India's changing corporate landscape

We are in the early stages of an extraordinary episode of rapid scaling up of new companies

Over the past 15 years, economic activity as well as wealth creation has shifted noticeably to the unlisted space globally. According to data compiled by the World Bank, despite significant gross domestic product growth, the number of listed firms worldwide has been unchanged since 2006, after nearly doubling in the previous 20 years.

During this period, flow of funds from private equity has grown. So have deal-sizes: Even large firms are now able to get equity capital without necessarily going public; whereas firms would earlier list at relatively early stages, these days one reads about private fund-raising at valuations exceeding $50 billion.

Aware that private equity (PE) was growing rapidly in India too, a few months back we began an exercise to identify unlisted companies with a valuation above $1 billion (going forward called “a billion”), which are called unicorns. The objective was to understand the impact these firms were having on the economy. While lists created by some research firms put the number at around 35, with more rigorous exploration, we had expected to expand this number by a dozen or so. Surprisingly, we found a hundred of them, and feedback after publication of our report suggests we missed quite a few more.

While the US and China have more unicorns than India, they have many more listed companies with market capitalisation exceeding a billion. The US has 2,825 and China 2,126 such companies, whereas India has only 335. The unlisted space is thus far more important for India’s economic momentum on a relative basis.

We included firms that met at least one of three criteria: Had a funding round at a valuation exceeding a billion; reported profits that, at the average valuation multiple of listed peers, would mean valuation above a billion; or where the last funding round was at less than a billion, but had strong business momentum since then. Screening from 50,000 unlisted firms for large profit pools and strong growth was necessary to include firms that generate sufficient cash for reinvestment and do not need more funding. Conversely, a better assessment of the value of loss-making firms may come from funds that invest in them: Detailed discussions with a large number of PE firms was important to make the process rigorous. We then removed firms that had once been unicorns but have slipped, or are subsidiaries of listed firms, multinational corporations or are a part of established business groups. 

The sectoral mix of the resultant hundred firms is diverse: In addition to the largely expected e-commerce, fintech, education technology (edutech), food-delivery and mobility companies, we found firms in Software-as-a-Service (SaaS), gaming, non-banking finance, renewable energy generation, modern trade and new-age distribution and logistics, bio-tech and pharmaceuticals. In mature economies with low-single-digit nominal annual growth in GDP, one needs to be in a disruptive business like technology to get the rapid growth necessary to become a unicorn.

Illustration: Binay Sinha

In India, on the other hand, with a double-digit nominal GDP growth over decades, sectors with growing penetration or formalisation can also see super-normal growth. Thus, our list also has a few companies in conventional sectors like jewellery, fabric, and even packaged food.

Notably, two-thirds of these firms started after 2005, compared to only 63 of the BSE500 starting this century and 180 starting before 1975. This is an extraordinary episode of new-companies scaling up in what has traditionally been a slow process. While valuations can be volatile in the near-term, we believe we are in the early stages of this reshaping of India’s corporate landscape. Given that it takes at least seven to 10 years for a firm from its formation to become a unicorn, and that new start-ups as well as funding have picked up meaningfully in the last five years, several more could be on the way in the next five to 10 years.

Why is this happening? Several changes are contributing to this, but the most important is the advent of PE, most of which has been of foreign provenance so far. India’s wealth per capita is among the lowest in the world, and four-fifths of it is in physical assets like a house or jewellery. As discussed in an earlier Tessellatum (“In search of risk capital”, May 2, 2018, Business Standard), at this stage of development of a country, equity capital, which is riskier for a saver than debt, is in short supply. Most of the currently developed countries relied on foreign savings when they were emerging markets. For example, in the first half of the 19th century, the US received savings from European countries such as England, France and the Netherlands. A large part of it was in the form of debt, which drove vicious cycles of economic boom and bust (even state governments defaulted sometimes). In India, these flows have been in the form of equity, and remarkably, PE funding has exceeded public-market fund-raising in each of the years over the past decade. This has been helped by global growth in PE funding, as pension and insurance funds have responded to low bond yields by increasing allocations to alternative assets like PE, but India’s share of global PE funding has also risen.

This availability of risk capital has allowed firms to scale up much faster than they would have if they only relied on their internal accruals to grow. The only other option available for rapid growth is to take on excessive levels of debt: If the project succeeds, the owner becomes wealthy, and if it fails, the owner may lose the business, but banks also bear the losses. Indian entrepreneurs were forming new companies at a rapid clip even in the 1980s, but three-fourths of all paid-up capital (this is an inefficient proxy, but the only one available) was in government firms, and capital per private firm remained low till restrictions were eased in 1991. Even then, however, only a few business groups had the risk capital to set up new businesses. It was the advent of PE that has allowed first-generation entrepreneurs to take business risks, triggering the reshaping of India’s corporate landscape.

This is the first of a four-part series on “100 Unicorns: India’s changing corporate landscape”. In the next parts we will discuss other factors that have made India a fertile ecosystem to absorb this influx of capital, the impact of these unicorns on the economy, and what lies ahead.

The writer is co-head of APAC Strategy and India Strategist for Credit Suisse