Indian promoters claw back control

The Oyo deal was a landmark moment in the Indian startup ecosystem, even globally. It was the first instance in India of an internet entrepreneur increasing their holding in their startup in such a significant way.

After Agarwal’s announcement, founders of at least two other , ride-hailing service Ola (ANI Technologies Pvt. Ltd) and education content provider Byju’s, are considering ways to increase their ownership in their companies, people familiar with the matter said.

In recent times, Ola’s founder and CEO Bhavish Aggarwal has been at the forefront of taking back control of his startup from investors. Then there’s Byju’s, one of the fastest growing internet companies in India. Its valuation has jumped to nearly $6 billion from a few hundred million dollars just three years ago. The company’s founder Byju Raveendran and his family still control more than a third of the firm—far higher than most other unicorn founders.

Executives at three venture capital firms confirmed that the founders of some of their portfolio firms had also expressed eagerness to undertake similar transactions. “Several entrepreneurs have approached us to figure out ways to buy back stock in their own startup," an executive at a top investment bank said.

Ola and Byju’s didn’t respond to emails seeking comment.

These attempts by entrepreneurs to increase their stakes are driven by their need to ensure they don’t lose control of their companies. After raising large rounds of capital, the holdings of founders drop to the single digits within a few years of starting out. At most Indian unicorns, institutional investors control an overwhelming majority of shares. This leads to complicated situations, especially when the startup goes through a difficult spell.

The Oyo exception

The executive quoted above as well as venture capitalists said the Oyo deal is likely to be an exception rather than a precedent. Agarwal’s purchase is ostensibly designed to give him more control over Oyo, but the deal has been made possible only because it was facilitated by Masayoshi Son, the founder of SoftBank Group Corp., Oyo’s largest investor.

It is well-known that Son is a mentor to Agarwal. Son is presently the most powerful figure in the startup world given the sheer size of SoftBank’s investment dry powder. His backing of Agarwal was the driving force behind the Oyo deal.

“What happened with Oyo is not a standard globally and to do that is not easy," said a partner at a top venture capital firm. “People understand that it’s a unique transaction that is driven by the strong relationship between Ritesh and Masa (Masayoshi Son). A lot of our portfolio entrepreneurs discussed it with us on how they could do this. But how many people can actually do it?"

Madhukar Sinha, founding partner at venture capital firm India Quotient, said only when large strategic investors like SoftBank are involved can unconventional transactions be considered. “Venture funds or financial investors cannot support such deals. Only large strategic investors can back or underwrite such a complicated transaction like Oyo’s. Oyo is still an unprofitable company and for a founder of such a company to borrow billions of dollars to increase his personal stake in the company, that is unlikely to be repeated elsewhere," Sinha said.

Moreover, the Oyo deal is a high-risk transaction. Agarwal has borrowed $2 billion from financial institutions to fund the purchase. At least part of the transaction valued the hotels brand at $10 billion. That’s a massive increase from the $800-900 million valuation the same company fetched only two years ago when it raised $250 million from SoftBank.

If Oyo fails to maintain or increase its $10 billion valuation, it will spell trouble for Agarwal and his lenders.

“Oyo’s strong growth, improved margins, superior improvements in customer experience led to Ritesh Agarwal, through RA Hospitality Holdings, signing a $2 billion primary and secondary management investment round... making it one of the first founder and executive-led management purchases in the technology and hospitality sector, globally," wrote an Oyo spokesperson in an email to Mint.

Risk and reward

We don’t advise our founders to do something on these lines where they take a loan and buy back stock from existing investors," said Rutvik Doshi, managing director at venture capital firm Investus (India) Advisors. “Starting up itself is a huge risk with all their eggs in one basket and then taking a loan to buy more stock is more risky. Similar things have happened in the public markets. Promoters of publicly listed companies have tried to buy back shares by taking a loan and if the share price falls, they are in the soup," Doshi said.

Though Agarwal’s move at Oyo is unlikely to be repeated at other startups, there are other means to reward founders and key employees. At several unicorns including Ola, Paytm and Rivigo, founders and senior employees have received large cash payouts from secondary share sales and bonus awards. Even at smaller companies such as payments firm Razorpay, logistics provider BlackBuck and online marketplace for used cars Droom, investors have rewarded key employees by buying part of their employee stock option plans (Esops).

Another way for founders and senior employees to get rewards for good performance is to receive additional Esops. In the past, the founders and senior leaders of Ola, Snapdeal and a handful of other startups have received either additional direct equity or new Esops in their firms.

