Indian Startup Ecosystem: What Happens Next

As the stock markets plunge across the world, including India, a lot of people are wondering what will happen to the Indian startup ecosystem. Earlier in the month, we just celebrated India’s reaching a milestone of the 100th unicorn in the country, as I wrote about in a recent article for Times of India.

Over last two years, Indian startups have attracted close to $55 billion in funding which is third in the world after U.S. and China. The stratospheric valuation of the private companies as well as the successful public listing of Zomato & Nayaka made this sector extremely hot and, of course, lucrative for the investors.

The big question is what will happen now as Nasdaq has dipped 28% from its peak, while the S&P has gone down by 18%. The U.S. markets are in correction territory, and we are flirting with a bear market. Meanwhile, the Indian stock market and the rupee seem to be in a freefall.

The big difference between this downturn and last two recessions in 2000 and 2008 has been the general inflation of asset prices across all sectors like stocks, housing, metals, and oil. During the last two recessions, we did not have such high inflation or the overhang of massive debt. The U.S. debt has crossed $30 trillion already while India’s fiscal deficit has jumped to 6.9% from 3.8% during the pre-COVID era. Coupled with very high inflation in U.S. and India, this is leading to a paradigm shift that I am calling “the end of Greenspan's put” (to play on the common idea of the Fed put).

In last 40 years, the U.S. Federal Reserve has always come to rescue of capital and stock markets by cutting interest rates and increasing liquidity to help increase the asset prices. This has led to a massive amount of asset inflation, as well as carry trade, where money flows into emerging markets. And these trends have pumped into investment vehicles like VCs and private equity funds, especially focused on these emerging markets like India.

This excess liquidity led to large investments being made in Indian startups over last two years as well as bullish stock market which made IPOs very lucrative.

I foresee the following to happen for the Indian Startup Ecosystem now:

1. Sharp Correction in Valuations: As growth stage investors like Tiger Global, Coatue, Softbank etc., have exited the space, startups are seeing a big correction in their valuations. Many of these startups were being valued on price over vision, and now they are facing harsh reality of the real world that values companies on free cash flow. This is already evident as activity in growth rounds that are typically Series C and onwards, have dried up in the market.
2. Massive Layoffs: Startups have pushed wage inflation to stratospheric levels as they were in a mad rush to develop proprietary tech platforms for illusionary business needs. The investors are to be blamed for that as they thought of tech alone as the differentiator as well as value creator in the startup investments they made. This, combined with demand from crypto companies, created an artificial demand for software developers and data scientists, which has led to massive wage bills with very poor unit economics. Now the funding has dried up, and investors are forcing companies to become free cash flow positive overnight. This new reality is leading to mass layoffs, which India is not used to as a country. It will be interesting to see what it does to the startup scene in India and the confidence around startups among millennials who comprise the majority of employees in these companies.
3. Forced M&A:?The investors will force a large number of VC-funded startups to merge to lower their burn rates and rationalize the costs, so that they have a higher chance to survive. This will lead to further layoffs, as well as right sizing of the companies. This result will be painful for everyone.
4. Shakeout in VC Industry: We are already seeing that funds like Tiger Global, Softbank, etc., face big losses. Additionally, a strong reaction from LPs is going to lead to big shakeout in the industry. As we witnessed in the early 2000s, I foresee close to 80% of the funds not being able to set up a new fund. In fact, a lot of funds will be forced to do follow-on rounds for their existing portfolio of companies. This will inevitably lead to returns that will not be able to meet the hurdle rates threshold.
5. Stronger Companies Will Emerge: I can relate from own experience, as we started Biz2Credit in early 2008 just before the Great Recession. Companies that survive the disruption of an event such as this are going to be much stronger and will solve real pain points for consumers and businesses. This will force companies to once again become frugal and more outcome driven.

This scenario will be there for the next 12 - 18 months before we start seeing a new reset to a new normal in the economy. In the meantime, my challenge to startup leaders is to buckle down and focus on driving measurable results and real business outcomes. We are indeed living in interesting times.