BUBBLE BURST OF START-UPS IN INDIA –LIKELY OR NOT LIKELY?

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BUBBLE BURST OF START-UPS IN INDIA –LIKELY OR NOT LIKELY?

In the post-world war era, many of us are often tempted to believe that we have tamed the rowdy business cycles and the haunting days of ‘The Great Depression of 1930s’  are well past us. Whether it  were the 1973 oil crisis, the Asian Crisis of 1997 involving collapse of Thai currency or the Dot Com Bubble of 2000, somehow the repercussions were contained in a short span of time;  and we thought we had entered the golden era of ‘The Great Moderation’.
Come 2008, the sub-prime mortgage crisis in US housing market jolted the world and the financial meltdown caused a global recession. While Merrill Lynch sold itself to Bank of America for $50 billion, half of its market value the previous year; Lehman Brothers failed to even find a buyer. Ultimately, it filed for bankruptcy and the Federal Reserve had to roll out a bailout package considering that these companies were “too big to fail”. Anyhow, it was a slow demise of Lehman Brothers and many other companies, which led to a total global loss of around $15 trillion.
Since then, the investors have been careful with their money. Many investors of industrialized nations have preferred to use their cash surpluses for innovative start-ups. Recently, India, too has been riding on the start-up wave, especially tech start-ups. Some of them have earned quite a name in the market for themselves. A new term, ‘Unicorn’ has been coined for those enterprises which reach $1 billion mark, and 142 companies already qualify for the tag. Some of the big-wigs of start-up world include Flipkart, Zomato, Uber, Snapchat, Pinterest, Quikr  and Dropbox.
To encourage young entrepreneurs, Prime Minister Modi has also launched a scheme ‘Start up India, Stand up India’. Under the scheme, the government promises to simplify the start-up process, develop start-up hubs to enable knowledge exchange, provide 80 per cent rebate on filling patent applications, and develop 35 new incubators and 31 new innovation centers. Talking of China, which has 780 government guided funds to finance start-ups, government is very much eager to boost the entrepreneurial spirit through financial aid and favorable policies. In a similar fashion, the Indian government has also decided to launch a government fund with a corpus of 10,000 crore.  Although the scheme sounds promising in terms of reducing the red tape, the success will depend on how seriously it is executed over the next few years.
Once again, investors seem very cheerful about the boom in the market. Due to the fear of missing out, investors with deep pockets are more than willing to burn cash and make new riches before somebody else takes the money home. Companies like Uber are able to spend fortunes to keep their drivers on the road, thanks to the endless stream of money that venture capitalists and angel investors put in. However, as the initial phase of euphoria fizzles out, companies like Zomato, housing.com and food delivery app Tiny Owl have carried out layoffs; and people have started asking questions. Are we about to meet an another cousin of 2000 Dot-Com Bubble, where initially, even an updation of website design would lead to 1000% increase in stock price, and later on the bubble bursted into a spectacular fiasco.

Is the bubble real?
One cannot outrightly deny that the start-up fetish is slowly turning into a bubble. Most of the investments are based on the net present value (NPV) of future earnings. Thus the fundamental value of these companies is much less than the publicized values. Year by year, these companies are generating losses, hoping to earn profits in future, and continue to give huge discounts to attract customers. E-retailers, for instance, are having an average loss of 140 rupee per item.
Why are the start-up profits moving at a snail’s pace in India? The peculiar demographics of India are also at play here. Two-thirds of Indians are under 35, which make up the biggest age group for using internet. However, internet connectivity is very low and most of the people cannot access broadband services. Secondly, the per capita income in India is at Rs 72,889 for 2014-15, as per Central Statistical Office (CSO) data, which is not even one-fourth of China’s per capita income. People have little money to spend and they are not yet ready to trust the online modes or new born startups. In such a scenario, it becomes imperative to capture maximum number of customers and reap economies of scale. Many industries are disintegrated right now and will become profitable only when few large players are left. E-commerce players, Flipkart, Amazon, and Snapdeal  are the three biggest players in the Indian market. Flipkart, with largest market share, merely controls 5% share of the market while on a similar pattern, Alibaba, in China, controls 80% share of the Chinese market. Thus, in the long term, if Flipkart wants to be India’s Alibaba, it will have to emerge out as the biggest player.

Will the crash happen anytime soon?
Indian start-ups wave is still at an embryonic stage. There is a long time before the bubble bursts. Many of the big companies have a fair chance of survival, although they might lose their value after a skeptical valuation. These companies have innovative business models and some part of the discounts they offer is financed by their savings from not having to invest in Brick-and-Mortar model. At the end of the bubble, mature companies will emerge out as winners. Rest of them will be acquired or be merged with the leading companies, for instance, Mumbai based CarTrade, which deals in second-hand autos, acquired its rival CarWale, eliminating it’s competition.

Who is going to be affected, if at all the bubble bursts?
Most of the start-ups are still private. To go public, first they need to be listed on stock exchanges.  So the general public is hardly at risk as far as retail investing is concerned. They might take a little hit if they own mutual funds which have further invested in start-ups. Otherwise, there is not much loss.
Venture capitalists are at utmost risk, but the money is mostly coming through foreign players, who have a greater risk appetite and have secured their positions through various safety clauses. Most of these investors take preferred stocks which gives them preference to recover their investment amount prior to anybody else in the case of liquidation. So, they will be the first ones to jump off a ship in distress. Also, we must not forget that the captain goes down with the ship. Thus, the founder of the company is most vulnerable, not to mention the employees of the company as well. They will suffer the most as they lose their livelihood once the company lands in trouble.

How to survive through the Bubble burst?
Despite all the uncertainty surrounding the future of start-ups, India has received $5bn in investment 2015 alone. It is quite a phenomenon in itself, since India was hardly trusted with such amounts before. In return, the start-ups need to be flexible in their approach. Cash must be used more for investment purpose rather than consumption expenditure, else it will only add to their debt with zero addition to the assets. More importantly, they need to be open to dilution of control. They say that the worst mistake a movie director can make is to fall in love with his own movie. Thus the budding entrepreneurs should be bold enough to merge and share control with other body corporates, if the need arises. And last but not the least; innovation is the driving fuel of start-up sensation. Therefore, young entrepreneurs need to continually improve and innovate to keep alive the interest of their customer.

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