Indian start-ups take off

By Anand Mishra
In Cover Story
September 9, 2016
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cover-storyA mong all initiatives that the Narendra Modi government has taken, Startup India has found  the mutest coverage in mainstream Indian media. This is understandable to an extent because the entire start-up space is still shrouded in a mist of elitism for most ordinary folks. But probe a little, you will find a world which is teeming with activity; energetic and passionate activity, full of entrepreneurial energy, willing investors and most important of all, brimming with dreamers who are not afraid to bet on their ideas. Ideas that address unfulfilled needs, even unknown needs of ordinary and not so ordinary people.

In a world where ideas have started to matter more than money, an ecosystem has finally taken roots which tests the ideas, bets on them, rewards the performers and provides a respectable and decent exit route to those whose ideas are found wanting. Welcome to the new India; the third largest startup country, a country that is asking  questions and is  providing answers in form of solutions. And it is in this paradigm that the Startup India initiative provides a structure which could facilitate the next giant leap for Indian unicorns.

Third biggest

cover1India has made rapid strides in start-up space and has emerged as one of the world’s largest startup centers over last few years. With 4,200-4,400 startups currently operating, the country has emerged as the third largest startup nation in the world, behind only the United States and the United Kingdom. Both Israel and China are and just behind India. According to a report of Nasscom (Start-up India- Momentous Rise of the Indian Startup  Ecosystem, 2015), this number could cross 12,000 by 2020, a cumulative annual increase of more than 22 per cent. There are ten socalled unicorns, defined as startups  with a valuation of more than USD  1  billion, namely Flipkart, InMobi, MuSigma, Ola, Paytm, Quikr, Snapdeal,  Shopclues, Hike and Zomato. In 2014, start-ups created 65,000 new jobs in the country, in 2015 about 85,000 more new jobs were created; by 2020 this number is expected to shoot up to 250,000 jobs annually.

The funding for start-ups has also seen tremendous rise of late. According to Nasscom, the funding for start-ups went up from USD 2.2 bn in 2014 to USD 4.9 bn in 2015, a hefty jump of 125 per cent. More than 390 start-ups received funding in 2015 as against 179 in 2014. Also, the overall venture capital (VC)/ private equity (PE) funding and seed capital funding went up by 2.2 times and 6.5 times, respectively, in 2015 over 2014. Reflecting increased confidence in the Indian start-up ecosystem, the number of active investors went up from 220 in 2014 to 490 in 2015. During 2015, eight out of the ten largest investors in Indian startups were foreign firms.

In terms of segments, B2C, comprising of eCommerce and aggregators is the biggest segment and gets most funding, whereas hyperlocal eCommerce and consumer services are the have seen the sharpest rise in funding. Over last couple of years, higher value addition services such as analytics, internet of things (IoT), health-tech and payments have also emerged strongly. Because of a large and growing domestic market, most startups including unicorns, are domestic market focused and have not been deriving any significant earning from export of services or sales.

Geographically, Bengaluru, Delhi and Mumbai have been preferred for founding and setting up startups, in that order. These three cities together host about two thirds of all Indian startups. Hyderabad and Chennai make for the next level of preferred destination. According to the Global Startup Ecosystem Ranking 2015, of Compass, Bengaluru, widely considered the “startup capital” of India, was ranked 15th in the global ranking of the best startup ecosystems. The city is home to about 26 per cent of all Indian startups,  making it the biggest startuphub  in India and the third largest in the world. Delhi NCR is home to nearly 23 per cent of Indian startups, mostly headquartered in Gurgaon and Noida. Mumbai occupies the third slot with 17 per cent of the country’s startups.

What explains the rise?

So what explains this phenomenal rise in the country’s start-up system? Experts cite three major broad themes on which the trend is riding. First, the diffusion of technology and its spin offs in multiple ways have enabled activities that were not possible earlier. Second, the culture of entrepreneurship has grown. Third, the financial ecosystem has started to mature.

