Prateek Shetty (name changed), 29, a junior sales executive in a Bangalore-based edutech start-up, got the shock of his life in early May. Over e-mail, he was told his services would no longer be required, and that he had to put in his papers in the next few days. Several of his colleagues also received the same message. “We were given no explanation as to why we were being fired,” says a distraught Shetty. Frequent e-mails from his seniors did talk about a plunge in sales in the weeks before the layoff as Covid cases abated and schools and colleges reopened. Senior staffers were told to reduce costs in various departments, but a job cut came as a total surprise. “I was not even given a full salary for the whole month, and was asked to resign within a week,” he says. The Rs 5 lakh a year salary was just enough for him to take care of his retired parents and partly pay for his younger brother’s education. Shetty has turned to social media now to scout for a new job. “I have got a few referrals through Twitter, attended some interviews too, but haven’t got an offer yet. There are fewer jobs in start-ups now,” he says.
Shetty’s plight is among the raft of bad news coming in from across the start-up spectrum in the form of big layoffs as companies face a funds squeeze in an environment marked by uncertainty, high cost of funds and the growing clamour for more due diligence following instances of reckless spending and even cases of alleged fraud. Media reports point to over 5,800 start-up employees being axed since the beginning of 2022. As the start-up sector goes through a phase of rationalisation, even unicorns have not been spared. This year, edutech firms Unacademy and Vedantu have laid off 600 and 624 of their staff, respectively, while online retailer Meesho has laid off 150 workers from its grocery business. Pre-owned car seller Cars24 has axed 600 staff, and cab aggregator Ola has asked 2,100 staff to leave in the January-March period. Furniture start-up Furlenco and social commerce platform Trell, (the latter is under investor scrutiny for alleged financial irregularities), have cut their staff, too, by 180 and 300, respectively. The layoffs in India come amidst similar news globally. Since April, 20,000 workers have reportedly been laid off from tech start-ups, mostly in the US.
When Reality Strikes
Until just a few months ago, start-ups were the toast of the town. From cab aggregators to food tech firms to online retailers of furniture, fashion products or medicines, the new legion of start-ups were in hot demand. As hordes of youngsters, many of them fresh from the country’s prestigious professional colleges, sought to give wings to their entrepreneurial dreams, big money followed suit. A host of marquee global investors queued up to fund these start-ups. Government data says India has seen 60,000 new start-ups since 2016 in 56 different sectors, employing around 600,000 people. The country added 14,000 start-ups in 2021-22, a giant leap from just 733 added in 2016-17. Over a 100 of them have entered the prestigious ‘unicorn’ club of start-ups that command a valuation of $1 billion (Rs 7,760 crore) or more. Over the years, these unicorns raised about $90 billion (around Rs 7 lakh crore) in funding and have a combined valuation of $333 billion (Rs 25.8 lakh crore) by industry estimates. India is now in the top league of countries with the most unicorns, after the US and China.
But that story seems to be losing its shine now as the sector goes through a massive correction. The Ukraine war has stoked inflation, prodding central banks to raise interest rates to rein it in, leading to more costly capital. As money becomes more expensive and the geopolitical environment gets more uncertain, investors are becoming more selective, asking a lot more questions than they used to and, in some cases, even shying away from risky businesses they would have backed earlier. Start-up investments by private equity (PE) and venture capital (VC) firms fell by half in April to $1.6 billion (Rs 7,760 crore) on a year-on-year basis, says a report from Indian Private Equity and Venture Capital Association-EY.
Huge funds were chasing start-ups in a market that was flush with liquidity in the Covid years as countries resorted to big stimulus measures. Covid also gave start-ups the perfect opportunity to cash in on a situation where physical restrictions were the new normal. Online retailers, food aggregators and edutech companies were among those who benefited the most as their models help circumvent physical barriers to deliver products and services to the consumers’ doorsteps. Valuations of such start-ups went through the roof, with the first half of calendar year 2021 seeing the most action in recent times. Start-up funding in the first five months of 2021 touched a record high of $8.76 billion (Rs 67,979 crore), almost 80 per cent higher than the funds received in the first half of 2020. A few of them, including payments firm Paytm, lifestyle retailer Nykaa, insurance aggregator Policybazaar and food tech firm Zomato, went on to list on the stock markets. They had mixed fortunes, but their listing on the exchanges seemed to symbolise a coming of age for Indian start-ups. But now the tide has turned.
