Startups: Is It The Beginning Of The End?

With the Delhi High Court issuing orders to the government to investigate 21 commerce sites for violation of FDI norms, the party of highly valued startups is facing a reality check. When such an investigation is combined with a slowing trend in funding, there is a belief that developing markets are going to witness a second dotcom bubble. Or are we seeing a bubble when there is none? Data suggests that this year $6 billion was pumped into Indian companies through 600 deals. This has been the largest amount of money being bet on the Indian startup ecosystem. This has also led to several legal hassles and that is just the beginning.

BW Businessworld in its stories -- Caught in the Big Sale and What Clicks, What fails -- pointed out that there are several things that are not working in favour of the Indian startup ecosystem.

First, the structure of these e-commerce companies are to be questioned. The market is cornered by four e-commerce companies which have created several logistics and wholesale companies that exclusively buy products on behalf of their parent marketplace business. Everyone knows that Foreign Direct Investment or FDI rules suggest that only 25 per cent of the product can be sourced from allied businesses (where the market place company is a stake holder through a another registered entity). All e-commerce companies are flouting these rules. To name a few, there is W S Retail, which is linked to Flipkart, while Cloudtail and Prione are linked to Amazon. These wholesale and logistics companies and the myriad of sharing holding structure is perhaps what the government is going to investigate.

These companies were created because FDI is not permitted in multi-brand etailing. These wholesale arms of etailers buy in large bulk from original equipment manufacturers and discount products on a large scale which is against the spirit of the law because marketplaces are supposed to connect with the 12 million small sellers across the county. This is the first case which is being investigated by the government. However, the government needs a forensic accountant to remove the haze that surrounds the accounts of structured companies, which are registered in different names and has different shareholders under whose name the monies have been pumped in to the parent organisation. If this is proved, then the government will emerge triumphant. Unfortunately, it will be detrimental to employees and consumers.

This is the second aspect to consider; if funds stop investing several of these companies will close down and at least 75,000 jobs are at stake. What's more, the trickle affect - of funds escaping India because of its legal and tax implications - can be felt by 5,000 other startups that are employing at least 10 people on an average. Unemployment will continue to be rampant in the coming years. Data from the Labour Department suggests that only 16 per cent of the total 600 million work force - were salaried employees in the country. About 50 per cent were self-employed and the rest were casual labour. As many get added to the salaried pool, startups are expected to provide at least 5 million jobs. Without an ecosystem to foster the growth of ideas, job losses will be a common phenomenon among youth.

However, this cannot be a reason to stop probing companies that have flouted FDI rules. The investigation will be on funds which have created different arms to maximise shareholder returns.

The consumer is used to discounts today because these wholesale arms have been able to negotiate prices with OEMS or manufacturers. No wonder the All India Footwear Manufacturers and Retailers Association approached the high court and prayed for an investigation. To substantiate further; Nike and Puma get 35-45 per cent of their revenues from market place owned wholesale companies. No wonder small sellers cannot discount their items on market places when competing with these wholesale companies.

The third factor is the tax harassment in India which is having an adverse impact on entrepreneurship. Several small sellers are harassed by state governments to pay additional tax for selling on market places like Amazon, Snapdeal and Flipkart if their product moves from one state to another in the country. On one hand, market places use their own companies to negotiate prices, which violates FDI rules and on the other hand there are state governments like UP and Karnataka which harass small sellers for using market place platforms. With extreme confusion from the federal nature of Indian taxes and courts, doing business is extremely difficult. No wonder, the lawyers and politicians and, some businessmen, get rich while the rest remain confused about the nature of doing business on etailing platforms.

Fourthly, companies will continue to fail. This is the nature of the startup business. Funds chase a few trends and only 1 or 2 companies survive. This has been the nature of fund raising. The latest to go through a rethink are hyper local delivery businesses and food tech and delivery startups like Tiny Owl. This year realty dotcoms like Housing are going through a reiteration of business plans. There have been lay-offs in Zomato. And amidst all this, the entrepreneurs pay for the loss and not the funds because of the preferential liquidation clause, which means the fund gets its invested amount when the company makes a fire sale to a buyer.

However, BW Businessworld supports the spirit of ideas and entrepreneurship, which is sweeping the country. Unfortunately, the other small businesses struggle to survive, the concentration of large sums of money in very few companies will destroy the fabric of employment and civil life.