Is there a Startup Bubble?
"Start-ups are the engine of exponential growth, manifesting the power of innovation. Several big companies today are start-ups of yesterday." – Narendra Modi.
What qualifies as a startup?
Startup means an entity, incorporated or registered in India not prior to five years, with annual turnover not exceeding 25 crores in any preceding financial year, working towards innovation, development, deployment and commercialisation of new products and services.
Indian Startup Ecosystem
In recent years, the Indian startup ecosystem has really taken off and come into focus on its own—driven by factors such as massive funding, consolidation activities, evolving technology and a burgeoning domestic market. The numbers are depicting—from approx. 3000 startups in 2014 to a projection of more than approx. 11000 by 2020.
However, majority of these startups that get a good amount of funding have failed over the years and according to the report by IBM Institute for Business Value and Oxford Economics found that 90 per cent Indian startups fail within the first five years. While startups may be the future, the present scenario is a bed of roses with the thorns untrimmed. Recent layoffs at startups like Zomato, TinyOwl and Housing.com have led rumours that the dot-com startup scene in India is about to collapse and so the startup bubble is about to burst.
Wealthy foreign investors, invigorated by low-interest rates in India, have pumped in millions of dollars into the Indian startup market, especially in the dot-com sector. The Government led by Prime Minister Narendra Modi has urged the entrepreneurial spirit in India to surge. Under the vision of “Make In India”, the government has launched several schemes to promote self-sustainability and to encourage people to make their own jobs. Could it be that their faith in the online startup sector was misplaced?
The dot-com sector has been getting millions in funding. However, most of the companies are yet to turn profitable since investments are usually based on speculative earnings. If we have a look at the recent startups, they are funded heavily to last for the next 12-18 months. Also, most of them are working on the “unicorn” model instead of the “cockroach” model to gain market dominance. And wait, they are not alone. They have innumerable counterparts who are giving them neck to neck competition.
Recently, TinyOwl laid off around three hundred employees in Mumbai, which led to large-scale protests since their severance packages had not been paid off. Housing.com too reportedly fired about six hundred employees, and the “unicorn” startup Zomato reportedly fired 10% of its staff globally.
It is not only layoffs, but the world also witnessed a lot many billion-dollar startup deaths in recent years. As of now, only thing startups are eyeing is growth. Profitability is not in the picture. But how long can they ignore profits? Consider the case of Housing.com. It incurred a loss of Rs 48 Cr on revenue of Rs 1.48 Cr in the fiscal year, 2014. Flipkart has incurred losses amounting to Rs 2000 Cr. Numbers like these are bound to dishearten investors over time. Sooner than later, the investors will ask for the path to profitability.
How long will investors support this?
Investors are already questioning the methods employed by the startups in India which are not considering the profits and just going after the growth. One of the reasons that justify the apprehension is that startups are trying to acquire customers mainly through selling anything and everything at a discount. Moreover, they are adopting accounting methods. They are amortising discounts that they provide on sales as capital expenditure, instead of accounting for this in the year of sale. This leads to inflation of their balance sheets. Another reason is the dismal success rate of tech startups world over, which is bound to blight the Indian success story.
“If a company is losing money on every transaction, then the business model is not sustainable.” -Devangshu Dutta, CEO, Third Eyesight
Asset bubble in balance sheets: An asset bubble is considered a periodic phenomenon which occurs when the value of assets increases much faster than its real value. Sooner or later, the high prices become unsustainable and they fall dramatically until the item is valued at or even below its true worth. In this case, because the e-commerce companies are still not publicly listed, the underlying is the book value of the business as against the sky-high valuations that are doing the rounds today.
Now after establishing the fact that there is a startup Bubble, the next question is how critical it is, how soon will it burst and how much will it impact the overall economy of the country?
The chances of startup bubble bursting are minimal but there can be other consequences. This time, since the startup bubble is prevailing in privately held Indian e-commerce companies and that the valuations here are also closely linked to the soaring valuation of US tech startups, five types of events may result in an investor pullback and there can be several endgame scenarios, for the small as well as big players, alike.
Small players will eventually run out of cash and shut down operations
Declining valuations of startups like Uber and Dropbox
Companies may start struggling to raise further rounds of funding
Startups may get acquired by bigger players in the long run, with only three-four major players existing in the market.
Industry saturation and consolidation underway
How startups can control the impending damages due to bursting of the bubble: startups will first have to rationalise their costs and move towards a profitable business model. Also, they should start focusing on providing better customer service to build brand loyalty. To keep up with growth experienced, startups should continuously remain engaged in innovation to exploit the market/audience. Layoffs and devaluations are painful, but these may be considered as the much-needed course correction for the Indian start-up ecosystem.
Most of the major e-commerce startups are looking for filing an IPO in the next 12-24 months, thereby seeking a much higher valuation than what they currently command.
An IPO could be an important aspect in the Indian startup ecosystem, it is not only about the money but also about the significant amount of information that needs to be made public with the consent of the investors. That’s where they are very creative in curbing their companies. Most of them will not be able to open up to the scrutiny that an IPO brings.
Is it easy for a Startup to release an IPO?
With new guidelines from SEBI dated Oct, 2018 in the form of Innovators growth platform (IGP), an IPO for a start won’t be a distant dream. The big change in the new IGP policy framework is that it does away with the earlier requirement for a company to show its financial track record for the previous three years. Startups looking at IPOs through this route will be able to raise capital much more easily and will also have greater operational freedom and it will also create a level playing field.
Finally, to conclude we can proudly say that India has one of the fastest-growing startup ecosystems in the world. However, it is not in the best of the shapes and investors sooner than later will lose confidence in these startups also the failure rates of these startups is alarming. Though the bubble created may not burst any time soon, it is better for the startups to change their model.