Something has gone wrong with the Indian start-up party

30 May 2022 , 09:22 AM

Just about a few months back, the Indian start-up story  looked so very different. You just needed a good idea with some professionals from reputed institutions as founders. Once the business plan was ready and top line visibility was there, these start-ups were able to raise equity capital. Of course, nobody really bothered about operating profits, leave alone the bottom line. The assumption was that once the top line grew and market share was captured through aggressive “on your face” marketing, profits would logically follow. In a span of 4-5 years, more than a hundred unicorns dotted India’s start-up landscape.

In the last few months, something seems to have gone wrong in the entire setup. Top line growth is still happening, but operating profits seem to have gone farther away. Most start-ups have inflation-sensitive expenditure models and that is coming back to haunt these start-up founders. If you just look at the fourth quarter ended March 2022, even the established start-ups are seeing their spending growing faster than sales, resulting in widening of net losses in the quarter. But the trigger was perhaps the listing story.

Listed and not too happy

In the last one year, a number of start-ups listed at fancy market valuations but the post listing performance failed to live up to this hype. Check out this table.

Company Name	IPO Listing	Issue Price	CMP (27-May)	Returns (%)	52-week high	52-week low	Market Cap (Rs Crore)
Easy Trip Plan	Mar-21	187.00	393.75	110.56%	476.50	135.43	8,556
Nazara Tech	Mar-21	1,101.00	1,167.35	6.03%	3,354.40	1,050.05	3,833
Zomato Ltd	Jul-21	76.00	62.05	-18.36%	169.10	50.35	48,856
CarTrade Tech	Aug-21	1,618.00	618.45	-61.78%	1,610.00	462.10	2,886
FSN (Nykaa)	Nov-21	1,125.00	1,351.80	20.16%	2,574.00	1,208.40	64,103
Policybazaar	Nov-21	980.00	687.00	-29.90%	1,470.00	542.30	30,881
One-97 (Paytm)	Nov-21	2,150.00	616.65	-71.32%	1,961.05	511.00	40,005
Star Health	Dec-21	900.00	663.50	-26.28%	940.00	603.00	38,186
Delhivery	May-22	487.00	541.00	11.09%	568.90	474.00	39,196

Data Source: BSE

A quick reading of the above table would tell you that some of the largest digital start-ups in the last one year have been less than flattering post listing. Obviously, the institutional portfolio investors and the retail investors do not have the same level of tolerance towards sustained losses and cash burn as the VCs and PE funds. Even in cases where the stock prices are above the IPO price, they are closer to the yearly lows.

So, is the start-up challenge all about the intention to list them? Not exactly. The stock markets only provide a more realistic medium-term view of a stock and its performance. In this case, the stock prices were only reflective of a harder truth which most of the buyers were either unable to see or unwilling to acknowledge. Here is the start-up reality.

Reality 1: Manpower is being rationalized

The tide normally changes first on the recruitment front. It is not just that companies have frozen recruitment. There has been large scale rationalization of manpower in most start-ups. From marquee names like Vedantu, Meesho, Unacademy and Cars24, the total lay-offs in high profile names have been over 9,000. That is just the official figure. If you take the actual numbers and the smaller start-ups, the pinch is a lot more.

One reason, of course, is the slowdown in the global ecosystem. Most are fearing a recession in the US in the next few quarters and that is forcing start-ups to be cautious. In some cases, the situation is the reverse. Edtech came into prominence in India when COVID shut down schools. With normalcy returning, the online academies are looking less compelling. The same is also true of ecommerce, as people return to the malls.

Reality 2: Funding pipelines are drying up

To be fair, it is not entirely a scary scenario. In the first 5 months of 2022 (January to May), start-ups received $17.5 billion in funding. However, most of the big PE firms like Sequoia, KKR and Y-Combinator have cautioned their investee companies to be careful with cash burn. Obviously, it is not going to be a blank cheque scenario any longer. Also, more start-up money, of late, is coming from sovereign funds.
A major dampener for the start-up ecosystem was the massive $27 billion loss reported by JapanesePE Fund, Softbank, for financial year FY22. Many of their mega investments in start-ups, including their sizable India investments have turned the other way. That also tightened funding lines for start-ups. With funding pipelines drying up, it is a Catch-22 situation as start-ups balance the need to conserve cash with the need to perpetually grow.

Reality 3: What does not work, does not live

Many of the start-ups are rationalizing their operations much faster than what traditional brick-and-mortar companies would do. The most popular shift is the tendency among the star-ups to outsource bulk of their routine operations to professional agencies. They don’t want to incur running costs on areas that do not directly add to their top line. There is a good deal of administrative functions and even routine marketing that has gone out.

Then there are specific cases. For example, Swiggy shut down its grocery delivery vertical in 5 cities. Meesho also let go off employees from its grocery business. Edtech firms have let go people from their content creation teams as the demand did not keep pace with the supply lines created. In the start-up ecosystem, what does not work, does not live.

Reality 4: End of the (Spend + lose =  value) model

Aditya Puri of HDFC Bank used to say that “Most Fintechs were taking market share from banks by draining capital to give discounts. That is hardly banking”. He is right. From Paytm to Flipkart to Meesho; the basic rule book was almost the same. Raise equity, give steep discounts, gather market share and enhance value. That was a good model to begin with but not a good model to sustain. Eventually, it boiled down to whether the start-up was really adding value to the customer. That is where the funding lines selectively started drying up.

To be fair, the start-up story is still a great story. Excesses are normal in any rally. The global liquidity taps are tighter, but will not remain tight for ever. However, the runway for start-ups has certainly reduced from around 4-5 years to less than 2 years. That is hard reality that start-ups have to contend with. Roadblocks to the start-up ecosystem are not bad. That is actually helping start-ups and VCs be more pragmatic.