India generates many unicorns and decacorns, but who benefits?
Two mythical creatures resembling prancing horses have occupied the thought process of our COVID-19 ravaged minds and Indian popular discourse for the past few months. This column is not about the winged creature – which has captured the attention of the highest court in the land – but about dissecting the horse with a horn; no, a horse with a thorn.
As we celebrate India’s emergence as the third largest ecosystem for start-ups in the world – after the US and China – it’s time to pause and consider the emergence unicorns and their impact on job growth, capital markets and society in general.
The term ‘unicorn’ – a private tech startup with a valuation of $1 billion or more (about Rs 7,500 crore) – was coined by Aileen Lee, an American angel investor and founder of Cowboy Ventures, a company of venture capital, in 2013 India did not have a single unicorn then.
Today terms like minicorn, soonicorn, unicorn, decacorn, hectocorn, seed capital, seed capital, angel investor, evangelist, private equity, venture capital, cash burn, churn, burn rate, funding incubator, non-disclosure agreement, term sheet, sweat capital, series A, B, C….rounds, crowdfunding, pre-IPO funding, are all part of the popular lexicon.
According to a report, there were eight unicorns in 2018, nine in 2019 and eleven in 2020. Last year, 44 unicorns emerged, bringing the total number of such businesses in India to 85, according to news reports. According to Inc42.com, Indian startups raised more than $42 billion in 1,583 deals in 2021, more than the total funding they raised in the past three years combined. In terms of number of transactions, FinTech and e-commerce companies took first and second place, followed by SaaS (software as a service). The country received $77.8 billion in seed funding from the year 2018 to the fourth quarter of 2021.
India’s startup ecosystem is not just growing, it is setting and breaking new records. The graph below shows the investments that have flowed in over the past few years.
These data and others mentioned in this column may vary depending on the source. Because there is no official database recording the source of financing, the value and the number of these transactions. Also, many startups do not disclose their deal size.
Valuation and financing path
Startups begin their journey as an idea with no attached value. When these ideas are converted into a business plan with rough financial forecasts, investors are attracted based on the attractiveness of the idea, the reasonableness of the business plan, the experience of the promoters, their expertise and market assessment of the product or service. Starting with seed capital, angel investors and venture capitalists use several formulas to determine company value before investing. Venture capital financing then takes place in “rounds”. After the seed cycle comes Series A, Series B, Series C, the pre-IPO series leading up to the IPO, with valuation, based largely on opaque formulas, multiplying with each cycle of financing. With each round, the bet of the founding promoters gradually decreases. Promoters are free to take on debt instead of diluting their stake.
Additionally, high-growth companies almost always need to burn capital to sustain their growth before they reach profitability.
Standard measures, such as earnings after tax (PAT), earnings before interest, taxes, depreciation and amortization (EBIDTA), cash flow may not be easily applicable to companies that often generate impressive losses. Thus, valuation metrics, such as annualized gross market value (GMV), cost of goods sold, or number of active users and/or paying users are used. Little is known that real revenue comes from the commissions e-commerce companies receive from sellers or the listing fees they charge producers to list products on their sites.
Why cry foul?
According to TV Mohandas Pai, an industry veteran and co-founder of Aarin Capital, “I don’t think anyone should be worried about the surge in valuation of unicorns. Investing is a leap of faith between the investor and the company, with two parties to the transaction who are willing to work together. He further asserts: “If the assessment is not carried out, it is between two parties and has nothing to do with public money“.
Fine as long as it’s between the developer and the venture capitalist. The question arises when this valuation is carried out with individual investors through an IPO. Isn’t it appropriate to question the assessment at this time? Unicorns are changing long-established valuation arithmetic, putting retail investors on a rudderless boat while taking the angel and other prenatal investors on a Royal Caribbean cruise!
A booming stock market, the halo around crypto-assets and NFTs, overvalued unicorns, massively oversubscribed IPOs are stealthily creating a dream of quick riches in the minds of new Indian “pandemic investors”. Many, if not most of them, have yet to experience the market declines that are regular in stock markets around the world.
Works? What professions?
According to the ‘NASSCOM Tech Start-up Report 2021 – Year of the Titans’, Indian startups directly created 6.6 lakh jobs and created 34 lakh indirect jobs in 2021, 70% of which were through platforms. e-commerce, mobility and food delivery. The official website of the National Investment Promotion and Facilitation Agency claims that “startups not only develop innovative solutions and technologies but generate large-scale jobs”, without mentioning a specific figure. Mohandas Pai, in a recent interview, said startups have created 15 million jobs and added, “We are on track to become a digital colony by 2025.”
Startups are increasingly being touted as engines of economic growth, largely because they create jobs. We often forget that the majority of startups, which often start with a single employee (the founder) fail in the first year. Only a few, who have the ability and the financial backing, can grow and be stamped as unicorns and dramatically distort our views. In reality, the majority of startups do not create jobs. A disproportionate number of jobs are in low-skilled services. They pay less and create a less equal society. Jobs created by e-commerce companies, food delivery platforms, and logistics companies fall into this category.
Renowned investment banker PN Vijay adds: “Unfortunately such a high proportion of the workforce does not have decent wages, has appalling working conditions (remember the time the pizza delivery boy begged you not to complain about the late delivery, claiming will the discount given by the company be clawed back from his salary?), no representation in any form, are forced to sign opaque contracts and unintelligible, and of course, have absolutely nothing to say in management. »
How many of the growing number of unicorns, with technology at their disposal, have gone into manufacturing? Areas such as smartphone accessories, e-waste recycling, furniture manufacturing, automotive components, leather goods manufacturing, 3D printing, robot and drone manufacturing are waiting to be tapped. The pandemic has generated an unprecedented volume of plastic waste. Added to this is the packaging material thrown away daily by consumers from e-commerce platforms. Can we ignore the reality on the ground and allow ourselves to create scum in the name of realizing a digital economy?
If India is to achieve global manufacturer status, manufacturing startups are the answer. But MSMEs get over 40 permits to take and pay every step of the way to get the license before they can even lay the groundwork for their start-up and when it is up and running they regularly face harassment from corrupt service providers.
Ganga N. Rath is a former central banker. The opinions expressed are personal.