Why Covid might be a ‘blessing in disguise’ for Indian startup ecosystem?

“Next two years will be carnage in the Indian startup ecosystem Abhishek, don’t even think of coming back” — said a bold voice on the other line. My heart sank. It was one of the investors from a top 10 VC fund in India.

While my twitter feed was full of VC gyan — ‘Recession is the best time to start a company’, ‘We are open for business’, and ‘We’re closing more deals than before’, I was getting this contrarian advice on a 1-on-1 mentor-ship call. I trusted it more for obvious reasons. He further went on to explain as why he thinks so;

1. Most funds will spend time on portfolio — so less time scouting new startups. Most VCs say the spend 1/3rd time scouting new deals, 1/3rd doing diligence, 1/3rd on portfolio in normal times, but now it will be 75% portfolio, 25% other work.
2. Most funds wont be able to raise new funds in their typical 18–24 month cycle so the current fund deployments will get stretched, means pace of investing will slow down
3. Most funds will use their dry powder in saving the winners, and dump the loosers sooner

The left part of my brain was illuminating hearing these words, it was indeed so logical. How could I not believe him?

Soon my Whatsapp started ringing with sad forwards of top Indian startups firing in troves. Bounce fires >300 people . Ola lays off 1,400 people. Swiggy lays off 1,100 in May and then 350 more in July. Zomato lays off 500+. (More details here).

My fears got confirmed when I received a call from my old college buddy from IIT. He was the perfect track ‘A’ kid — IIT -> IIM ->BCG-> Unicorn. But he had been recently laid off from his startup and his words pretty much summed up his frustration — ‘Abhishek, all my friends who shifted from BCG/Mckinseys of the world to fast moving startups are now crying’.

Hearing his words, made me think whether all the progress we made in talent availability for startups would be undone by this tiny virus?

The stigma of insecurity/instability against startups had just gotten lifted in the last decade. Startups for talented were considered ‘risky’ in late 2000s, ‘cautiously optimistic’ from 2010–15, and had become the ‘norm’ in 2015–20. With these layoff and the pandemic, we are definitely setback in time for accessing great talent from ‘safe’ industries by at-least 2–3 years.

“I trust that everything happens for a reason, even if we are not wise enough to see it.” — Oprah Winfrey

I firmly believe that this pandemic has been a boon for Indian startup ecosystem, one that will only bore well for startup founders and their investors (but not necessarily the employees & late stage investors).

Why I believe all is well?

1. Startups are more than well-capitalized, given 2019 was a mega year in fundraising

As per Techcrunch, Indian startups raised $14.5B in 2019 vs $10B in 2018 by more than 700 companies. Not to say that this was done at record valuations. 57 of these round were > $100M (INR 750cr) as per Yourstory. Most of these startups have not spent much of this fund raise and have enough not only to wither the storm but also to come out stronger at the other end.

2. Lay offs are bad for the employees, but great for the company

Most of the trimming of the fat has happened at the senior levels of these companies. Consider an average salary of a AVP in a Unicorn startup at INR 60–80-lacs ($90k-110k) vs the entry level employee being paid INR 3lac-6lac ($5–8k). So a 15–25% of workforce cut means reduction in employee expenses of proportionally much more (atleast 2x). CEOs have obviously kept the essential workforce, operations of these startups have not suffered a bit -> case that proves that it is ‘trimming of the unnecessary fat’. Many unfortunately have also used Covid as an excuse to take this bold step, which they’d be unable to justify in the hunky dory times.

3. Finally, ‘Growth over profitability’ flipped to ‘Profitability over growth’

As they say — ‘A picture is worth a 1000 words (…and the one with graphs is worth a million)’. Here are some charts from famous Indian startups:

Source: Zomato Annual Report 2019–2020

Source: Mobikwik Annual Report 2019-2020

While some intellectuals might say that startups like Mobikwik and Instamojo had stepped off the fundraising spree and started focusing on profitability long before the pandemic hits and hence….

But Zomato is right in the midst of ‘winner take all’ battle with Swiggy. That too in a sector where their Chinese’s counterpart — Meituan Dianping has not only become profitable but also listed on HK stock exchange with $140B market cap (~20x of Swiggy’ $3.6B tag & Zomato’s $3.25B tag combined). It’s a sector with much bigger size of prize and hence the fierce battle among equals (where even Softbank had gotten scared to take sides yet).

