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Startup Funding, Challenges And Opportunities It is important to understand this sector as it will help in determining the growth prospects

By Anshul Khetan

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In his thoroughly researched book, India Unbound, one of the most fascinating thinkers of modern India Gurcharan Das points out that the idea of entrepreneurship ranks third in the caste system (Vaishya community or business community). He adds that knowledge (Brahmin-ism) appears first in the social hierarchy which is one of the reasons why India does not produce many entrepreneurs. Till date, many businesses are family-owned or handed down in legacy. This book was published almost twenty-one years ago. The point of why India cannot produce entrepreneurs made sense to readers, critics, academia, and intellectuals when the book was released. But in the past twenty years things have changed.

Today, increasingly, there are many young people who want to start their own ventures. Various studies reveal that the tendency to start one's own venture is very high in Generation Y (those born in or after 1998). This is because they have seen quite a few uncertainties in their life (2008 Global Financial Crisis and the present pandemic). Given this inclination, it is important to understand India's start-up sector which is attracting many young people. More so, it is equally important to understand the challenges, opportunities of this sector as it will help us in understand the growth prospects of this sector. Here is the low-down:

In the first nine months of 2021, private equity-venture capital (PE-VC) investments continue to grow and reached record high of $49 billion. This is 52% higher than what was invested over the same nine-month period last year and exceeding the full year 2020 investment figure of $39.5 billion. The deal count between January and September 2021 has reached 840 deals compared with 651 deals in January-September 2020, data from Venture Intelligence shows. This tally excludes PE investments in real estate. Some notable VC funding deals announced in India during January-July 2021 include $3.6 billion raised by Flipkart, $502 million raised by Mohalla Tech (ShareChat), Zomato's capital raising of around $500 million, and $460 million raised by Think and Learn (Byju's). This shows the growing acceptance of the ability of Indians to do well as entrepreneurs. Besides this, a crucial factor many point out is: Today, any good idea which is commercially viable and addresses a space where demand or incremental demand is high will not go unfunded. Funding of a good idea of a start-up is not a big challenge. The other major factor being most of these ideas are asset light and are solving an end-user pain point which makes it attractive for the investing community.

Most, however, point out that there is still a "perception challenge" which many people who want to start a venture face. And that challenge is: understanding the creditworthiness of start-ups. Many point out that banks and other funding entities look at start-ups from a very traditional business point of view. Start-ups are evaluated from the variables of debt-to-equity ratio, profits and other profit and loss and balance sheet items. The point they miss is unlike traditional businesses where the bank takes risks like equity contribution risk, project risk, operational risk and market risk most of the start-ups already have achieved a reasonable scale and have large equity financing upfront before they reach out to traditional lenders. . But venture capitalists and other strategic investors such as private equity firm look at the scalability of business. They look at what a start-up intends to address. If a start-up intends to address a demand, then its success is sealed. If not funding from banks, there are investors who are looking for interesting ideas. Analysts and economists note that globally there is liquidity which is chasing good ideas.

Proponents of start-up business model say that in terms traditional parameters to gauge a business, it is important that financers look at visibility of revenues, profitability, and gross margins of a start-up. It is estimated that a start-up founded on a solid idea takes three to five years to breakeven in its business. Once breakeven is achieved, these businesses run like any listed professionally run company with significant professional oversight. Besides, start-ups are new age business ideas addressing new age problems or demands. Losses of start-ups founded on a viable idea are largely due to marketing, employee expenses, and expenses related to technology. Largely, these losses are not related to poor response to business model. Further, the losses are largely funded by equity the financing is required for growth. Hence, most believe that funding entities must look at start-ups from a new perspective.

In addition to this, many a time, lack of understanding of a business model of a start-up becomes huge barrier in its funding. Many a time, businesses take time to reap the desired results. Habits formation takes time in consumers. The process is to attract consumers and then convince consumers to buy products by giving them good and cost-efficient services. Once a consumer is used to buying a service, there comes a point he or she may buy services more frequently. Many traditional and old funding entities do not understand or are not convinced about this process. But given the tremendous response to start-up Initial Public Offerings (IPOs) in recent times, there are investors who find a certain amount of value in these businesses.

Also, since most start-ups have no predecessors or peers in the industry, they operate they are deprived of any potential funding. This is a key reason why banks and other funding entities stay away from funding start-ups. But a counter point to this line of thinking is why would a start-up have a peer? A start-up is an innovative idea. It is not a Me-Too company which enters a business because it has low entry barriers. A start-up idea is an exploration of a virgin territory. This is a fundamental reason why a start-up does not have a peer or predecessor. Lastly, most traditional funding entities such as banks look for collaterals when they finance manufacturing companies. These entities follow the same approach when it comes to funding a start-up. Again, this expectation of a collateral or security is against the very grain of entrepreneurship. The collateral of most start-ups is their brand power which they have earned over a period. This is intangible asset. But it is an asset, nonetheless. The stupendous response to recently listed start-up IPOs is a proof of how large investors are willing to pay premium for brands which have established themselves in recent times.

In the coming years, there will be increasing number of people who will prefer starting their own venture. This is because in a growing economy like India demand is either growing or stable. Any service which meets consumers' expectations is rewarded by Indian consumers. The success of Amazon and Amazon Prime Video is a case in the point. But the only way a start-up will receive acceptance of traditional funding entities is when they not only address a real demand which is sustainable but also deliver on their services and financials in the long run. A start-up founded on a well-researched premise which addresses a real absence of a service and provides it is likely to score well not only financially but also in terms of quality of services. This is because only by achieving these goals start-up businesses can be taken seriously by markets.

Anshul Khetan

Head, Debt Syndication, Advisory, Edelweiss Wealth Management

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