Technology has completely altered the way business is done, both from customer and business perspectives. Infrastructure requirement has shrunk as entrepreneurs can access the market through the internet, thus obviating the need for a large part of the market chain. With middlemen reduced to almost nil, the margins have never been better for businessmen even as prices for customers have declined across the board. Also, the ways of marketing have changed with social media ruling the roost. Furthermore, the ease of communication has reduced the costs for startups and increased the reach and complexity of capabilities available to entrepreneurs in a faceless manner.

cover2But the fact that technology has improved the environment in which businesses can be started and operated is only one side of the story. The other side of the story is the willingness of financiers to put in money in untested yet exciting ideas. This willingness is a new phenomenon in Indian market. As venture capitalists try to spread their wings outside traditional zones of US, UK and Israel, India has emerged as a great place where ideas are being generated at a great speed and the market is ready to absorb new products, services and solutions. This increased marketability of ideas is bringing more money to the table. This also explains the  emergence of specialized investors such as seed funds, angel funds, take out financiers etc. in the Indian ecosystem.

As the third piece of the riddle, the Indian society has started to accept risk takers. More students in premier engineering institutes are today opting to test a new idea rather than just resting easy with a cushy job. And the healthy aspect of this trend is that it is not only the rich students from metros who are willing to walk alone, even students from smaller cities are not shying away from starting on their own, which is unique as they have a more grounded perspective of unfulfilled needs at local levels in tier II and tier III cities. Also, the stigma of failing is beginning to weaken, though at a very slow rate, which allows entrepreneurs to get up and try again once they have fallen in an attempt. Realizing this, the government has also took steps that failed entrepreneurs are not penalized heavily (more on this in later segment). Finally, handholding has become more prominent now with more and more academic institutions starting their own incubators and allowing students to brainstorm, test and fine-tune ideas hitherto impossible.

cover3And all of these are riding on three important enablers. First, the economy has been growing at a good clip even as many other economies have shown signs of weakness. A good growth has allowed the USD 16 billion e-commerce segment to do well which has lured more entrepreneurs and funders to bet on this segment which is the biggest in start-up space. Second, the declining prices of smart phones has allowed rapid proliferation, which coupled with the equally rapid proliferation of internet, has enabled people to surf more while on the go. As per a report by Counterpoint Research, at around 220 million, India has toppled the US as the second largest smart phone user country. Further, at a shade below 35 per cent penetration, there are over 462 million Internet users. This shows the scale of market for various startup services and solutions, especially  in  tech related space. Third and a very important enabler has been the rising gap in valuations of startups in India and in developed markets. Because Indian start-ups are valued much reasonably, their attractiveness to foreign investors has increased.

But some sticky problems remain

In a recent development, two of India’s unicorns, namely Flipkart and InMobi shifted their headquarters to Singapore, which reveals that all in not well with the Indian ecosystem and there are gray areas which if not addressed, may prevent  India from claiming its rightful place in the start-up world. While Flipkart and InMobi got highlighted but they are not isolated cases. More and more smaller startups are making Singapore their home even though they more or less earn their total revenue from the Indian market and their entire workforce is located in India. According to one estimate, approximately 200 Indian startups relocate to Singapore every year, and the trend is increasing.

So what does Singapore offer that India does not? The simple answer is that the island nation is at the top of the “ease of doing business” ranking, where India features at number 130. Regulation regarding reoccurring payments (the major source of revenue for software companies offering their products on a subscription basis) forces a lot of firms to set up business abroad in order to process these. Another issue is the difficulty in complying with bureaucracy, which the government hopes to address by the reforms in the Startup India initiative. So, even as tax breaks are proposed to be given as part of government assistance, it does not help much, as startups tend to not make any profits during their first years.

According to experts, the context and environment which startups germinate and operate in matters a great deal. India’s startups have suffered from challenges in starting, running and closing businesses. According to The Doing Business index, while India has recently improved in the parameters like starting a business, dealing with construction permits and getting electricity, but has dropped in parameters such as accessing credit and paying taxes. With GST, the problems arising out of complex taxation system which varies from state to state would hopefully be solved leading to improved environment.

Then there are issues at educational level. While many academic institutions have started incubators, industry’s complaint is that research at universities is often not applicable or accessible to startup ecosystem. This is on top of the fact that the research itself is often lacking marketability. These factors constrain the success chances of spinoffs from universities. Also, the education system is not geared to impart skill and problem identification/ solution training, which limit growth of entrepreneurship. India consistently ranks very low on innovation indices and the poor innovation climate is bane for startup culture.

As for financing, while it is true that money flow has increased tremendously, the reach has not necessarily widened. The venture money has a habit of flowing to the top players which have already established. This explains the fact that the major portion of new rounds of funding has restricted to top 25 per cent of the start-ups. Also, the financing is geographically concentrated with NCR, Mumbai and Bangalore cornering over 90 per cent of total start-up financing in 2015. These, along with Chennai, also accounted for nearly 80 per cent of the total angel funding. So far, funding has also shown a bias in favor of entrepreneurs graduating top end institutes. A two month study done by YourStory, a startup news website, last year showed that 60 per cent of the series-A funding raised by startups during this period went to those founded by alumni of the IITs or IIMs.