“We flourished in an environment where resources and capital were abundant,” says Gaurav Munjal, co-founder and CEO of Unacademy. “But now we must change our ways. Winter is here.” In a recent letter to staff, Munjal said that tech stocks are crashing and burning globally due to tighter monetary policies and rising interest rates. “We are looking at a time where funding will dry up for at least 12-18 months. Some people are predicting 24 months. We must adapt.”
A big reason for the correction has been the easing of the pandemic. Almost all major economies barring China have opened up following the three debilitating waves of the pandemic. China, whose financial capital Shanghai was under strict lockdown in the past few weeks, has eased restrictions to an extent. In India, most offices in cities and major towns are working at full capacity. Even large technology firms like Tata Consultancy Services and Infosys are thinking of getting most of their staff back to work. Schools in some states have reopened to a completely offline model. With the easing of physical restrictions, there has been a bigger demand for physical shopping, eating out and travel. This has dented the exceptionally high demand for online retail, food and education businesses. The edutech business has been particularly hit. Bangalore-based edutech firm Udayy reportedly shut down a few days ago, after laying off their 100-120 staff. “We had enough capital in our books, but the business no longer made sense in the offline worldcustomer acquisition cost became very expensive,” co-founder Saumya Yadav said in a media interview.
Yet another reason is the uncertainty surrounding Russia’s war on Ukraine, which has stoked inflation and raised interest rates, making capital expensive and investors edgy. In March, Masayoshi Son, the high-profile CEO of one of the world’s largest PE investors, SoftBank Group of Japan, came under pressure for his mercurial investment style that led to expensive bets on start-ups across the world, including in India. “I promise you I’ll be more careful and listen. My views do not change, but my behaviour becomes a little more careful,” he was quoted telling investors during a presentation in Manhattan in March. But the assurances came a little late as the firm’s Vision Fund posted record losses of $27.4 billion in 2021-22.
“Earlier, start-ups had leverage and everyone was rushing in to invest,” says Prashant Choksey, co-founder at Mumbai Angels, a firm that invests in early stage ventures. “Investors were busy signing off term sheets. There was a gold rush. But now, the leverage has moved from the start-ups to the venture capitalists and the PE players.” Start-ups have suddenly realised that there is no one waiting for them at the other end. It is not the paucity of funds that’s the problem, but the cautious nature of those dealing with the funds, says Choksey. “Liquidity is available in the market. The system is full of money...but it has become cautious,” he says. Some feel investors are equally to blame. “I won’t blame the start-up founders as much as the VCs and PEs who kept pumping in that kind of money into these companies and expected them to grow at no cost,” Nikhil Kamat, co-founder of online broking firm Zerodha, said in a television interview. His firm is entirely bootstrapped—industry jargon for a firm that has no external funding.
EARLIER , START-UPS HAD THE LEVERAGE AND EVERYONE WAS RUSHING IN TO INVEST. BUT NOW, THE LEVERAGE HAS SHIFTED TO VENTURE CAPITALISTS AND PRIVATE EQUITY PLAYERS
Caution is the Byword
The present situation gives investors a lot more leeway to conduct better due diligence—study the business models, the path to profitability and understand the organisation’s culture and integrity of the founders. The recent episode concerning Singapore-based fashion tech start-up Zilingo, where the board sacked Indian origin co-founder and CEO Ankiti Bose following an independent forensic audit into complaints of financial irregularities, has highlighted all that can go wrong. “Limited partners (LPs, who arrange and invest capital for a fund) are getting wary,” says an investor in start-ups. “When the valuation falls from $1 billion to zero, it’s just not acceptable. The whole incident was an eye-opener.” Zilingo’s fall became all the more drastic since its investors included high profile venture capital funds such as Sequoia Capital of the US and Temasek Holdings of Singapore. The company was valued at $970 million (Rs 7,529 crore) in 2019 when it raised $226 million (Rs 1,754 crore) from these PE firms.
