 "funding winter, startup, india inc")
India's startup ecosystem has been growing rapidly, now occupying the third rank globally, with over 125,000 startups. India is now home to the fastest-growing unicorns, driven by a youthful, dynamic, and tech-savvy population fostering entrepreneurship and innovation. Initiatives like Startup India have bolstered this ecosystem by empowering startups and nurturing their entrepreneurial skills.
Furthermore, foreign investments have acted as a catalyst in propelling this growth. These investments bring in much-needed capital for expansion, access to cutting-edge technologies, and opportunities for global market penetration.
According to some estimates, foreign investments account for approximately 36 per cent of the total investments for startups in the last decade. It is important to understand the crucial role played by foreign venture capital (VC) and private equity (PE) firms in the companies they invest in. Over the years, the role of an investment fund has drastically changed, from being just a source of earning passive income to now being a catalyst for innovation, streamlining operations, and injecting market dynamism. Given that the primary goal of a PE investment is to make a profitable exit, their involvement in company operations has now increased.
Typically, in PE investment deals, the investor takes up a board seat, thereby taking an active role in the company’s decision-making process. At the core of this strategy, there are two primary stakeholders, the founders and the investors. While the firm looks to maximise its returns as soon as possible, the founders are driven to further build their companies in a way that creates sustained value. However, the past few years have seen companies prioritise valuation and customer acquisition over profitability and long-term value.
Following the 2008-09 financial crisis, the US Federal Bank implemented Quantitative Easing, increasing money supply and lowering interest rates. This "easy money" policy allowed firms to borrow cheaply and prioritise growth over fundamentals, catalysing economic activity but potentially obscuring risks.
This meant that investors could chase valuation without due regard to growth and profitability. Understanding local dynamics is crucial to navigating environments where business fundamentals may have been deprioritised in favour of rapid expansion.
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There are no regulations in India that impose a fiduciary responsibility on PEs, although PEs typically nominate a board member to oversee their investment and actively partake in the company’s critical decision-making processes. However, investor nominees, just like any other board member, have certain fiduciary duties such as acting in good faith to promote the company’s objects and acting in the best interest of the company, its shareholders, employees, and the community.
As there is no legal reprimand, often these fiduciary duties are not taken as seriously as they should be. The fundamental objective of a PE is to get a favourable exit. Subsequently, it becomes crucial that board decisions are made based on utmost due diligence. For instance, Byju's, a tech-enabled education startup that became highly valuable, faced financial difficulties due to failed acquisitions. Notably, the acquisition of WhiteHat Junior, which was not a portfolio company, was aggressively pushed by an existing investor close to a PE firm, portraying it as a potential $1 billion revenue company. This aggressive acquisition strategy led to enormous losses for Byju's and stakeholders, highlighting the risks of prioritising growth over sound business fundamentals.
Similarly, in the Davidson Kempner loan, while there were other proposals on the table, an existing investor had aggressively pushed for going with Davidson Kempner. Now, ironically, both the investors cited above are part of the sect involved in cases against Byju’s alleging lack of transparency and corporate misgovernance. Another notable example is the case of Wink & Nod and MobiChemist and Guild Capital. In both cases, the startups faced significant financial and operational challenges due to Guild Capital's actions, including delayed investments, withdrawn funding, and failed acquisition deals. This ultimately led to the shutdown of MobiChemist and the resignation of Wink & Nod founders.
While foreign investments offer undeniable benefits, they also come with potential pitfalls. As investor sentiment sours, there is a risk of capital withdrawal, leading to market instability and a potential cash crunch impacting their day-to-day operations. The example of Snapdeal's investor dispute also highlights this vulnerability. Facing global competition and changing investor priorities when e-commerce was taking shape in India, Snapdeal struggled to meet growth targets, leading to a fallout with its largest investor SoftBank.
Just as MSMEs form the backbone of the Indian economy, startups have an equally important role to play in dynamically securing India’s economic future and making it Atmanirbhar. As the Indian startup ecosystem continues to flourish, it is crucial to ensure that what befell MobiKwik does not happen to Byjus, as there are millions of students across geographies who are dependent on new ways of teaching and learning. A carefully curated and holistic approach is essential for harnessing the benefits of external investment in our burgeoning national economy in the growth of startups, mitigating associated risks, and building a resilient economy capable of sustained growth and continuous innovation.
(Dhanendra Kumar has been Executive Director at the World Bank for India, Sri Lanka, Bangladesh & Bhutan, and First Chairman of the Competition Commission of India. He is currently Chairman of Competition Advisory Services LLP.)
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
