Last week, fintech startup ClearTax raised $50MM to fuel its growth as the go-to platform for tax management and compliance. 

There are two things that are certain in life, death and taxes, quipped Daniel Defoe. The distaste for taxes, and anyone associated with it, is universal. The additional complexity, which a lot of people believe is by design, allows the flourishing of middlemen. An activity that is necessary (paying taxes), with the skill concentrated (tax professionals) is lovely or business, but terrible for consumers. Indian companies and citizens file a mind-boggling, 10 trillion INR ($140 Bn) worth of taxes every year, even a sliver of this market is massive. With more than 250K+ professionals and firms, the industry is highly disorganized.

As long-time readers would know, what do you think when you see a large, disorganized and opaque market?

Disruption.

ClearTax stepped in, circa 2011,  to be a friendly and approachable face for tax compliance. Like most startups trying to overhaul an industry, the company was started by an industry outsider, in the form of "US Return" engineer Archit Gupta. Returning from the US to help Indians file better returns sounds poetic, but it is grounded in sound business logic. 

Since the advent of the present government, there has been an aggressive push for everything government to go online. Taxes were the first to be expectedly digitized, with e-filing increasing rapidly right from 2014. Who is best placed to file tax returns digitally?

A digital tax filing startup, of course. 

ClearTax, which quietly helped e-filing happen since 2011, suddenly found itself in a good spot. Government regulation usually goes terribly for most startups (remember crypto exchange Zebpay?), but it went the opposite way for ClearTax. The Indian government announced making e-filing mandatory by 2016, and it would be brilliant for ClearTax. When the government is doing customer acquisition on your behalf (remember PayTm during DeMo?), you only say thank you. 

Early backers also found themselves extending their welcome to ClearTax, which became the first Indian startup to be funded by startup incubator YCombinator in 2014. One would expect that a startup backed by YCombinator, doing 2% of India's 45 MM (1MM) tax filings would find it pretty easy to raise capital again.

It would not be, and that is emblematic of the difficulties in consumer tax filing businesses.

While the volume of tax filing individuals is really high, the number of times one file tax is just once a year. Additionally, most people, already engaging in the "hated" activity of filing tax, scrimp on paying anything extra over taxes. People pay as little as INR 800 ($11) to file taxes. Even with 40MM people filing taxes, assuming an average of $20 spent by everyone, it's an $800MM market at best. 

Businesses with low touchpoints and high ticket size (AirBnb), and high touchpoints and low ticket size (Uber) are massive. A business with low touchpoints, and a low ticket size will have little recall value and just be a nice business.

ClearTax, unfortunately, found itself in this low-low quagmire, excarberated by the resources needed due to the high seasonality of the tax filing business (once a year). 

Investors needed a bigger problem to solve, and ClearTax began to look wider than just consumers. The company, while having a beautiful product, essentially functioned as a matchmaker for tax professionals and consumers. In early 2016, the company began to focus on SME tax filings as well. While it doesn't seem like a big change, it was a fundamental shift in the business model from B2C to B2B. 

It would turn out to be a masterstroke.

With ClearTax strung of funding for a couple of years, the Indian government came knocking again. In May 2016, the Lok Sabha (India's Lower House) passed the Goods and Service Tax bill. This would essentially enforce every Indian business to comply with a new tax regime in a year's time, and it would be done online. Systems of old would become redundant, and professionals with updated skill sets would be needed. SMBs had no infrastructure to deal with such a change and were scrambling. Who would step up when a new game-changing regulation would be passed, with legacy incumbents too slow to move?

A digital tax management startup, of course. 

Government regulations would come bringing good news again. It is little wonder ClearTax announced its Seed rounds in the same month GST was passed. While I am being speculative on the investing process here, it is clear that ClearTax was now a fundamentally better business. It's funny it took ClearTax two years to sustain on a $100K investment and was able to raise $15MM in a span of 2 months. 

Evolving from a matchmaker to a Software-as-a-Service (SaaS) company would be no easy feat. ClearTax committed to building out a product, that would help businesses be GST compliant when GST was rolled out. The market it was playing in had now expanded substantially. There were 42 MM SMBs, and ClearTax could charge them$150 per year for handling their invoices. You were suddenly looking at an $8Bn market for SMBs alone, v/s an $800MM market at best. 

It wasn't only an expansion of market that happened, the business model itself became substantially better.

From one-off touchpoints with consumers, ClearTax now had an access to daily transactions for businesses. As a consumer, I might go anywhere every year to file tax (no stickiness), but businesses once onboarded would be tied to ClearTax due to their data (high stickiness). The SaaS model also was fundamentally more profitable than the matchmaker. While ClearTax may have to pay 50-60% of its earnings from consumers to the tax professional (CA) as cost of goods, SaaS would have susbtantially better profit.

It is not unexpected that ClearTax makes 75% of its revenue from businesses, while only 25% came from consumers. It has more than 100K businesses and 25K taxprofessionals. Assuming a $300 average for business (it has fairly large clientssuch as InMobi and IBM), and $100 for professionals, you're looking at $30-40MM from businesses alone. Adding the 25% from consumers, the business is likely doing $40MM of revenue. For a deal that was worth $50MM, and likely for 15% of the company, the company is valued at ~$300MM and is at 7x revenue. 

Let's look at the unit economics. On the B2C side, assuming the company makes $20 per customer, and pays out 50% to the tax professional because it adds a technology layer, it makes $10 of gross margin. Usually customer acquisition costs (CAC) hover around 200-300 INR ($3-$4) and the company thus likely makes 2x CAC on one customer. This is healthy, but the B2B side is better.

The company would make $300 per customer every year, and even assuming it requires 10x of a tax professional's time, it is spending $100 on COGS. That is a 67% margin, or $200. Assuming business CAC to likely be 10x of consumers ($30, close to what it is found to be), the company is making 6x CAC customer. The B2B side will be significantly profitable, lifting profits for the company. The B2C will be good for branding. 

After multiple iterations, ClearTax looks like a winner in the market, with ever-increasing ambitions. From a small startup serving just retail consumers, the company has evolved into a big player serving sizable businesses. To put things into perspective on how far ClearTax has come, omnipresent accounting software business Tally does $40MM of revenue. The company's capital raise is well placed and looks likely to make investors money.

ClearTax could truly disrupt tax compliance, and capture both the market and significant profit in the process.