Profit per order — Zomato

But Zomato has flipped the scale in contribution margin per order, from loosing INR 45–50 on each order to making INR 27 on every single delivery, is a complete swing on the other side. Orders might have been reduced by 50% but in turn, profitability has improved significantly. ‘Forget growth, make money’ is the new mantra.

4. Cash-rich early stage startups get more time to build with higher quality talent available, in the ‘off-season’ sale

A lot of 2nd time or senior entrepreneurs raised large seed rounds (something unheard of even in the valley) in 2019.

1. Jitendra Gupta (ex Citruspay founder) with $25M for Jupiter
2. Shailesh Nag (ex PayU MD) with $8M for Dot.pe
3. Sujith Narayanan and Sumit Gwalani (ex Google Tez execs) with $13.3M for Epifi
4. Kunal Shah (ex Freecharge founder) with $30M seed for Cred & subsequently $125M Series A within 1 yr

While Jupiter & Epifi are still in product development stage for their neo-banking/PFM product — the pandemic has not only given push to digital money but also given them more time to build. When no new competitors are getting funded anymore, what’s the race?

Moreover, the #1 stress for a founder was —Hiring. Great talent who earlier had offers from at-least 3 startups is now begging for a job — indeed discounts are large on salaries offered for sure. Moreover, all companies are busy protecting their core businesses — lending ones are particularly hit and will take some more time to recover.

This perfect storm of lots of cash, no new funded competitors, longer time for any competition to prop up and relatively easier availability of great talent is a recipe for success for many of these ‘product’ led companies.

I am a bull on India and will remain so. Lots of mega internet companies will be built in the next decades to come and early-stage investors/founders will make a lot of moolah.

Its not the IF, but ‘when’

Late stage investors will get their returns too, but maybe not that much (unless they bet on Indian SaaS which is another secular growth ‘underrated’ story). Why do I think so?

While Jio accelerated the adoption of these internet platforms but could not do anything to accelerate monetization. As monetization depends upon ‘disposable income’ Indians have (related to GDP per capita), the current macro slow down has only pushed it out by a few years to say the least¹.

And if you don’t believe me still on how returns get impacted due to early investing — let me take you through the example of Saif’s investment in Makemytrip from 2005 to 2008. One of the best bets in the VC world indeed, where they picked up on the future of online ticket booking way before anyone else. The Midas touch turned their $25M (invested between 2005 to 2008) in to $400M — 16x return indeed. But in terms of IRR (internal rate of return), it was 26–32% (given exact timing of entry/exit is not known). That’s amazing returns, but is it what they aspire for? You should ask your VC friends :).

Only a fool would dispute that more Indians will buy things online, will pay digitally, and more SMEs will do business in ‘white’, rather than black. The question is not about ‘if’, but ‘when’. The returns for investors completely change if it takes 5 yrs to get there vs 10 yrs or even 15. Founders are in this for long term and for them, the timing doesn’t change anything (more are in their late 20s or 30s, so what’s the hurry?)

But in a parallel universe, with the profitability being the new mantra, the valuations might again rise in 2–3 years with the changed story being ‘Wow, you are an internet company and you are even profitable so early’. After all, its the story that sells, not the numbers !

But Indian is tale of two countries — not India and Bharat , as some use that definition to distinguish between rural and urban economies. But to me, its the traditional industries (Steel, power, manufacturing, telecom) and the internet economy (Flipkart, Ola, Amazon, Byju’s). 2010–2020 has been a nightmare for traditional industries — lots of bankruptcies, NPA mess of INR 10 lac crore, macro slowdown with twin balance sheet problem. Whereas the internet economy in the same period saw — 25 unicorns being born, $17B cash exit for Flipkart, and $15B being pumped in single year in Indian VC. Could the two be any more different?

“We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.” — Roy Amara²

[1] Disclaimer that BYJUs (edtech) is an outlier because every middle class family spends all their savings on their children’s education as the only hope

[2] ‘Indiastack’ is a true joker in the pack which will prove Roy’s quote in years to come. UPI is the tip of the iceberg, 2nd order effects of ‘consent’ layer & ‘OCEN’ framework will empower Indian financial services ecosystem to drive India’s GDP growth engine for years to come.