How sustainable are Indian unicorns' business models?

If there was one theme in the startup ecosystem that dominated 2021, it was unicorns! After all, 2021 saw the rise and rise of India’s start-ups with the unicorn-base doubling. Out of India’s 90 unicorns at the beginning of 2022, about 46 had emerged in 2021 itself.

“The unicorn wave in India is still going strong: one unicorn has been added every five days within the first two months of 2022, and India is expected to have 100+ new unicorns in 2022” - HDFC Securities report
 
And, in various quarters, the optimism has also carried on into 2022. According to an HDFC Securities report, accelerated funding activity is expected to create over 100 new unicorns in India in 2022.

In fact, according to a report, from the beginning of 2022 till April-end, India saw the rise of 14 new unicorns. These are Fractal, LEAD, Darwinbox, DealShare, ElasticRun, Livspace, Xpressbees, Uniphore, Hasura, CredAvenue, Amagi, Oxyzo, Games24x7 and Open.

All of this, has papered over some of the early indications in the ecosystem -- from corporate governance concerns to the sobering performance of some start-up IPOs.
And, dark clouds could be around the corner.

A number of venture capitalists recently told Business Standard that the pace at which unicorns will emerge in India might get a bit slower in 2022. One of the major reasons for this slowdown could be the challenges within the ‘soonicorn’ ecosystem. In fact, only a handful of soonicorns have been able to raise funds in the first quarter of CY22.  

“The pace will reduce in the second half of the year due to global macro risks affecting liquidity. But net-net, we may still end up with a number close to that of 2021” - Anand Prasanna, Managing Partner, Iron Pillar Fund

Iron Pillar Fund Managing Partner Anand Prasanna told Business Standard that the pace at which unicorns emerge would reduce in the second half of the year owing to the effect of global macro risks on liquidity. According to Prasanna, increasing customer acquisition costs, poor performance by some consumer tech unicorns that went for IPO recently, and India’s macro-economic challenges could affect the pace of unicorn creation in 2022.

Some other reasons for the slowdown are a spike in the US interest rates, the Russia-Ukraine conflict and of course the rising inflation.

Another major reason for a slowdown in unicorn creation could be that
 
After a frenzied investment activity in 2021, the market is likely to be cautious this year and investors much more choosy. This could be another reason for a slowdown in unicorn creation, and not necessarily a bad thing. There might be a need to slow things down and look at the sustainability of these unicorns.

Let’s start with valuations.
Consider the funding lifecycle of a start-up. First comes the seed round. Then comes Series A, Series B, Series C, and pre-IPO series rounds, all of which usually culminate in an IPO. Now, as one news agency pointed out, there are doubts that the valuations, which multiply with every funding round, are based in a large part on opaque formulas.

Metrics that are the gold-standard for traditional companies, from profit after tax to EBIDTA, are not generally useful when it comes to companies that continue to run in losses. Instead, cost of goods sold, GMV and active user counts are the valuation metrics that have to be used.

This might not be a matter of great concern as long as it is the venture capitalists alone who are shelling out cash based on these valuations. But, it becomes unsettling when retail investors get involved through an IPO.

Then there are matters of ethics and corporate governance. Amid reports of data fraud and tax evasion at Indian start-ups, the Commerce and Industry Minister Piyush Goyal recently said that new-age companies must strengthen ethical and corporate governance standards, otherwise, start-ups would earn a bad name. While Goyal didn’t mention the name of the startups, his statement comes after several reports of corporate governance lapses at unicorn Bharat Pe over the past few months.

So, are India’s unicorns by and large sustainable?

Parth Gandhi, Founder and Chief Investment Officer, Bombay Capital says there are several companies with strong valuation expectations and there are also several that have underperformed. Overall, the Indian ecosystem is producing promising companies with sustainable valuations, he says.

There will be more disruptive start-ups and more bumper new tech IPO offerings in the near future. However, for everyone to benefit from them, especially retail investors, Indian start-ups might have to rethink how valuations are arrived at and the role of corporate governance in the organisations.