Home / Opinion / Views /  The shadow on startups of capital cost shudders

In banking, by an old quip, work goes by a 3-6-3 routine: borrow at 3%, lend at 6% and play golf at 3pm. In a globalized scenario, thanks to a flood of easy money in a policy adventure of pandemic proportions, some rates got dunked into the minus zone. Lazy banking need not translate into lazy investing, but the drift is clear in this caricature of our recent unicorn chase: get funded today, burn your stash tomorrow to buy a customer base and encash it the day after. Reality is far more complex, of course, but among online startups, ‘money for the asking’ almost rang true for a bit. By 2021, venture capital (VC) deals in India were in full boom. Their value leapt from a quarterly average of about $3.1 billion over 2019 and 2020 to $5.6 billion in the first quarter of 2021, by PwC data, and then broke above $10 billion for a run that began last July and lasted three quarters. It was too good to last. As an inflation flare-up forced the start of a US Fed monetary reversal, VC funding dropped 40% in the three months to end-June 2022. While early-phase fintech funding held up, and India-focused funds may have swelled this year, how long the overall squeeze will last is anybody’s guess. Our startup challenges have clearly steepened.

Free credit at the top of the system did act as a stimulus. A massive dose of easy money for lenders—some of it cheaper than free—served to ease further lending, debt yields (and roll-overs), investments, other spending and more, injecting the fuel deemed to be a no-brainer as an economic boost. For big investors of capital, it reduced break-even points of return to new lows. As with any extended glut of capital, however, a worldwide hunt for yield among those flush with funds would surely also have driven riskier bets. Some of these wagers might have had an expiry date set by a Fed policy switch, which explains today’s anxiety over a big rout ahead as rates of interest rise. Not all VC players will feel the same heat. Large investors tend to operate as risk spreaders, with portfolios diversified to ensure that a few smash-hit ventures can make up for a pile-up of duds. Many online plays have been in ‘winner-takes-all’ markets, where success demands a do-or-die scale-up; for the data gathered to attain critical mass and form a competitive edge, this had to be done fast, so big money spent on customer swoop-ins made strategic sense. But such grand plans now have to contend with a phase of costlier capital.

As the math gets redone, startup valuations have been shaken, public issues put off and austerity adopted. Unicorn status or otherwise, business plans that are not rate-rise and slump resistant stand to get exposed as the tide of liquidity turns. Control over cost bloats was only to be expected, but there may also be space for shifts of strategy in some cases. In fields like fintech, notably, value-creation models need not be size-driven. Digital finance, for example, could use the open-proof power of blockchain ledgers to exploit the inefficiency of an old brick-set sector, rules willing, perhaps even profitably so from the word go; our central bank will have to balance its innovation okays with financial stability, as its governor indicated in Friday comments on fintech. But even in other fields of play for startups, paths to profit could draw upon the value of an idea in itself. A business with a sales spiel that’s uniquely attractive enough to keep it viable at any size would not only grow steadily, but always merit venture funding. Whatever the scale of play, the lure of a “better mousetrap" remains as relevant as ever. Need fulfilment is still the basic game.

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