Investing Winter - Unicorns, Scorns & Valuation Thorns

India enjoys a vibrant startup ecosystem, that has been inclusive in nature, so far, with merit being the prime basis. It has attracted the brightest of minds across the length and breadth of the country, including the much spoken of India and Bharat cohorts. The sector has also attracted private investments to encourage the proof of concept and its scale of delivery.

The Economic Survey 2021-22 report indicated that the number of newly recognised startups have increased to over 14,000 in 2021-22 from only 733 in 2016-17. "India had a record number of start-ups (44) reach unicorn status in 2021," said the Economic Survey, adding that India overtook the UK to emerge as the third highest country in the number of unicorns after the US and China, which added 487 and 301 unicorns, respectively, in 2021. More than 61,400 startups have been recognised in India as of 10, January, 2022.

During the year 2021, at least one new startup had cropped up in 555 districts, compared to 121 districts in 2016-17. Moreover, ministry data shows that since the launch of the Startup India initiative on 16 January 2016, more than 69,000 startups have been recognised in the country till 2 May 2022. Innovation in India is not just limited to certain sectors. Startups are solving or attempting to solve problems in 56 diverse sectors, with 13 per cent being involved in IT services, nine per cent in healthcare and life sciences, seven per cent in education, five per cent in professional and commercial services, five per cent in agriculture, and five per cent in food and beverages.

Startups also reflect the ethos of contemporary India, where it is socially acceptable to work in a startup even in the smaller towns. Parents say with a sense of pride that their children work in a tech startup. This trend marks a cultural divergence, for not so long ago a so-called government job or a job with a known-brand was the only way to socio-economic acceptance. We now even have 16 January being celebrated as the ‘National Startup Day’. In a speech earlier this year Prime Minister Narendra Modi had said, “While in the pre-2014 era, only big businesses in the metros were prospering, today there is at least one startup in 625 districts of the country”.

*Startups - celebrity status 

Currently the Indian startups, collectively with 100 unicorns, with a total valuation of $332 billion, are the third largest in the world. Of these unicorns, 14 were in the limelight earlier this year. Despite the pandemic, in 2021 India saw 44 startups enter the “Unicorn” club. In 2021 alone, the Indian startup IPOs (initial public offerings) raised over Rs 45,000 crore from the public market. Some of them are even among the top 25 valuable companies on the bourses ‒ no mean task, considering that their peer-entities are as old as the new-age founders. With valuations of many of these listed entities down by a large margin currently, many investors lost monies while the initial private equity (PE) and venture capital (VC) investors may have made profits during the listing.

As much as we have to celebrate the success of our startup enterprises, and even celebrate the failures and learnings from every entrepreneurial attempt, we have to proactively worry about their   missing or can-be-bettered governance aspects. That’s something that we won’t be able to solve easily, at least for some time in the future.

Of late, there is pressure on startups to showcase revenues and more importantly profits. It’s common for us to hear of startups shutting down, our friends who turned founders or entrepreneurs admitting difficulties and business failure. It is evident that the founder of a startup has to act as a ‘jack of all trades’ across each business function. Looking at successful founders and business leaders, one learns of a simple, yet difficult skill ‒ the ‘ability to unlearn’.

*Painful losses & expensive equity

The year 2022 has been difficult for most asset classes globally. One has many choices to blame this situation on ‒ geo political issues, the Omicron wave, the Russia-Ukraine war, the silent Chinese lockdown (surprisingly, this the world still does not speak of, as much as it did not question China on how Covid came about in the first place), inflationary trends, capital markets hiccups, crash in SPACS, slowdown in commodities, crypto crash and regulatory quandary. Most PE and VC funds have seen their profits crash and valuations of their portfolio vanish. Some of them have also incurred losses and yet have that business need to raise their next investable fund(s).

“Enterprise-value-to-revenue multiples across software have been cut in half over the last six months and now trade below the 10-year average. Growth-adjusted multiples have fallen even further and are well below the 10-year average and pushing the 10-year lows. With the macro uncertainty around inflation, interest rates, and war, investors are looking for companies that can produce near-term certainty”, said a Sequoia report recently.

“Unlike prior periods, sources of cheap capital are not coming to save the day. Crossover hedge funds, which have been very active in private investing over the last few years and have been one of the lowest cost sources of capital, are tending to wounds in their public portfolios which have been hit hard”, the report quoted in the media said. “Many don't even have the capacity to invest, as the drawdown in their public portfolios has created an imbalance in their hybrid funds where their private investments (which have not been as dramatically marked down) represent more than the maximum private capacity within their funds”.

As a Smart Alec might point out, venture investing seems to have turned realistic, and back-to-business-basics. For now, there is no more easy money available. For the investors cannot afford to have any ‘full monty’ outcomes on their investments!

