been made, and instead says that talks and considerations are ongoing.
If there’s a fire sale, as a buyer you’d want to buy up the goods ASAP before someone else can scoop them up. But CarTrade doesn’t seem like it’s in too much hurry.
One significant difference between regular fire sales and startup fire sales is that few buyers can actually buy entire startups. If you’re a startup trying to desperately sell yourself, it’s usually either your competitor or a company in an adjacent space that can get any value out of you.3
Now there aren’t too many startups in the same industry as GoMechanic. Working with garages is difficult—they’re fragmented, extremely tech averse, even teaching garage mechanics to use your app might be quite a challenge. And if you’ve ever tried to service a car you’d know that honesty isn’t garage-owners’ strongest suit (GoMechanic clearly fit right in). GoMechanic didn't have too many competitors to begin with, and it’s easy to imagine that those that existed wouldn’t really have cash to spare to buy a whole company.4
So GoMechanic’s best bet would be companies in an adjacent industry. It reached out to everyone, including Cars24 and Spinny, two of CarTrade’s direct competitors in the used car industry, but they refused.
If you’re CarTrade, and you want to buy a company that was valuing itself at $1.2 billion the year prior, which had been valued at $285 million two years prior, for a steal-deal of $30 million, you’d normally just leap in to buy it. But if you’re the only buyer on the market, the longer you wait, the more desperate the seller gets, and the better the deal you get.
What makes it even more difficult for GoMechanic to sell at the $30 million price is that Orios Venture Partners, one of the company’s early investors, told its own investors that their investment in the company was worth nothing. That’s probably a price that CarTrade is willing to pay for GoMechanic.
Orios expects to get nothing, the founders get rich?
If we went forward in time and saw that GoMechanic did manage to sell itself for $30 million (or $10 million, or $1 million, or whatever), would we think of the startup to have been successful?
The answer is no, no, absolutely not. GoMechanic has raised $62 million till now, so selling for anything below that just means that it burned money. But can a failed startup be profitable for its founders?
GoMechanic’s 4 co-founders own about 25.5% of the company. If GoMechanic does sell for $30 million, they’d get about $6 million or around ₹50 crore between the four of them. That doesn’t sound too bad, honestly. If you were an early investor in GoMechanic, like Orios, you burned cash. But if you’re a founder, being able to sell at any price means that you get rich.5
Addendum: After a couple of folks in the VC space objected to the last paragraph above (about the founders getting rich) maybe it’s worthwhile to expand on it in the main post itself, instead of in the footnote:
Venture capital investors make risky investments in startups. Sometimes the founders of these startups are young, untested folks, getting large amounts of cash for the first time. All of this adds to the risk. A nice way for investors to reduce the risk of losing money, is to insist that they are paid first in case the company is sold, acquired or something along those lines. So if a VC investor invests $10 in a company for 10%, but the company is sold finally for $50, instead of getting 10%, that is, $5 , the VC might get $10 (their original investment) or more, depending on the exact contract and other VCs’ contracts.
The last two years the market was hot and startups had a lot of money. The competition wasn’t between startups to get funded, but between VCs to fund the right startups. (Tiger Global managed to get a reputation to fund large amounts with minimal due diligence.) So, it’s possible that GoMechanic’s founders negotiated having no liquidation preferences while taking investments, since it raised money when the market was high. There’s no mention of liquidation preferences in the media at the moment, so we don’t really know the case. But whether the founders do get rich or not depends on those specific liquidation preferences GoMechanic’s investors negotiated when they invested.
I think this can be a recurring theme for this newsletter. For investors, fraud is fraud only when they’re the ones affected .
Startups that don’t generate cash can’t be too valuable for other investors who aren’t in the same or similar line of business. For instance, a private equity firm that’s in the business of buying companies usually buys inefficient businesses and relies on extreme cost cutting to increase profits, before selling it off. Can’t do the same for a startup which doesn’t make any money in the first place.
A good contrast to a startup like GoMechanic, that’s difficult to sell, are fintech startups. Fintechs have tons of competitors in banks, payments companies, NBFCs, etc, any of whom can buy them if their mood’s nice. Being a player in a crowded space has its benefits.
This isn’t always true, of course. Sometimes founders invest a lot of capital in their startups when starting out and selling below that price obviously means that they lost money. Separately, investors often have “liquidation preferences” that’s basically a mandate that if the company is sold, acquired, etc. they get paid first. At least until they recoup their initial investment. That said, the last couple of years have been very founder friendly, and GoMechanic was a market leader. There’s no indication of a similar liquidation preference being applicable in this case, but it’s also me just guessing.