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New Wave Of FDI Reforms Could Help Take Struggling Start-Ups To Shore

23/06/2016 8:40 AM IST | Updated 15/07/2016 8:27 AM IST
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On 21 June, the Government of India took a significant step towards making India the most open economy in the world. Through this reform it has allowed 100% Foreign Direct Investment (FDI) in food retail, civil aviation and 74% in private security agency and pharmaceutical businesses. This step comes at a time when the Indian start-up network is witnessing one of the hottest summer seasons of the past few years. The inhabitants of this third-largest ecosystem in the world have been in search for new resources of liquidity to ensure their survival. If early signals hold any truth for the foreseeable future, the present funding scenario can turn out to be a drought, which can last for some time to come.

[I]n the first three quarters of 2016, compared to the same period in 2015... the total value of venture capital invested has taken a drastic fall of over 80%...

In February, this year, Morgan Stanley reduced the valuation of India's biggest unicorn, Flipkart, from $15.2 billion to $11 billion. Data from VCCEdge shows that in the first three quarters of 2016, compared to the same period in 2015, the number of venture capital deals have fallen from 138 to 88, and the total value of venture capital invested has taken a drastic fall of over 80%, from $1.8 billion to $334 million. According to Sudhir Sethi, chairman of IDG Ventures, "The sentiment is cautious."

The reason for this caution are factors such as uncertain global economy, slowdown in China, expected increase in interest rate in the US, and a private vs. public valuation disconnect with disappointing initial public offerings (IPOs). Due to the slowdown in the Chinese economy, on the flip side, Indian start-ups have attracted the attention of prominent Chinese Investors that include Fosun Group, Xiaomi's founder Lei Jun (Shunwei Capital Partners), Cheetah Mobile, Baidu and Tencent. However they are also treading with extreme caution after observing the funding decisions of US-based hedge funds in India. According to Aditya Rao, chief executive of the services start-up LocalOye, "These are definitely testing times for the start-up ecosystem...2016 is the year where everyone is trying to re-evaluate their strategies and put a strong focus on revenues and margins more than anything else."

Even though entrepreneurs are slowing the growth rate, they are taking out time to reinforce the processes of their start-ups.

Since employee costs at India's leading start-ups account for more than 35% of cash burn rate, facing paucity of funds, start-ups have started pruning the head count of workers. Over the past several months, online marketplace Snapdeal, restaurant discovery platform Zomato, and auto classifieds CarDekho have let go of hundreds of employees. Other than just firing employees, they are also tweaking their hiring strategies; the number of job offers by start-ups to graduates at Indian Institute of Technology has reduced drastically. Even employees with work experience are not being spared; the compensation packages being offered are down 50-60%. Average pay for hires is down to $5-7 million from $10-15 million and the salary offers of more than $10 million have fallen to 100 from 500 in the previous year.

Founders have been left with few alternatives other than to accept this slowdown to be the new norm that includes:

Watchful investors: Preference is being given to quality over quantity. Start-up founders are finding it increasingly difficult to raise the required capital; in order to do so they are being asked to become better at managing capital and improving the efficiency of each rupee spent. Early stage start-ups are finding it easier to survive and grow, as the funding requirements at that level are lower with the concept not proven. Norwest Venture Partner's Mohan Kumar says: "Capital as a barrier is giving way to companies that have good execution, great product and path of profitability. Such companies will get funded and need not worry. This trend is actually very good for entrepreneurs."

Although investments might have become subdued, with these new FDI norms money will still be available for start-ups with capable teams and viable ideas.

New systems and processes: Since change is the only constant in business, founders in turn are innovating in order to set up effective communication lines with investors and employees. Appropriate HR policies are being formulated to ensure increase in productivity, morale and efficiency of under-pressure employees. As companies are changing metrics to measure growth, lots of e-commerce companies, such as Snapdeal, are moving away from the Gross Merchandise Value (GMV) to customer-centric strategies on their platform.

New funding sources: These processes are encouraging the emergence of domestic funding sources, which are necessary for long-term, sustainable, healthy ecosystem, and to safeguard the Indian economy against volatile global markets. As a result, well-known Indian industry veterans such as Pawan Munjal (Hero Group), Nandan Nilekani (Infosys), N R Narayana Murthy (Infosys) and Ratan Tata (Tata Group) are aggressively investing in start-ups. Successful founders such as Sachin Bansal (Flipkart), Deep Kalra (MakeMyTrip), Vipul Parekh (BigBasket), and corporate honchos Rajan Anandan (Google India) and TV Mohandas Pai (Manipal Group) have also joined this rapidly growing list. Along with this trend, micro funds such as Seedfund, Utilis, Unicorn Ventures and Endiya Partners possessing a corpus of between $15-25 million have also started investing capital which is smaller than the start-up investments by regular venture capital firms but larger than those made by high net individuals (HNIs).

To ride this tide and leverage the opportunity provided by these reforms, founders have to focus on core business strengths and not experiments.

In spite the efforts of the government, India is still finding itself ranked at 130 in the ease of doing business ratings by the World Bank. To improve the country's position in these rankings, the Indian government is proposing further implementation of a unique identification number to carry out all business transactions. Along with this it has implemented a new e-commerce policy to govern online retailers, and is planning to roll out GST (Goods and Services Tax) by end of the year.

The cycle of funding hysteria, which started in 2014 after Flipkart raised $1 billion, has continued with Chinese behemoth Alibaba's successful listing of stock in the US markets; Japanese investor Softbank steered capital earned from this listing into Indian start-ups. So far, this year is proving to be the other side of the coin, where to make most out of the situation founders need to keep the new norm in mind. Even though entrepreneurs are slowing the growth rate, they are taking out time to reinforce the processes of their start-ups. Although investments might have become subdued, with these new FDI norms money will still be available for start-ups with capable teams and viable ideas. To ride this tide and leverage the opportunity provided by these reforms, founders have to focus on core business strengths and not experiments. They must be concise in marketing efforts, give importance to the morale of employees and maximize customer experience.

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