If we zoom out and look at the last decade at large, we can clearly see how India has changed...
2021 was distinctly a coming-of-age year for the start-up ecosystem. Venture capital firms logged strong inflows, incubating 43 unicorns in India in 2021 alone. Pre-IPO funds also raked in massive inflows as a few large unicorns such as Zomato, and Nykaa debuted on bourses. Prior to 2021, there were only a handful of listed internet stocks, but in 2021 investors bought into some of the well-established internet companies despite their immediate financial losses. This demonstrated that investors are mature enough to appreciate long-term value, though these companies are currently losing money.
Investing in start-ups, particularly those that are driven by technology and are present in emerging sectors, worked for many in 2021. Private market valuations of internet companies looked way too high in 2018, but the rally in internet names in public markets has put these valuations in a different orbit altogether. And this has left many value investors in a quandary since such valuations look lofty when seen through traditional valuation lenses. However, there is method to the madness. There are reasons for such a thumping response to start-up IPOs in 2021, as well as to VCs’ quest to fund start-ups that are burning money.
If we zoom out and look at the last decade at large, we can clearly see how India has changed, and that digital adoption is not limited to cities alone. Industry after industry is changing as consumers adopt digital means for doing business. New-age companies are plugging the gap between demand and supply across sectors. All in all, the potential of new-age or start-up theme will play out in Indian markets in a much bigger scope in coming years. One can look at China to see how it plays out when young population adopts digital means.
The elephant is trumpeting the dragon
China has demonstrated explosive growth in digitalizing its economy over the past couple of decades. Widespread technology adoption among consumers has spawned new companies and business models and created wealth for investors in the process.
India is also following a similar path, and investors are gung-ho about massive digital platforms catering to a large and young population potentially creating outsized wealth.
“Today, almost 98% of India (mapped by PIN of India Post) is covered by e-commerce, but only 150–180 million consumers are shopping online”
The Indian government has also played its role via the JAM trinity – Jandhan Yojana, AADHAR and Mobile – which has accelerated bank account penetration. While the Jandhan Yojana scheme gave bank accounts to many, AADHAR solved the identity issue and data-enabled mobiles made numerous transactions possible and easy. Democratization of the payment stack by NPCI has enabled a low-cost interoperable payment system across banks and payment platforms. Proliferation of 4G connections has resulted in 773 million Wireless Broadband subscribers in 2021 compared with 102 million in 2015. These subscribers are using mobile for digital payments, shopping online, entertainment, etc. This is the foundation that would support tomorrow’s digital consumers’ diverse needs.
Today, almost 98% of India (mapped by PIN of India Post) is covered by e-commerce, but only 150–180 million consumers are shopping online. In the past one and half years, hordes of consumers have opted for the digital route to fulfill their needs, thanks to the restrictions imposed by lockdowns in the wake of Covid-19. Businesses that adapted to the new normal have benefitted in terms of increased business.
Despite all this, the percentage of individuals transacting online – be it ordering food online, trading in stocks, calling for cab services or shopping online – is far lower than that of China. This implies great potential for growth for Indian start-ups.
“It is clear that the government wants to create a business-friendly environment for start-ups”
The long growth pathway of Indian start-ups is more sustainable compared with China. India scores over China due to favourable demographics. For example, Indian population is younger than the Chinese counterparts by ten years. China has a median age of 38.4 years compared with 28.4 years of India. Besides, India has a bigger English-speaking population. More importantly, India is a democratic country. Indian regulations are more stable and consistently evolving. In contrast, China recently upset the apple cart with knee-jerk and not-so-well-thought of regulations in its bid to clamp down start-ups in edu-tech and gaming.
Digital transformation is real
Digital adoption is a secular trend and is leading to ‘creative destruction’ of supply chains, marketing channels and even business models. Old-age businesses, which are slow in adopting new ways of doing business, are losing their share to new-age, disruptive businesses. This is a huge opportunity for start-ups in India.
Although this may seem obvious, but the underlying forces are not so obvious. In many cases, consumers need to be incentivized to change their old ways of doing business. Companies need to invest in educating customers on how new products would solve their problem. Many platforms are built on the principles of network effect, wherein more buyers bring in more suppliers while more suppliers bring in more buyers. However, for network effect to kick in to drive self-fueling growth, there must be an optimal number of buyers and suppliers on the platforms.
Venture capital has played a key role in solving these challenges at an early stage. They have also been able to advise companies on many pitfalls, thereby saving entrepreneurs’ time as well as capital. Venture capital investors have been willing to fund these cash-burning platforms in the high-growth phase. This has helped establish many business models and achieving scale in those industries.
“While the market follows its cycle of euphoria and pessimism, investors need to evaluate their start-up business based on a three-pronged framework”
Needless to say, for every success, there are many failures, but the winnings are large enough to absorb the losses, and that’s the nature of the beast. E-commerce, ride hailing, payments, food delivery, and ticket booking are a few businesses wherein there is sufficient scale, and market leaders have been consolidating their position. Competitive pressure in these industries is going down and – gradually – we may see some loss-making companies clocking profits soon. On the other hand, Direct to Consumer (D2C) brands, single-segment (vertical) e-commerce companies, Business to Business (B2B) e-commerce companies are still burning cash and are at a different stage of maturity. We do see some businesses in this space becoming large and profitable as the industry matures and consolidates.
With its ups and downs start-up investing is here to stay
It is clear that the government wants to create a business-friendly environment for start-ups. Eligible startups established before March 31, 2022, were provided a tax incentive for three consecutive years out of ten years from incorporation. In the recent Union Budget, Finance Minister Nirmala Sitharaman announced that the same deadline has been extended till March 31, 2023. The Union Budget 2022 also capped the surcharge on the capital gains tax to 15 percent. This helps to reduce the tax liability of high-net-worth individuals funding start-ups. The budget also came out with various announcements to create an ecosystem which will improve ease of doing business.
While the market follows its cycle of euphoria and pessimism, investors need to evaluate their start-up business based on a three-pronged framework: eventual unit economics, quality of network effect and addressable market. The ability of management to scale the business and expand into adjacent areas would also be a key driver of value creation over the long term. To be sure, some companies won’t not be able to meet investors’ expectations and their business models will falter. But many companies will scale up, become profitable and create outsized wealth for investors. While the market follows its cycle of euphoria and pessimism, investors need to evaluate their start-up business based on a three-pronged framework: eventual unit economics, quality of network effect and addressable market. The ability of management to scale the business and expand into adjacent areas would also be a key driver of value creation over the long term. To be sure, some companies won’t not be able to meet investors’ expectations and their business models will falter. But many companies will scale up, become profitable and create outsized wealth for investors.
About the Author
Ashish Kehair, is CEO & MD of Edelweiss Wealth Management
Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect the views of the Economic Times – ET Edge Insights, its management, or its members