Let us accept the fact that fund raising, will need the ability to pitch a story. It is also narrative-gaming. For all its worth, investors will milk their stories ‒ the story of the large Indian consumer base, which they have done so far. It also helps to speak of how many problems are solved in transforming consumer behaviour. That also would make the case for hefty management fees to be collected by the private funds.

*Business lineage vs disruption

In this age of Industry 4.0, business disruption is evident from the fact that 54 per cent of the Fortune 500 companies from the year 2000 are extinct (remember Kodak?) and many other that could feature in the 2030 list may not have been born yet! McKinsey’s study suggests that the average life-span of Standard & Poor's 500 firms was 61 years in 1958, which now stands at less than 18 years. It also believes that in 2027, 75 per cent of the companies currently quoted on the S&P 500 would have disappeared. Can our startups demonstrate sufficient business case for their disruption, to help them survive another few years? 

Venture funding has slowed down over the past three quarters. What was once a pitched battle between PE & VC firms due to abundant liquidity, gave out larger valuations of tech startups. That sentiment has shifted to the pragmatic outlook of asking the portfolio platforms to be relevant to market conditions and to start meeting revenue goals. And in other terms, simply cut cash burns.

Many startups have started closing down non-core business areas, and cutting on marketing spends. The dramatic blitzkreig of IPL sponsorship to showcase the arrival of the new big-boys (pardon the gender) has to be sustained with business survival for the next few years; else it would become an expensive box ticket for having viewed few matches and hobnobbed with the cricketers!

Some are on a hiring freeze; some of them are on retrenchment mode too, even though their intentions are couched in differentiated-English argots in phrases like “heartbroken”, “thank you for valued service and belief in our platform”, “our business needs that certain roles will need to be resized or rethought-of”, “you will always be cherished”.

Talent retrenchment in the startup space has been increasing over the past few months. As much as their PR-gurus try to cow down these ‘negative’ news, it still permeates across the industry. Of course, talent resizing is part of any business rightfully, and no moral judgement can be passed. That’s where the lifestyle of the founders and investors become a sore thumb. In a business slowdown scenario, they cannot be having the lifestyle of the rich and the famous. It’s simply poor optics.

Creating Indian domestic capital pool?

Home-grown Indian venture funding entities have shown resilience in raising funds from global investors. Such a corpus is far less than what a big-3 global VC or PE firm raises as an India-specific fund. This creates a probable journey of western narrative of funding and steering enterprise-behaviour for profit booking. But who bears any losses?

Advantage India can be when we can have a larger pool of domestic funds, creating a larger global economy that is business-sustainable, investor friendly and adding value to its stakeholders. This would not allow for any knee jerk profiteering motives that one sees in many investing landscape currently.

Flogging our startup ecosystem for just driving home a point about Indian enterprises could be a risky strategy for our policy initiatives. It would be prudent to concentrate on further simplifying our ease-of-doing business and to open avenues for a larger global pool of funds for Indian entrepreneurs. We also need to create a larger academic research ecosystem to nurture such entrepreneurial journey for the nation. The classic case in point being the Silicon Valley, ably supported by the trio of academic ecosystem, private investors available with risk capital appetite and policy framework to support founders to attempt, venture failures, notwithstanding.

The risk capital will be available for nations and markets which is welcoming of them to profit. For this, the Indian capital markets have to open up with caution and not in abandoned bliss, for it could hurt the retail investors’ sentiment when profits don’t show up. Debt markets have to open up for the startup ecosystem, for it cannot grow only on the back of a privately funded equity capital, as it has done so far. The Centre can also increase the corpus set aside for funding startups in this period when global PE/VC investors are likely to reduce investments.

*Time to focus on ‘dhanda’

The PE and VC funds will continue to search for those interesting investment ideas. Here is where the Indian entrepreneurs have to showcase their mettle ‒ in building a frugally funded business and engaging the consumer. The good news is that the Indian landscape is rich with many such experience.

Accolades in Delhi or Davos should not matter for startups. Their private investors would benefit from those photo ops for their newer deals and fresh flow of fund raising into their newer themed funds. Which is what a few such large global entities active in the Indian startup community did recently at Davos. No wonder a plethora of their portfolio founders were present to showcase their journey to help those funds court new investors.

It would actually be the ability of these entrepreneurs to get their consumer engagement act right, and become part of consumers’ daily needs that could get them on the path to profitability, and business survival. The old photo memories won’t solve for failure of the business picking up. Raising money is not the same as making money! Profitable startups or companies with strong unit economics will get the newer funds that will be available.

In the larger macro context, some of these celebrated startups might have business hiccups and might even fail. It is okay to accept such failures, but not to forget to learn from those failures. It is good to go back to investing basics, and entrepreneurship basics ‒ to create a business that will survive Industry cycles, dynamism of consumer sentiments, economic volatility and still churn out profits. Surely, the Indian startups will rise up to this basic ask.