Opinion and Editorial

It’s time to believe in unicorns

Sumit Chakraberty
Filed on August 28, 2021

The 13-year-old food delivery firm Zomato invested around $100 million for a 9.3 per cent stake in the eight-year-old grocery delivery startup Grofers last week.

In India, a new maturity level of the ecosystem, a broadening of sectors and a surge in numbers prove that startups whose valuation have crossed $1 billion are poised for a takeoff

The 13-year-old food delivery firm Zomato invested around $100 million for a 9.3 per cent stake in the eight-year-old grocery delivery startup Grofers last week, linking up two of Delhi’s entrepreneurial poster boys. It made Grofers the 25th startup in India this year to become a ‘unicorn’, a term coined by a venture capitalist in 2013 to describe a startup whose valuation crosses $1 billion. The mythical creature represents the rarity of such startups, but the current birth rate of unicorns makes it a bit of a misnomer.

At the rate at which it is going, there will be as many unicorns born in India this year as the 36 that were created in the past decade till 2020, going back to adtech firm InMobi in 2011 and e-commerce company Flipkart in 2012. But even more than the spike in valuations and money flow, a broadening of sectors in which unicorns are appearing indicates a new maturity level for the Indian startup ecosystem.

Not surprisingly, the lion’s share of venture capital has been going to digital services of all kinds, such as food and grocery delivery. They’re going after India’s massive consumer internet market, which is next only to China in size. Nearly half of India’s almost 1.4 billion people are active Internet users, and the availability of affordable smartphones and mobile data keeps increasing the percentage of connected folks.

The game is to become market leaders in various segments of this space — as Zomato and Swiggy have done in food delivery — leaving many other failed players in their wake. This takes huge capital infusions for building out the services, acquiring users, and scaling up fast. Zomato, for example, raised over $2 billion in multiple rounds since its inception. That may seem like a lot for a company that’s still ratcheting up losses at the same rate at which it is growing, but its $13 billion valuation after getting listed on Indian stock exchanges last month was manna for its early investors. And the fact that the share price has stayed marginally higher than its listing level a month after its stock market debut shows that even mutual funds and retail investors have an appetite for betting on tech plays such as this, undaunted by a tripling of its losses to $48 million in its first quarterly earnings report for the April-June period this year.

Investors buying into India’s consumer Internet story are more interested in the revenue growth, which swelled to $113.4 million from $35.7 million in the same period last year for Zomato, buoyed by rising numbers of people ordering food online amidst the pandemic and lockdowns. Sceptics will see this as a passing phase, convinced that orders will drop once people return to eating out. Believers, on the other hand, are convinced that pandemic-induced shifts in consumer behaviour are here to stay.

Pessimists will point to low order values, making it hard to cover delivery expenses and overheads, thus entailing losses on transactions. Optimists, on the other hand, look forward to an inexorable rise in online spending, as percentages of a large population moving into the middle and higher income groups and urban centres continue to rise in a growing economy.

“It’s no longer an asset class that’s on the fringes. It’s becoming mainstream,” says Sid Talwar, partner at India-based VC firm Lightbox, pointing to the tech IPOs being lined up this year and new classes of investors getting involved with the startup scene. Talwar has witnessed the evolution of this ecosystem from the turn of the millennium when he moved to India to found a vocational training startup, Evolv, which he sold to NIIT in 2007, before becoming a venture capitalist.

How the lie of the land was set

The first real exuberance came in late 2014, going on to 2015, when Japanese conglomerate SoftBank and American investment firm Tiger Global started pumping money into consumer Internet startups that looked like taking pole positions in the race for market leadership. Snapdeal, Ola, Paytm, Quikr, and Zomato became unicorns during that period, while new entrants like Grofers got a leg up to aim for similar valuations in later years.

Almost inevitably, there was a rethink in 2016. Business models and paths to profitability came under increasing scrutiny as assumptions about consumer spending were reassessed. Tiger Global seemed to disappear from the scene, while SoftBank had to deal with some of its big early bets like Snapdeal and Housing failing to live up to expectations. Tiger Global-backed Shopclues, which became a unicorn in early 2016 on the promise of capturing tier-2 e-commerce, got sold in 2019 for a reported valuation of less than $100 million.

Blips such as these are par for the course for venture capitalists. American retail giant Walmart’s acquisition of Flipkart for $16 billion in 2018 did a lot to restore confidence in the market and bring new liquidity. SoftBank’s Vision Fund II and Tiger Global are among the big active investors again in 2021. But the landscape appears a lot broader this time.

Tracxn data shows that the top investor this year, going by deal size, is GIC, the sovereign wealth fund of the Singapore government, which puts it on par with Tiger Global and SoftBank. Hobnobbing with US venture capital and private equity firms among the big boys is Saudi Arabia’s Olayan Group, which has made a bet on edtech unicorn Byju’s. French asset management firm Carmignac and the Qatar Investment Authority were among new investors that participated in $1.25 billion in funding for Swiggy this year, in its bid to keep up with arch rival Zomato that took a punt on an IPO at a time when the stock markets are booming the world over.

Investors did pause to take stock at the height of the pandemic last year. Chinese investors like Alibaba and Tencent also had to put their plans for India on hold as regulatory walls arose following border skirmishes. But when one door closes, others open. Indian startups had to look for alternative funding avenues, paving the way for new investors and IPOs.

