As heat rises, Indian startups head to the deals table

Photo by United Nations COVID-19 Response on Unsplash

As the novel coronavirus started spreading rapidly across the country in the second week of March, internet startups were among the first off the block to adopt work from home (WFH) policies. An entrepreneur Mint spoke to attributed this to the fact that startups grasp the concept of “virality” far better than other companies.

Yet, many startups had remained more or less sanguine then about their prospects, convinced that no matter how bad things got, demand for digital products and services would soar as the fear of transmission would keep hundreds of millions of people at home.

Two months later, that optimism has turned into dread.

At many companies, revenues have vanished, supply chains have been thrown into disarray and piling costs have depleted cash reserves. Even after the national lockdown ends on 17 May, demand is likely to remain weak for a long time. Sales will fluctuate wildly for several months depending on outbreaks of the virus and attendant lockdowns, making efficient cost management tough or impossible, especially for those startups that have physical operations.

Rather, the crisis will lead to large numbers of startup failures, as deprived of capital, ill-conceived business models collapse, investors said. In addition to more startup failures and a wide drop in valuations, a spike in mergers and acquisitions (M&As), especially distressed sales, is expected over the coming year, driven largely by investor attempts to cut losses and save face.

Rising dread

More than 14,000 startups, including unfunded firms, have shut shop since Tracxn Technologies Pvt. Ltd, a data platform, started tracking this number in 2016. Over the past two months, more than 250 startups have already shut shop, according to Tracxn, which calls the list “Deadpool.” This number is expected to increase sharply in the coming months.

“Startup closures will increase significantly over the next year (compared with the past), and we should expect more M&A activity as well,” said Abhishek Goyal, co-founder, Tracxn. “For startups that had a mediocre business model or were losing a lot of money on every transaction, it will be very tough to raise funding now. If you were burning money to achieve scale and then hoping to figure out a business model—these kinds of startups will struggle badly.”

Goyal, however, added that if a vaccine or cure is found for the virus any time this year, then internet startups “will see a correction (in funding and valuations) rather than a bloodbath.”

“Like 2016-17 and 2012-14, there will be one cycle of correction this time, too. Even before the virus spread, there was talk of a funding slowdown. The virus has only sped it up. In addition, because SoftBank isn’t as aggressive anymore, late-stage funding will suffer. We could see private equity firms doing more late-stage deals, and they usually offer (lower valuations and funding amounts compared with SoftBank). So there should be a correction in valuations,” Goyal said.

Taking their cue, investors have started either delaying investments or demanding lower valuations—“down rounds”—as the price of new capital.

Deeper cost cuts and steeper falls in valuations at startups are expected over the coming months as a devastating economic recession, more severe than any that India has experienced in decades, takes hold, entrepreneurs and investors said. Startups are facing a long-drawn-out downturn, which is likely to last more than two years, they said.

One obvious exit route for startups and investors in this environment is M&A.

Startups in many sectors are considering mergers—venture capitalists are driving these discussions. These sectors include the new crop of ride-sharing startups, social commerce and online lending. All these sectors have been badly hit by the covid-19 crisis. These sectors have several mid-sized startups that were burning through cash battling each other in order to gain market share. Till now, no clear winners had emerged, even as losses rose.

“Consolidation of smaller firms in a sector, say a No. 2 and No. 3 player coming together to survive or take on the market leader, only makes sense if their respective investors commit to putting significant capital in the merged entity,” said Ritesh Banglani, partner, Stellaris Venture Partners, a Bengaluru-based early-stage venture fund. “But there has to be a strong case for consolidation, otherwise M&A is more a face-saving step for investors.”

Already, some large acquisitions have been discussed.

Mukesh Ambani’s Reliance, which has bought several startups including Haptik, Fynd and Embibe over the past two years, is in discussions to buy medicine delivery firm Netmeds, according to a person familiar with the matter. The news was reported earlier by The Times of India. Various media outlets have also reported that Zomato held early talks to buy grocery delivery firm Grofers for more than $750 million, though the two companies have denied holding the discussions.

Anand Lunia, founding partner, India Quotient, an early-stage venture fund in Mumbai, agreed and said that Reliance and other large companies in different sectors may buy internet startups in higher numbers over the next two years compared with the past.

One space that seems ripe for consolidation or startup failures is fintech. Apart from lending, many companies have cropped up in spaces like payments, wealth management, neo-banking and insurance. Many of these companies have struggled to acquire scale and differentiate themselves. They could become “zombie” firms in this slowdown, prompting their investors to push for distress sales or to cut them loose.

Build over buy

While investors are hoping for more and bigger deals by companies like Reliance, they are less hopeful of Indian unicorns (startups with billion-dollar valuations) making big acquisitions.

To be sure, apart from FreeCharge, some of the largest acquisitions in the Indian startup ecosystem have worked out well for the buyers and their investors. For instance, Flipkart’s acquisitions of Myntra and PhonePe; PayU’s acquisition of Citrus Pay; and Naspers’ buy of RedBus have all yielded windfall gains for the respective acquirers.

Still, in this environment, when many of India’s most valuable unicorns like Oyo and Ola are battling for survival, acquisitions by them are unlikely. Even the few unicorns that are thriving in the covid-19 crisis are hesitant to make big bets.

Last year, PolicyBazaar asked an executive to bring attractive acquisition targets to the company’s notice. Over the past eight months, PolicyBazaar has vetted 15-20 companies every month. Yet, the company found “nothing worth buying,” said PolicyBazaar co-founder and group chief executive officer Yashish Dahiya.

“We just didn’t think it adds value to us. In cases where we found something interesting, we looked at whether we should buy it or do it in-house, and doing it in-house seemed to be much easier. We figured that with one or two employees we can build it, so why bother? If we find that somebody has built a product that we can’t replicate in six months and that adds value, we’ll certainly buy. But we haven’t found that yet,” Dahiya said.

In conclusion

Another factor that complicates M&A, at least among unicorns, is the fear of the antitrust regulator. In the past, food delivery companies Swiggy and Zomato, as well as the two largest transportation apps, Uber India and Ola, have considered merging.

But apart from the disinclination of the founders of these companies to join hands with their rivals, what stopped merger talks from moving forward was the belief that a combination would be opposed by the Competition Commission of India (CCI).

“It is unlikely that there will be consolidation among unicorns. In most sectors, there are virtual duopolies. The CCI has been very active in the internet space, so it is unlikely that they will approve of two big internet companies in a sector coming together,” a venture capitalist said, on condition of anonymity.

This article was first published on livemint.com

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.