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Conundrum in the Indian Start-up Ecosystem: Valuations and Funding

Apoorv Kaushal and Pradumn Santhalia, Hansraj College


Start-ups in India as in many other parts of the world have received increased attention in particular in the last two decades. Their numbers are on the rise and they are now being widely recognised as important engines for growth and jobs generation. Through innovation and scalable technology, start-ups can generate impactful solutions, and thereby act as vehicles for socio-economic development and transformation. The Federal Government launched its most famous ‘Make in India’ campaign in 2014 to attract FDIs and encourage domestic companies to participate in the manufacturing sector and ‘Start-up India Action Plan’ in January 2016 organized by the Department of Industrial Policy & Promotion (DIPP) to incentivise, restrict hindrances and build a strong ecosystem for start-ups. The major highlights of the scheme are Self-Certification Compliance; Legal support, fast-tracking & 80% reduction in the patent registration fee; Funding support via a fund of funds corpus of INR 10,000 crore, and a 3 Year Tax exemption. As a matter of fact, we have 38,815 active start-ups in India inclusive of both funded and bootstrapped businesses and 5,694 active investors as of 2021 and start-ups have created 187,004 direct jobs since 2016. Indian Institutes of Technology (IITs) have been ranked the world's fourth-largest producer of billion-dollar start-ups, according to a study by UK-based accounting company Sage. IIT alumnus accounts for 12 billion-dollar start-ups including Flipkart, Snapdeal, ShopClues, Zomato and Ola.

Our objective is to highlight the disparity in the relationship of funding and valuation of a start-up compared to its profitability and turnover. We’ll use data available in the public domain for our research. Also, we’ll be stressing upon the issues/challenges faced by entrepreneurs in our country.

The typical financial life cycle of a start-up is a 4-step process:

1. Bootstrapping/Angel Investors or Seed funds- A bootstrapped start-up is started by using existing resources of the entrepreneur, such as personal savings, garage space etc. whereas Angel investors invest solely in the entrepreneur’s idea.

2. Venture Capital- These are still early stages of funding for a business also known as Series funding. They are used to scale business operations and usually comes from Institutional investors. For ex- Y Combinator, Sequoia capital, etc.

3. Private Equity- They usually prefer stable companies and the capital is utilised to fund new technology, make acquisitions and solidify balance sheet. For ex- KKR & Co. Inc., The Carlyle Group Inc., etc.

4. Public Markets (IPOs)- Late-stage start-ups may feel the need to expand more aggressively and create a global presence. Hence, they usually go to the stock markets of the country which provide liquidity to these companies.

Valuations and Funding of Start-ups in India

According to a report by Credit Suisse India is home to 100 unicorns combined with a combined market capitalisation of $240 Billion and the third largest set of Unicorns globally. The largest ones are mostly Technology-based dominated by sectors like E-commerce (33%), B2B (24%), Consumer Internet (12%), and Mobile Apps (10%). Another interesting fact is that Indian Startups have raised a total of $7.8 billion in the first four months of the calendar year 2021, which is almost 70% of $12.1 billion raised in entire 2020. The average funding size has increased to a whopping $25.21 million up from $14.94 million in 2020 and $18.41 million in 2019. For this study, we have collected data for 8 unicorn start-ups in India and compared their PAT/loss for the relevant period.

Note: * The exchange rate for INR to USD is taken for 2nd July,2021 i.e Rs.74.55 for 1 USD.

From the above table, we can infer that many of the famous Unicorns in India have profitability which is in stark contrast to their valuations. Although, many of them have witnessed an increase in revenues in recent years but the subsequent costs incurred to earn that revenue are also on the rise. One of the major factors contributing to this in India is a highly price elastic market and the propensity to pay for goods and services is very low even if there’s a differentiated product. This can be attributed to the fact that CRED, one of the Unicorns, spent Rs.727 to earn a single rupee of operating revenue in FY20 as the company incurred heavily on marketing just because it was able to raise excess funds. Not just CRED, this is the case with many E-Commerce and technology-based start-ups like Flipkart, Myntra, Byju’s etc. who spend heavily on advertising and marketing related costs. Another factor contributing to this is that capital these days has become a lot cheaper since the number of Angel investors and VCs has increased and investment terms are liberal. This leads us to another loophole in the system i.e. Founders raise capital by diluting their stake over some time and eventually exit (like Binny and Sachin Bansal of Flipkart sold their stakes to Walmart in 2018) leading to these huge funds/businesses bearing losses for these entities and the burden gets shifted. Also, as the stake gets diluted the accountability from a founder’s perspective gets reduced and hence, they might not make the extra efforts to grow the business or per se keep it profitable. But compare this to a bootstrapped model like Zerodha which is somewhat revolutionary in the space of Indian stock broking business where both accountability and the desire to keep the business profitable is much higher. Since founders control the majority of the stake, the onus of business performance is on them and higher profits mean funds available for expansion and sustenance of the organisation. Also, they haven’t spent even a single rupee on advertising or raising external capital or debt. The focus is on innovating the products and services and efficient utilisation of resources.

However, in India failure is often frowned upon in society and hence many budding entrepreneurs used to relent often, from taking that big step and quit their secure day job to start something of their own but the booming Start-up culture has greatly changed that and has somewhat inculcated the American culture of treating failures as mere stepping stones. This can be widely observed of how keen even college students are of starting something of their own. This can be considered as a big plus because eventually, this leads to more job creators in the economy.

But a triggering question still looms, whether valuing an organisation solely based on its product or even customer base without even considering its actual financial performance is acceptable?












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