Government financial bailouts and low interest rates globally have led to a lot more liquidity as funds seek out fresh pastures with hopes of better returns. India’s maturing startups are a magnet for them. In turn, this makes the Indian startup ecosystem more resilient as many new investors enter.

“The exciting part is that the opportunities available in India have woken up both international investors as well as domestic investors, whether they are institutional investors, family offices, or angels,” says Talwar. The rise of unicorns, seen in that context, has a multiplier effect on the ecosystem. “If nothing else, the ability of these companies to scale fast and raise large sums of money has caught the interest of investors that had not invested here before, and legitimised the Indian startup ecosystem in their eyes.”

Zomato’s pre-IPO funding round, for instance, had names like Kora, Bow Wave, and Dragoneer apart from the usual suspects like Tiger Global. “If I’m a large fund and don’t understand India very well, where will I go? A company valued at $10 billion that will be publicly traded is an easy way for me to enter the market. Getting into an education company valued at $15 billion that’s buying up companies globally gives me comfort and safety,” explains Talwar, referring to Zomato and Byju’s.

The unicorn domains

Zomato has been a litmus test for a loss-making company to get listed, riding on growth potential in the future. There are now a line of unicorns queuing up to get listed, from payments company Paytm to insurance comparison site PolicyBazaar and cosmetics marketplace Nykaa. “If I have access to multiple ideas coming up in multiple sectors, some of which I understand better than others, that gives me a better opportunity to invest,” points out Talwar. So, it’s not only a larger universe of investors but a more diversified field of unicorns as well that we now have in the startup ecosystem.

While e-commerce, fintech, food delivery, and mobility were the first fields where unicorns roamed, because of the potential for growth in those spaces, we now see other spaces opening up for mega funding rounds. For example, last week’s announcement of a $650 million funding round for Eruditus, valuing it at $3.2 billion, makes it the second edtech startup to become a unicorn this year, joining Upgrad. It began with Byju’s, which became a unicorn in 2018 and is currently the highest valued Indian startup. Now there are four edtech unicorns, with several more ‘soonicorns’ carving out their niches in the sphere of learning.

Not everyone takes a sanguine view of the funding boom in edtech that has set off a marketing-driven push for scale, where success is measured more in terms of the numbers of students signing up rather than the outcomes for those students. China’s recent crackdown on edtech firms was in response to them being perceived as preying on the guilt of parents who fear missing out on giving their children a leg up in a competitive environment. We have seen a similar backlash in India towards hyperbolic ad campaigns.

Nevertheless, the larger picture is that the demand for educational avenues far outstrips the supply in the country, which makes a strong case for edtech. The maturing of the ecosystem also means the smart money can seek out businesses and sectors that have a solid underpinning, because the choices are wider even for investors who want to write large cheques.

Four of the startups that became unicorns this year are in the domain of enterprise tech. India’s legacy of providing IT services for multinational companies — as well as a home for their R&D centres — has created a huge talent pool familiar with the needs of global enterprises. Spinning out of that are startups creating SaaS (software-as-a-service) products for specific verticals as well as horizontal plays across verticals. The post-pandemic imperative for digitisation in enterprises of all kinds has given this a boost.

The first unicorn to arrive in this space was Freshworks in 2018, followed by Druva, Icertis, Postman, and Zenoti. The number has almost doubled this year already, with MindTickle, BrowserStack, Chargebee, and Innovacer raising funds to scale up SaaS products for HR and training, software testing, subscription billing, and healthcare data analytics respectively.

Software as a service

Apart from the spike in money flow this year, another factor in the accelerated emergence of unicorns in this sector is a change in the way SaaS startups are valued, explains Prasanna Krishnamoorthy, founder-partner at SaaS startup accelerator Upekkha.

Typically, these startups have recurring revenues while costs are low once their software products have been validated in the market. Gross margin can be as high as 80 per cent. Then, if they have three-year contracts for customers renting their software, it doesn’t make sense to value them on the current year’s revenue.

“My sense is that the (valuation-to-revenue) multiples have gone up because people are factoring that if you’re in SaaS and have a low churn (of customers), your revenue is almost guaranteed for the next year and the year after that. So most SaaS startups earn more from the same customers year after year without additional sales costs,” points out Krishnamoorthy. “Many of these businesses didn’t lose any revenue even during the pandemic, whereas travel and many other sectors lost large amounts of revenue. On the contrary, SaaS startups grew even faster because of a higher demand for their products. That’s why if you look at the recent financing of SaaS startups in India, they’ve been at a very rich multiple compared to the past.”

The favourable perception of Indian SaaS products, thanks to the success of the likes of Freshworks and Postman in global markets, also means that startups in this sector are now being treated on par with their global peers. The downside for investors is that SaaS startups can fuel much of their growth from their dollar revenues instead of depending on venture capital.

So we can expect the consumer Internet startups playing in the Indian market to continue to hog the headlines with mega funding rounds. It’s harder to figure out which are the ones that are true innovators creating value in their products and services, and which are the duds that fake it. For now, it’s a tidal wave of money sweeping into startups that are scaling up. As Warren Buffet put it, “Only when the tide goes out do you discover who’s been swimming naked.”

(Sumit Chakraberty is a writer based in Bengaluru, India. Write to him at chakraberty@gmail.com)

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