What Indiranagar ka Gunda says about the global economy4 min read . Updated: 20 Apr 2021, 12:11 PM IST
- Venture funders with access to a great gush of crisis-response liquidity are pouring money into startups
A few days ago, an advertisement featuring the retired Indian cricketer Rahul Dravid, who’s not known to lose his cool, broke the internet. The adspot shows Dravid fly into a road rage. One of the shots in the commercial has Dravid waving a cricket bat threateningly and shouting, “Indira Nagar ka gunda hoon main." The locality of which he proclaims himself the goon, Indira Nagar, is in Bengaluru. Of course, Dravid must have been paid a bomb for this ad, given that it required him to portray a side of him that probably doesn’t exist.
The ad was for a fintech startup and unicorn called Cred. A unicorn is basically a startup valued at over $1 billion. A Bloomberg news report of 12 April points out that: “In the space of four days, [India] minted at least six new startups with a valuation of $1 billion or more."
It’s raining unicorns in India. Nonetheless, the question is this: How can a startup that barely has any revenues and is making heavy losses be valued at over a billion dollars? The answer lies in the fact that large global venture capitalists (VCs) have been buying stakes in Indian startups at prices that makes them worth more than a billion dollars each.
This has been happening in an economy where bank lending to industry has been flat for the past five years. Of course, lending by banks cannot be compared with investments done by VCs. Banks lend money to what they deem as safe and relatively risk-less business ventures. Startups are deemed to be too risky by banks.
The VCs know that many of the startups they have invested in are likely to go bust. But they are betting on the fact that some of these will end up doing so well that they will make up for their losses on other ventures and thus leave a profit on the table overall.
Nevertheless, businesses that banks finance and those that VCs invest in operate in the same economy. So, what makes VCs so optimistic and banks so pessimistic?
Banks not lending is primarily a function of the fact that most corporates do not seem interested in borrowing. The profit margins of Indian companies, both listed and non-listed, have been falling over the years; this has led them to under-confidence in their economic future, and hence the slowdown in bank lending to industry.
On the other hand, interest rates in large parts of the rich world are low or negative. Interest rates in the United States have been low since the financial crisis of 2008 broke out. Japan has had low interest rates since the 1990s, after its real estate and stock market bubbles burst. Parts of Europe are seeing negative interest rates, suggesting that the rich world doesn’t seem to have much use for all the money floating around.
In the aftermath of the financial crisis that broke out in September 2008, rich-world central banks, led by the Federal Reserve of the US, printed a lot of money. They resorted to the same tactic in early 2020, after the covid pandemic broke out. The US Fed alone has printed more than $3.5 trillion since the end of February 2020. This has driven down interest rates to extremely low levels.
Hence, there is a large amount of money in the rich world that is desperately seeking returns. The VCs have access to this money and are betting big on new-age Indian startups by investing in them at extremely high valuations.
Most of these startups work on the concept of ‘network effects’, with each extra customer enlisted making the network more valuable than what simple addition would suggest. Take the example of food-delivery apps. More the number of people using food-delivery apps, the more sense it makes for restaurants to be on those apps as well.
To achieve network effects, startups need to first build scale. This means getting more and more people to use their apps. This explains why many apps offer customers huge discounts initially.
Of course, these discounts mean startups in the first few years of trying to establish themselves end up spending a lot of money without generating much revenue, thus suffering large losses. But they continue to stay in operation, despite mounting losses. This is made possible by VCs constantly investing fresh money in startups at higher valuations to keep them going.
The huge discounts on offer are typically designed to deny competitors easy access to the relevant market and attain a monopoly (or a duopoly) in the process. Once that is done, the idea is to cash in on this market and make huge profits. If that does not happen, then the hope is to sell out to some other VC and exit the company.
This business model is an outcome of the times we live in—that is, of easy money and cheap internet-access. It would not have been possible at any other point of time because the huge losses made by startups in their initial phase would simply have bankrupted them.
This also shows the inflationary impact of the money-printing being carried out by central banks across the world. In the past, money printing led to inflation that affected entire populations, with prices of essential goods rising as more money chased the same amount of goods and services.
This time around, extra money-printing has led to asset-price inflation and not the conventional sort. Startups that may or may not make money someday are worth more than a billion dollars. Stock markets around the world are in frothy zones. House prices in the rich world are rising. And Bitcoin… let me not even go there.
Vivek Kaul is the author of ‘Bad Money’
Never miss a story! Stay connected and informed with Mint. Download our App Now!!