Decoding the Funding Woes Of the Indian Startup Ecosystem In the Wake Of COVID-19
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The Indian start-up landscape registered massive growth and made windfall gains in 2019 on the back of large-scale government support, access to easy growth capital and technological innovation. Data by industry body Nasscom pointed to the fact that with the addition of more than 1,300 tech startups in the year, India continued to have the third-largest number of start-up ventures in the world. The year 2019 also witnessed a record, nine start-ups in the country achieve the coveted unicorn status (clocking a valuation of $1 billion) while four start-ups were listed publicly.
However, the Indian start-up growth story has adversely been impacted since early months of 2020 with the outbreak of the COVID-19 pandemic. With the COVID-19 virus engulfing the globe, the economic climate in the country has certainly become highly turbulent. With business environment being extremely dynamic, almost on daily-basis, small businesses and start-up enterprises are finding it exceedingly difficult to raise working capital in the face of falling valuations.
Promoters of startups are under severe financial stress and are facing challenges to maintain operational continuity, with availability of traditional funding options being scarce. In fact, if one were to believe the trade buzz, several start-up businesses are already in the process of initiating steps and consulting their advisers to restructure their financial positions and tide over the COVID-19 crisis.
These are indeed challenging times. It is being observed across the board, from early to growth-stage deals, start-up businesses are experiencing a sharp fall in valuations ranging from 20-30 per cent including down rounds, at times. As a liquidity crisis taking the forefront, promoters are being forced to relook into their valuation demands and agree to tougher commercial terms. Investors are adopting cautious outlook by trenching-out the investment and choosing to have a tighter control on the usage of investment funds.
Kick-starting the sale of non-core assets in the current stressed environment may not prove to be a viable fund-raising alternative. The problem is compounded by the liquidation preference right which may be already granted to existing investors. In the event sale of non-core assets triggering such liquidation preference right, the investor would be the first recipient in the proceeds distribution waterfall and accordingly, it may not be possible for the company to receive the entire sale proceeds from such sale.
A report brought out by think tank Gateway House in February 2020 stated that an estimated $4 billion has been pumped into Indian startups by Chinese tech investors. China accounts for substantial foreign direct investment (FDI) into Indian start-up ventures. Given the change in the FDI landscape by the government of India recently, FDI from China, including from the investors residing in China, will require prior approval. This will certainly slow down the flow of FDI coming from China in the startup space.
Given the ambiguity around the ‘beneficial owner’ construct proposed in the latest FDI amendments, there are possibilities of the approval route being extended to investors/investment vehicles even outside China, in case the funds are mobilized from or controlled from China. Clarity on these aspects shall be necessary, in absence of which the FDI flow is likely to get hampered even from the other countries, one such example being Hong Kong.
The Indian start-up ecosystem has contributed immensely to the growth and development of the Indian economy and has also been a large-scale employment generator. The Small Industries Development Bank of India (Sidbi) in the month of April, 2020 has announced COVID-19 Start Up Assistance Scheme (CSAS). As oppose to the investment philosophy of Sidbi which is investing in equity, CSAS intends to provide working capital term loan of up to INR 2 crore to startups for a tenure of up to 36 months.
While this seems to be a ray of hope, some of the conditions attached to CSAS such as startups having positive unit economics, having positive net worth, having minimum turnover between INR 20 crore to INR 60 crores may result in various start-ups not meeting the eligibility criteria. The government of India will have to address the liquidity and funding requirements for the startups in more inclusive manner.
Given the global sentiment for de-centralizing the supply chain and finding feasible alternatives to the existing supply chain heavily reliant on China, initial steps taken up by the government of India towards the vision for Atma Nirbhar Bharat, increasing sentiments for being ‘Vocal of Local’, the startup space in India is well poised to play a pivotal role and make their mark on the India growth story certainly more than ever before. Impetus in the right direction will pave way and go a long way in helping the start-ups in India leverage the unique opportunities on offer.
* Vinayak Burman, Managing & Founder Partner, Vertices Partners; Hardik Thakker, Senior Associate, Vertices Partners