FB Pixel no scriptUnexpected things that defined Indian startup ecosystem in 2021 | KrASIA Year in Review | KrASIA
MENU
KrASIA
Insights

Unexpected things that defined Indian startup ecosystem in 2021 | KrASIA Year in Review

Written by Moulishree Srivastava Published on   8 mins read

Share
VCs pumped over USD 34 billion into Indian startups this year so far, 200% more than 2020, which created 41 unicorns.

For the Indian startup ecosystem, 2021 couldn’t have been more different than 2020—the year of the COVID-19 outbreak that changed the world forever.

Last year brought the larger local startup community to its knees, forcing them to focus on driving sustainable growth with reduced cash and better unit economics rather than chasing growth over profitability, a practice that had defined the startup industry for the past decade. Startup entrepreneurs leveled up as they navigated through the slowdown brought upon by the healthcare pandemic. Going back to basics, they learned to do more with less and figured out ways to build failsafe businesses. 

By the end of 2020, two things happened that set the stage for this year—rapid mass digitization in the South Asian nation and the VC funding rebound.

Despite the overhang of the healthcare crisis, 2021 turned out to be a milestone year for the Indian startup ecosystem. As consumer internet startups grew massively on the back of hundreds of millions of Indians devouring content and services online and transacting more than ever before, they raised an exorbitant amount of capital and scaled even faster.

This led to VCs writing bigger checks at higher valuations. Overall, this year investors pumped over USD 34 billion into startups—200% more than 2020, which created 41 unicorns. Certain sidelined sectors like crypto, gaming, and direct to consumers became darlings of investors. Unsurprisingly, e-commerce turned out to be the most funded sector with over USD 9 billion of capital inflow, followed by fintech.

Flushed with money, bigger startups gobbled up smaller rivals and adjacent businesses to fuel growth, giving early-stage investors high returns. While investor sentiment was at an all-time high, a  slew of startups took the call and decided to go public in a bullish market, which made global investors even more excited.

As we come to the close of 2021, KrASIA looked beyond the obvious at unexpected things that have defined the local startup ecosystem this year.

Lost focus on profitability

In 2019, coworking startup WeWork’s failed IPO and ride-hailing giant Uber’s poor market listing jolted Japanese conglomerate SoftBank out of its dream. It brought out the truth about its portfolio’s inflated valuations in the open, which made “course correction” a buzzword among VCs globally. India was not untouched as SoftBank tightened its purse strings and pushed its investee companies to cut down on cash burns and pave a path to profitability. The larger investor community in the country followed SoftBank’s footsteps.

However, the COVID-19 pandemic hit the country in early 2020, which led to the Indian government posing multiple nation-level lockdowns. Local startups were left with no other choice but to slash expenses to secure cash runways for the next nine to 12 months. Startup entrepreneurs and their VC backers scrambled to adapt and realigned their focus to achieve positive unit economics and create sustainable businesses.

One year later, that mindset has muddled—a direct consequence of more and more investors leading bigger rounds at sky-high valuations, betting on the pace at which tech startups are growing.

Arun Natarajan, founder of Chennai-based research firm Venture Intelligence, feels many companies that have raised money from VCs at billion-dollar-plus valuations don’t even have enough revenues to back their unicorn status yet, and hence for them, profitability is still far away.

“In the early stages, I don’t see startups talking about unit economics,” he told KrASIA. “Over the years, we have seen growth versus profitability debates. It’s one or the other, and that’s the nature of the venture cycle. Currently, VCs and companies are focusing on growth and not profitability.”

Many startups are raising multiple rounds and burning money to grow as fast as possible. To justify their high valuations, they need to keep meeting the targets they have committed to their backers.

“Most times, having a very high valuation is also a trap. If you cannot grow as fast as promised, the next round could very well be a down round” Anirudh A Damani, managing partner at Artha Venture Fund (AVF), told KrASIA.

Moreover, those with high cash burn usually have negative unit economics—they spend more money to get one customer than what they earn from her.

“The amount of money many startups, especially marketplaces, are investing to acquire customers, I do not see them being able to recover that for a long time,” said Damani. “They are going after growth, but nobody can quantify the cost of this growth.”

“A startup that is chasing growth may not be able to provide net cash profits. But at a transactional level, they must be positive.  A startup should figure out its unit economic positivity by the Series A round,” Damani added. “When startups that are incurring a loss on every transaction chase growth, they are effectively accelerating their losses. Such companies at scale create more losses.”

What VCs are currently looking at is whether these fast-growing startups can acquire and retain customers and gain market share, according to Anil Joshi, a managing partner at Unicorn Ventures.

He believes digitization has improved the cost of acquisition for startups, as they are gaining more customers and growing faster by spending a similar amount of money as before.

