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.
Even before covid-19 struck, loss-making internet startups across the world were facing a reckoning, as years of heavy spending failed to produce profits. The pandemic has demolished any hopes that startups would have a “soft landing."
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.
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.
Funding data, too, already reflects a sharp slowdown. So far this year, Indian startups have raised $3.3 billion in capital, according to Tracxn. With mega funding rounds unlikely, this indicates that funding will be much lower this year than the $15.7 billion Indian startups raised in 2019.
“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."
New restrictions on Chinese investors announced by India last month have added to the uncertainty around startup funding. Besides, the missteps by Japan’s SoftBank Group, which have prompted the company to cut its investment pace, have created a wide gap in late-stage funding.
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 any more, 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.
Already, many well-funded startups including Oyo, Swiggy, Zomato, Cure.fit and others have cut jobs and salaries to reduce cash burn. Some companies are moving into newer categories that could prosper in the post-covid-19 world. But these efforts will not nearly fill the revenue shortfall in their core businesses, while already-low margins will decline further.
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.
Merge or perish
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."
Banglani added that prices will be attractive for potential acquirers because many companies could struggle to raise capital in this environment.
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.
“We will see M&A activity in two cases. One, of the strategic kind, where a big firm makes acquisitions. Because prices are attractive, companies like Reliance may buy more companies, or banks may buy fintech startups in strategic areas. Second, where investors drive mergers between high-burn companies that aren’t doing all that well. There are many sectors that are quite crowded and where many companies have been trying for many years to become big but haven’t succeeded. In such a time, where funding is very difficult to get, the investors will decide to throw in the towel and try to merge with the one remaining leader in the space," he said.
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.
“It’s a tough market for fintech because the move to profitability has been forcefully accelerated," B. Amrish Rau, chief executive officer of payments firm Pine Labs, said. “We are more likely to see M&A of the distressed kind. Many companies hadn’t built solid business models, and they are especially vulnerable now. In lending, for instance, even NBFCs (non-banking financial companies) and some banks are in trouble. How will a lending startup with a tough model stand a chance? Those companies that hadn’t raised capital before this started will have to consider their options."
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.
Strategic acquisitions by internet companies can be tricky to pull off, as was the case with Snapdeal’s acquisition of payments firm FreeCharge. After buying FreeCharge for more than $400 million in 2015, Snapdeal was forced to sell the company for just $60 million in 2017 to raise cash in order to stay afloat.
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.
PolicyBazaar is a case in point. Along with Bigbasket and Byju’s, the insurance retailer is one of the few large internet startups that hasn’t been hurt by the covid-19 crisis. PolicyBazaar, in fact, has increased its advertising spending to cash in on the increasing demand for health and life insurance and expand its market share. It is better-placed than most others to make a risky acquisition.
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.
One reason behind PolicyBazaar’s avoidance of M&A is that the company has found valuations to be “inflated." “The other reason is that people just haven’t done that much ground-breaking stuff. If somebody has gone and let’s say build a partnership with an insurance company where they are selling some new policy, we could replicate that (easily)," Dahiya added.
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).
The same belief played a part in Flipkart choosing to sell itself to Walmart instead of Amazon in 2018.
“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.