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Profitability and unit economics to be Indian startups’ mantra in 2020

Written by Moulishree Srivastava Published on   7 mins read

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Poor performance of some of the big tech companies has seeded the idea of course correction in India.

While the talks of focusing on unit economics began in 2019, the startup ecosystem around the world took it seriously only in the latter half of the year when Japanese conglomerate SoftBank was jolted out of its dream as two of its portfolio companies, WeWork and Uber failed it.

The poor performance of both the US-based companies during their initial public offering which saw their valuations plummet like a pack of cards had its effect globally, and India wasn’t untouched by it.

The first half of 2019 was cheery for Indian technology startups as multiple new unicorns with a billion US dollar valuations popped up on the back of global investors parking their money in Asia’s fastest-growing economy. However, in the second half of 2019, “course correction” became the buzz word among the VC ecosystem, more so as the country was going through an economic slowdown and the truth about WeWork and Uber’s inflated valuations came out in the open during their IPO.

After the Japanese conglomerate bailed out WeWork with USD 9.5 billion rescue package in October, its Indian star portfolio company, Oyo, valued at around USD 10 billion, began cost-cutting and restructuring. Many other startups like Swiggy, Z0mato, and Paytm among others also realized that it was time to move away from cash-burning practices.

This shift set up the tone for the year ahead. At KrASIA, we looked at a few prominent trends that have already begun to shape 2020.

1. Focus on unit economics

As investors change their stance on companies burning cash to chase growth, major Indian startups across sectors are now shifting their focus to better their unit economics.

William Bao Bean, General Partner at SOSV, the second most active seed-stage investor globally, believes the market this year, should get a bit more rational, in terms of splurging money.

“Companies that splashed a lot of money don’t really have money (to burn) anymore,” Bean told KrASIA in a recent interview. “There’s going to be a focus on net revenue, reducing losses, and then a real focus on unit economics.” He believes the market imbalances caused by the big cheques that VCs wrote over the last few years won’t go away, but they’ll be reduced.

According to the investors and analysts KrASIA talked to, the changing macro global trends like the US-China trade war, WeWork’s unexpected performance, and Indian macro trends such as policy changes and economic slowdown, might bring some sanity in the investment scene.

“Capital is lesser of a moat now, a development which might help the best companies surface up better,” said Pratik Poddar, principal at Nexus Venture Partners. “There will be a focus on companies that are thinking about unit economics and long term sustainability. Competition is going to reduce because tens of companies in the same space will not get funded,” he added.

Anil Joshi, managing partner at Unicorn Ventures, said investors are indeed cautious about unit economics and the kind of cash burn that’s happening. However, he said, companies that are able to earn revenue while spending money on growth will still find VCs who are willing to invest.

2. The year of exits

While the Indian startup ecosystem doesn’t have many exits that it can boast of, a few companies over the last couple of years have given investors some hope.

According to Hans Tung, managing partner at Singapore- and US-based venture capital firm, GGV Capital, Flipkart’s acquisition by Walmart for USD 16 billion, IndiaMart’s initial public offering at Bombay Stock Exchange, and Oyo’s recent share buy-back have changed people’s perspective that exits need not happen only through IPOs.

“After China’s dramatic growth, India is the best market to potentially have that kind of exits and growth. So, investors are willing to give it more time,” he said.

Joshi of Unicorn Ventures said exits in the Indian startup ecosystem is likely to happen through acquisitions. With bigger VC firms showing interest in Indian startups, early investors would get exits through secondary deals that have already started to happen. Earlier this month, Inventus Capital reportedly sold its USD 25 million worth stake in Gurugram-based online insurance aggregator PolicyBazaar through a secondary transaction. Edtech unicorn Byju’s may also see secondary transactions estimated at USD 100-200 million giving early investors an exit soon.

In one of the biggest consolidation moves, food delivery giant Zomato gobbled up rival UberEats recently, while Naspers-owned payment company PayU acquired a controlling stake in homegrown digital lending startup PaySense.

However, according to Nexus’ Poddar, acquisition opportunities in India are limited as “we don’t have many large companies that have a cheaper source of capital from the public market yet.”

Joshi sees Reliance Industries, India’s largest company by market cap, leading the way as it has set a successful example by acquiring a handful of Indian technology companies last year. He believes many large companies may start acquiring soon following Reliance’s footsteps.