“Where portfolio companies are doing well, investors are drawing up Msops (management stock option plans) to further incentivise founders and management teams. All investors want founders to be incentivised and this is an effective way to reward them," Sinha of India Quotient said.

Founders’ battle for control

A transaction similar to Oyo had been attempted last year by Flipkart co-founder Sachin Bansal. The then Flipkart chairman had kicked off efforts to borrow between $450 million to $1 billion to increase his stake in the company. Bansal’s initiative fell through after he was forced out of the company ahead of its sale to Walmart in May 2018.

Indeed, in the past two years there have been several instances of power struggles between investors and star founders. Many entrepreneurs now view venture capital investors warily. They are demanding stronger rights for themselves and trying to limit those of their investors.

In India, investors have had the upper hand in dealings with entrepreneurs. That is a typical feature of a nascent startup ecosystem. But after a short period of 18 months starting from early 2014 when it seemed like Indian founders were becoming powerful, in the last two years, the founders of three of India’s leading startups—Flipkart, Ola and Snapdeal—have had a particularly tough time with their investors.

The power struggles at these three firms have led to very different outcomes. Flipkart was sold at a valuation of $21 billion even as Bansal left the firm after failing in his quest to obtain operational control. Then there’s Ola. Starting in 2017, Aggarwal has expanded his control over Ola by bolstering promoters’ holdings and rights at ANI Technologies Pvt. Ltd, Ola’s holding company. ANI Technologies has made sweeping changes in its shareholder terms, strengthening the rights of its founders and restricting those of SoftBank and others.

Last October, Lazarus Holdings Pte Ltd, a Singapore-registered entity, acquired 6.72% of ANI Technologies, according to the Competition Commission of India. Lazarus is controlled by Ola Founders’ Trust and a unit of Temasek, a Singapore-based investment firm. In April this year, Aggarwal and Ankit Bhati, the other Ola co-founder, increased their ownership in ANI Technologies through a rights issue, documents show.

At Ola Electric, which was spun off from the parent firm, Aggarwal has also attracted fresh capital from the same investors he was battling. Ola Electric Mobility Pvt. Ltd said in July that it had raised about $250 million from SoftBank to become the fastest firm to become a unicorn after Udaan, a business-to-business commerce platform.

Snapdeal and Micromax

At Snapdeal, the battle between investors and founders ended in bitter disappointment for the latter. In April 2018, Kalaari Capital and Bessemer Venture Partners transferred most of their 10% stake in Snapdeal to funds controlled by the families of the company’s founders, Kunal Bahl and Rohit Bansal.

The share repurchase transaction was a big let-down for the investors who had to take a haircut on their original investments in Snapdeal. In 2017, Bahl and Bansal were locked in a months-long boardroom row with SoftBank and Kalaari Capital, which wanted to arrange a sale of the struggling online marketplace to bigger rival Flipkart. Finally in August 2017, the Snapdeal founders blocked the sale, angering many of their board members and other investors.

A similar transaction followed at another startup that has seen its business collapse after a promising start. Earlier this year, the founders of smartphone and other electronics maker Micromax bought back shares from the company’s institutional investors including Sequoia Capital and TA Associates, according to filings with the Registrar of Companies.

Like Snapdeal, Micromax has struggled to survive after bleeding market share in smartphones to Chinese rivals. And like at Snapdeal, Micromax investors were desperate to recover whatever money they could and took a large haircut on their original investments. The valuation of Micromax crashed about 93% in roughly four years from a peak of ₹21,000 crore in 2015 to less than ₹1,500 crore in the transaction, according to a 29 August report in The Economic Times.

The global picture

Globally, the tide is turning against the founders of private internet companies and in favour of the investors. In 2017, Uber co-founder and then CEO Travis Kalanick was forced out by the investors after the company became embroiled in scandals. Kalanick was replaced by Dara Khosrowshahi. Despite efforts to make a comeback, Kalanick has been kept out of the company. Last month, Adam Neumann was forced to leave WeWork, the office-sharing startup, after the company had to postpone its initial public offering.

The exits of Kalanick and Neumann combined with the tepid stock market debut of Uber are momentous events in the internet space. Uber and WeWork were pioneering startups, and their growth-at-all-costs approach had been copied by startups in India and China. Their success had also made their founders seem invulnerable to investor pressure. Now that these companies have seen disappointing outcomes, investors are likely to rein in founders and exert more control at their portfolio firms.

“These events will have a cascading impact on consumer internet startups," a venture capitalist said, on condition of anonymity. “All the consumer internet unicorns in India are loss-making and they have no path to profitability. When funding dries up these companies will be in trouble and you’ll see investors do whatever they can to recover their money."