“Startups are focusing more on growth and attaining a leadership position now. If there is a high level of adoption of a product and service, and at the same time a high level of retention, money will come. Thus, burning cash to acquire more customers is not an issue,” he said. “If they can retain their customers and upsell them, they can bring customer lifetime value  (total amount of money customers are expected to spend on a product during their lifetime) to optimal levels.”

Reality check: Paytm’s poor market debut

The startup IPOs that kicked off in India this year were something no one foresaw, although investors were expecting more and more exits through secondary transactions and mergers and acquisitions. Several high-profile startups like food delivery giant Zomato and omnichannel beauty retailer Nykaa made strong public debuts, while a string of VC-backed companies including travel firm ixigo, online pharmacy PharmEasy, hospitality giant Oyo, logistic startup Delhivery, and e-commerce firm Snapdeal have filed draft papers with the market regulator.

The successful listing of Indian startups “shows there is a public market appetite for these companies, which didn’t exist earlier,” said Damani.

Amidst the IPO frenzy, fintech major Paytm’s public issue stood out. Not only did it open as India’s largest IPO at USD 2.5 billion, but it also listed at a steep discount of over 25% last month.

Industry experts attributed Paytm’s sky-high valuation, shaky business model, and lack of clarity on achieving profitability for its poor market debut. But it brought a reality check for startups as well as retail investors, particularly millennials who flocked to stockbroking apps this year to dabble in public markets expecting high returns from these high-profile startups.

“The message is very clear from Paytm IPO—startups need to have a path to revenue and profitability if they want to go public. If they have that, and in-between, they are making losses, it doesn’t matter,” said Joshi. “If you look at Zomato, nothing has changed for the company since its IPO because it has been able to show the path to revenue and profitability.”

Aside from its expensive shares, another thing that went wrong for Paytm was its inability to explain its business model clearly and how it plans to earn profits.

“Paytm is finding its story difficult to sell to Indian institutional and retail investors,” said Natarajan. “Because what they are doing on the B2B side is too complex for average public market investors.”

“Startups nearing public markets need to get their story clear, straight, and understandable, supported by numbers that show sustainable profitability or at least a path to that,” he said. “They can’t say they will have declining revenue as well as profitability. That kind of story won’t sell, especially because Paytm had a tough time explaining it.”

However, some investors feel if Paytm is able to pull through and starts churning profits eventually, it will prove to be a good investment in the long term.

“What happened with Paytm has happened with many companies in the US. Since the listing, there has been a considerable drop in the valuation of startups like Uber. That is how the public market functions,” said Damani.

“I don’t think people expected Paytm’s stock to double on the first day. It was already being sold at a discount in the grey market,” he said. “Those investing in startup IPOs shouldn’t expect to sell on day one and make profits—as those are traders and not investors.”

Bigger checks at higher valuations: Not another bubble

The funding in Indian startups has more than trebled to over USD 34 billion in 2021 over last year, led by marquee investors like Tiger Global, SoftBank, and Accel. More than 200 funds have made debut investments in India this year so far, making the local startup ecosystem much more competitive than before. Due to the funding deluge, check sizes rose significantly, while deals became more and more expensive.

“There is no shortage of good founders in India, but it doesn’t take away the fact that it is competitive for an investor. India is starting to resemble the (Silicon) Valley more and more,” Harsha Kumar, partner at Lightspeed, told KrASIA. “You may aim at ten and get five or six, but they will still be great deals.”

The Indian startup ecosystem has matured this year—in terms of scale and offerings. Startup founders are now thinking beyond capital and are focused on what their investors bring to the table, Kumar said. She believes check sizes will continue to grow meaningfully.

The reason many VCs believe the steep valuations—at which startups across stages are raising increasingly bigger rounds—are justified is the lightening fast pace at which local tech companies are expanding, the scale they have achieved in a short span of time, and the massive potential to grow on the back of humungous consumer base and available enabling digital infrastructure in the country.

Furthermore, investors believe the record capital inflow that the local startup ecosystem witnessed in 2021 is different from the last funding boom in 2015.

“In 2015, it was only e-commerce that gained traction from investors. But this time, it’s a totally different scenario where companies across the spectrum and value chain are getting noticed, funded, and gaining traction,” said Joshi. “Investors are finding it worthwhile. There is more interest and confidence in the space that is bound to increase valuation numbers, which is based on growing numbers.”

Joshi believes the trend will continue, and valuations are likely to sustain given the venture capital availability.

“The size of the market and the growth potential will always make India a prime investment hub for at least a decade or so,” he said. “Even if there is a course correction, because of external factors, it (valuations) will again rebound in time.”

Share

Auto loading next article...

Loading...