“Reliance has actually benefited by acquiring these companies and integrating them with their offerings,” he said. “What Reliance has done offers food for thought for many Indian companies to look at innovative solutions, which will help them expand their user base and offering, as well as add new revenue channels.”

3. India’s hottest sectors

Most of the investors KrASIA talked to are primarily bullish on two sectors—edtech and fintech. Byju’s raising USD 100 million from Tiger Global within the first two weeks of the new year is a testament to that.

“Even if the economy is down, Indian families would tighten their belt and spend money on helping the kids get the best education possible,” said GGV’s Tung. “So we are quite bullish on the sector.”

According to Joshi more than the general K-12 (kindergarten to 12th standard) kind of solution, the vertical edtech market is interesting as it offers specific solutions in areas like medical training, skill development, and civil services preparations.

Lending and wealth management has given investors a reason to see a lot of action in the fintech space.

“Because of Jan Dhan (the flagship government banking scheme), people from small towns, who also have access to smartphones, have come under the banking system,” Joshi explained. “This will allow fintech companies to tap what they couldn’t before. We expect to see more products revolve around wealth management, investment, and other financial services.”

Investors also expect B2B e-commerce to thrive this year, while the growth of B2C companies would be driven by tier 3 and 4 cities, otherwise known as the “Bharat” market. Other sectors like mobility, health-tech, and content will also see interest from VCs, as per industry experts.

4. B2B —the flavor of the year

After remaining in the shadows for years, B2B technology companies went mainstream in 2019. Industry pundits expect more of this happening this year, especially since the Indian economy is growing slower than the usual.

“We will see some B2B solutions emerge on the enterprise side,” said Joshi. “B2B will be the flavor of the year as the slow down in economy means more innovative solutions to lower the cost for companies.”

GGV’s Tung believes most of the B2B companies would get funded this year as they will play a much bigger role in a few selected B2C sectors like education and lending.

“As a VC who has invested in China, it’s easy to be wary of the Indian market because Chinese VCs make money through B2C commerce. But in India, GDP per capita is so low the B2C market will take more time to grow than it did in China, but the B2B market will show faster growth,” Tung said.

He believes, the slowdown should not affect companies that focus on the domestic economy, as they will have an opportunity to build a strong B2B2C model enabling existing businesses to be more efficient to sell.

5. Changing entrepreneurial landscape

Last year startups raised more money in a lesser number of deals compared to 2018. The trend is likely to further crystallize this year, meaning cheque sizes are going to increase even more.

According to Joshi, the quality of entrepreneurship has gone up in India, and at the same time availability of the capital has also gone up, which together are driving up the cheque sizes.

“Even if you look at seed-stage deals, which used to be USD 100,000 to 200,000, has now become USD 500,000 to 1 million,” he said, adding that while pre-series A is kind of a seed round now, the line between series A and Series B is thinning.

“The dynamics have certainly changed because the founders who have the right value proposition and are able to demonstrate that, are willing to wait for the right numbers before raising money and that is why the cheques are becoming bigger,” he said.

On the other end of the spectrum, there are second time, successful entrepreneurs who are building businesses that need bigger cheques from day one. “We now have successful entrepreneurs who are coming back and starting anew. They are more seasoned as they have seen the entire startup life cycle by building, expanding, and exiting their companies,” Joshi said.

Some of the second-time entrepreneurs include PayU’s ex-MD Jitendra Gupta, FreeCharge founder Kunal Shah, Myntra founder Mukesh Bansal, and Flipkart co-founder Sachin Bansal.

“India is seeing what the US went gone through a decade back,” Joshi said. “We will see a different value proposition from successful entrepreneurs who know how to navigate to build a company from scratch.”

Meanwhile, many early-stage investors are now scouting for experienced founders, instead of rookie entrepreneurs.

SOSV’s Bean said he prefers to invest in entrepreneurs who are in their early or late 30s or 40s. “We generally don’t invest in kids or super young people,” he said. “Because, to some extent, it takes some experience to build companies. People generally succeed better after they fail.”

As tech startups begin their course correction to achieve profitability and sustainability, experts believe, the exciting times are ahead and the Indian startup ecosystem is yet to bloom.

“While investors will not put in money as they were doing in the past,” Joshi said, “fundable ventures won’t have difficulty in attracting investors.”

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