Also, access to early stage capital is a still an issue. Lack of angel investment is a major lacuna in the start-up financing ecosystem and makes up for only 7 per cent of early-stage investment compared to 75 per cent in the US. And those venture capital funds that exist in India, prefer to invest in firms that are already generating revenues, thus leaving the seed capital financing a largely vacant slot. Further, venture capitalists prefer to make a few bigger investments rather than many smaller investments, leaving small ticket borrowers high and dry. Typically, entrepreneurs seeking Rs 5 million or less are highly unlikely to find an early stage investor. Broadly, those entrepreneurs, who don’t have a disruptive, high tech idea, often falter by sidelines on the venture street.

Getting policies right

cover4There is no denying that start-up system is primarily a private sector domain and private sector will continue to play the dominant role in the nurturing of start-ups in the country, the role of the government is very important in that it has to provide an environment in which ideas can emerge, start-ups can be created, nurtured, financed, marketed, and businesses and employment are generated. It also has to provide incentives for all stakeholders to give their best and also a cushion so that failures don’t kill the enterprising spirit. Realizing the importance of the segment, government is working on multiple steps to improve the business environment, improve technical skills and fill in the funding gap at the early finance level.

Earlier this year, the government launched the Startup India initiative to give a push to start-up culture in the country. The program incentivizes startups by exempting them from both corporate taxes for a period of three years. It also offers relaxation in certain labor laws for start-ups and promises improved processing times when dealing with government bureaucracy. A INR 100 billion fund-of-funds has been set up for investing into startups. The program has set some criteria for qualification to avail these benefits; for instance, the start-up should be no more than five years old, should have a turnover not exceeding INR 250 million, and it should innovate, develop or commercialize new products, processes or services that are driven by new technology or intellectual property.

To begin with, government incubators will “license” startups for eligibility of the program, but gradually private incubators will also be allowed to do the same. According to YourStory, nearly 60 per cent of Indian startups are estimated to be eligible to take part in this program. To increase the support to incubators, allocation to the Department of Science and Technology (DST, under the Ministry of Science and Technology) has been increased by 17 per cent. DST would be setting up 25 tech-focused incubators and will also fund 50-80 startups with 5 to 10 million INR each.

Action is also been seen at state level where many governments are either working on or have rolled out policies for supporting startups. States like Karnataka, Rajasthan, Kerala, Odisha, Gujarat, West Bengal, UP and Jharkhand have all offered various incentives for setting up start-ups, including incubation services, tax benefits and easier registration and financing norms.

cover5Improving business environment is a crucial aspect of bettering the start-up ecosystem and positive development is visible on these too. For example, the goods and services tax (GST), which has been passed by the center and is currently being ratified by states, will be a big relief in terms of reducing complexity of the tax laws. To allow start-ups to have wider access to finance, the Securities Exchange and Exchange Board of India (SEBI) has relaxed rules for start-ups to list, and for investors in such start-ups to sell their holdings. However, the most fundamental reform is the new Bankruptcy law which would allow time-bound settlement of insolvency and enable faster turnaround of businesses. This law will allow entrepreneurs to recover faster from failed ventures.

The start-up ecosystem of India has evolved rather rapidly over last few years and in last couple of years, serious money has flown in, which has its own positives and negative aspects. On the positive side, it encourages more entrepreneurs to come up with an idea that addresses an unfulfilled need. It also rewards successful ventures with successive rounds of funding which helps larger companies emerge from small set ups, as unicorns have shown. However, as the experience has shown, the money has remained risk averse and focused only on top end hightech  IIT-IIM club of entrepreneurs. This leaves most ideas unfunded. Hopefully, government’s efforts would bear fruits and make funds available for unglamorous ventures too. At systemic level, there is still a vacuum at very early stage funding which is the most complex part of the financing lifecycle.

Broadly, things are moving in the right direction as private sector has started to focus on problem areas and governments at central and state levels have started to work on improving the ease of doing business and compete for the start-ups. At the end, it needs to be realized that from the hundreds of start-ups of today, tomorrow’s unicorns will emerge and provide employment to thousands. As such, a nurturing environment needs to be provided to bright ideas so they can bloom to fullest.

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