It is not just the frauds that are foxing investors. In general, several start-ups tend to spend recklessly on promotions, hiring and compensation and on physical infrastructure, all of which bleed them heavily. In a highly competitive space, it becomes imperative to hire the best talent, and spend top dollars doing so. However, in some start-ups, the spending beat all logic. For instance, some edtech companies were offering up to 200 per cent higher salaries to poach talent from competitors, say sources. For these firms, educators were in high demand. However, rather than gauge the skills of recruits, they sometimes went by the social media presence of these educators or how many followers they had to determine whether they were worth the money. “There was too much frothing and overvaluation among start-ups,” says Choksey. “Most companies were on a path of hyper growth and were burning a lot of money.” These firms hired a lot of people thinking the funds would keep coming. But now reality has struck.
A similar concern was the high valuation of some of the start-ups, which did not match their financial performance. Data from Entrackr (which tracks start-ups) says that of India’s 100 unicorns, only 18 attained profitability in 2020-21, while 57 are deep in losses. The remaining 25, mostly registered in the US or Singapore, have not revealed their revenue, loss or profit figures, it said. According to Entrackr, the top five profitable unicorns are Zoho, InfoEdge, Zerodha, Five Star and Dream11 with Rs 1,917 crore, Rs 1,409 crore, Rs 1,122 crore, Rs 359 crore and Rs 327 crore in profits during 2020-21, respectively. In fact, when start-ups like Zomato, Nykaa and Paytm got listed on the exchanges, their share prices reflected the concerns investors had. Paytm has suffered the most, with its share price down to one-third of its issue price.
The way Forward
How long will the pain last and how can start-ups navigate these troubled waters? Sasha Mirchandani, MD and founder of Kae Capital, an investor in start-ups, says this is a temporary phase. “The start-up story will play out for the next 20 years,” he says. “When valuations of some firms ran up the way they have, a correction was inevitable.” According to him, the most prudent thing to do at this stage is cut costs. Meanwhile, companies that are well run, have a convincing business model and can show a clear path to profitability will continue to get funds. “Start-ups need to convince investors that they are not another sink-hole,” he adds.
WHEN VALUATIONS OF SOME FIRMS RAN UP THE WAY THEY HAVE, A CORRECTION WAS INEVITABLE. START-UPS NEED TO CONVINCE INVESTORS THAT THEY ARE NOT ANOTHER SINK-HOLE FOR CAPITAL
Others say the whole process is cyclical in nature, that investors will be cautious for awhile, and the market will start frothing all over again, maybe in six months or a year. But some others say the tightening on the funds front can go on for at least two years. “This is a test for all of us. We must focus on profitability at all costs,” says Munjal. Unacademy is aiming to make its centres profitable this fiscal. Apart from laying off staff, it has reduced its marketing budget, and has cut unnecessary travel and perks to educators.
As a matter of caution, investors may now start releasing funds only after adding performance milestones, so that progress at every stage can be gauged. For them, the priority continues to be bright and innovative ideas, and how large a market the new business can address. For now, though, uncertainty rules. As an investor in start-ups put it, things will go back to normal, it’s just that nobody knows when.
FACING THE HEAT | Why start-ups are in trouble
- Easing of the pandemic and reopening of offices and schools is creating a bigger demand for physical classes, shopping and eating out. This has dented the demand for online retail, food and education businesses
- Uncertainty about Russia’s war on Ukraine has stoked inflation and raised interest rates, making capital expensive. Investors are back in the driver’s seat, but are cautious and asking tough questions, sometimes shunning risky investments
- Investors are keen to do more due diligence before they decide to fund start-ups. This helps them study the business models of the start-ups and their path to profitability better, as well as gauge the integrity of the promoters and the organisation’s culture
- Huge “burn” in start-ups as some of them spent recklessly on promotions, hiring and compensation and on physical infrastructure, all of which bled them heavily. But now reality has struck and they have to take action by axing their staff
- High valuation of many of the start-ups did not match their financial performance. Of the 100 unicorns in India, only 18 attained profitability in 2020-21, while 57 are deep in losses, says Entrackr. Some like Paytm have seen a big slide in share prices since listing on the bourses