Turmoil at Byju's highlights hurdles for India startup scene

Turmoil at Byju's highlights hurdles for India startup scene

Even as India is being hailed as the next global growth story, a crucial building block for that success "- its startup ecosystem "- is getting pummeled.

Already stuck in a 15-month funding slump, India's young companies are in danger of becoming collateral damage to the country's highest-profile startup crisis in years. Byju's, India's most valuable upstart, is in turmoil after missing a deadline on financial statements, skipping payments on a $1.2 billion loan and losing its auditor and some of its board members.

The imbroglio reveals some of the unique challenges faced by India's entrepreneurs and may spook global investors. The consumer market in India is characterized by more than a billion people with fast-growing but still relatively limited spending power, resulting in intense price competition that makes it harder for startups to reach profitability. And domestic venture capital is scarce, meaning founders need to attract foreign investors who can stomach the market's risks.

Governance issues

It also highlights shortcomings in corporate governance, especially during a years-long startup boom that fizzled in early 2022. As venture funding was abundant and India was creating unicorns at an accelerating clip, Byju's was among companies that enjoyed easy access to capital to spend on acquisitions and expansion, with their venture backers more focused on growth than earnings potential. After that funding dried up, attention has turned to lapses in oversight at companies such as Byju's, said Ronnie Screwvala, founder of rival UpGrad Education Pvt.

"Governance and diligence has been low from all points of view," Screwvala said. "Of course, it reflects on the entire entrepreneurial and investment ecosystem in India."

A Byju's spokesperson declined to comment.

More scandals

Other prominent startups that got entangled in recent scandals include fintech firm BharatPe, which sued its co-founder and his wife for allegedly embezzling and misusing company money, and auto-services provider GoMechanic, which faced allegations of revenue inflation. The BharatPe case is pending and the people it sued have denied wrongdoing, while a GoMechanic founder has stated management "made errors in judgment as we followed growth at all costs."

Sequoia Capital's regional arm early this year started auditing its startup investments after such lapses rose, and this month, the US venture capital giant split off the unit into a separate firm.

Meanwhile, Prime Minister Narendra Modi's push to make India a tech powerhouse is gaining traction on many other fronts "- global firms from Apple Inc. to Samsung Electronics Co. are moving manufacturing to the country, while internet leaders Meta Platforms Inc. and Google are after its hundreds of millions of online users.

No benefits yet

There are few signs, however, that startups are yet benefiting from that trend. A sudden decline in tech valuations last year, coupled with rising interest rates and slowing economies, caused venture capital firms to push the brakes on new funding rounds, with emerging markets like India getting hit hard.

For Byju's, adding to that challenge was a sudden slowdown in demand for online education services. While signups jumped during the pandemic, India's cost-conscious consumers were quick to curb spending on its services once schools, universities and offices reopened. Some moved to cheaper rivals.

Cut-throat competition in India's consumer market is an all-too-familiar problem for Apoorva Mishra, founder of Dusminute, whose app connects apartment-complex residents and office tenants with electricians and plumbers and lets users order groceries. After relentless discounting by rivals made it hard to retain customers, the company decided to shut down and lay off its 200 workers late last year "- only to be saved at the last moment by a group of angel investors.

Lack of loyalty

"The lack of loyalty is primarily because of the hyper-competitive space," Mishra said. "There's always five other people who are saying that I'll do this job for 50 rupees less."

The additional funding helped Dusminute survive. It has now increased its staff to 250 people and expects to break even an an adjusted basis in July, he said. His company has raised about 240 million rupees ($3 million) and is confident it can soon raise a further 120 million rupees as investors focus more on profitability and not just growth.

Disappointing high-profile market debuts, many of which were criticized as overpriced at the height of the boom, have also had an adverse impact on India's startup ecosystem. Digital payments giant Paytm went public in one of the most disastrous IPOs of all time in 2021, and still languishes at 60% below its offer price as it struggles to reverse losses.

Zomato and Policybazaar

Two other prominent IPOs, delivery provider Zomato and online insurance marketplace Policybazaar "- both contenders in India's competitive consumer internet market "- have fared better but are still down about 50% from their highs. Like Paytm, the firms are still working to reach break-even.

The boards of many newly listed companies did a poor job pricing their IPOs, and investors have been disappointed by their slow progress toward profitability since their debuts, said Pranav Pai, the founding partner at Bangalore-based venture firm 3One4 Capital. Many companies have only recently turned their attention to earnings to convince investors of their future prospects, he said.

"An IPO is not the end of the road "- it's the start of a very different journey where a company begins delivering results for its shareholders in public markets," Pai said. "They've all learned this truth now."

What's followed is a significant decline in the size of Indian market debuts. Indian IPOs have raised just over $2 billion this year, a drop of 61% from the same period last year, even as the number of IPOs increased.

That's prompted venture capital firms and other major investors to reduce the estimated values of their startup holdings. Softbank Group Corp.-backed delivery firm Swiggy and ride-hailing provider Ola have seen their valuations reduced. Oyo Hotels, once touted as a revolutionary force in the hotel industry, has dropped by almost 80%. Just this week, Prosus NV cut its view on Byju's valuation by 15%, pegging it at just $5.1 billion.

To be sure, there are many aspiring startups still seeking to break through in India. Dozens of unicorns are working to survive through the downturn and emerge as successes in the future. Several of them are close to an IPO, according to Pai at 3One4 Capital.

Need for realistic valuations

To win over investors, those upstarts need to have more realistic IPO valuations than the companies that listed a year or two ago, Pai said. They should have clearer paths toward profitability and avoid overpaying for acquisitions, he said.

"Startups will now hesitate to overprice because the stock will be punished post listing," Pai said. "There'll be a lot more respect for capital in the process."

Even with the recent venture turmoil, the long-term opportunity in India remains attractive, Bejul Somaia, a partner at Lightspeed Venture Partners, said in an essay posted on Twitter this month. It's already the world's largest digital market after the US and China, and more value will be created as the country's services go online, he said. But to seize the opportunity, founders and investors need to be disciplined, patient and prepared to play the long game, said Somaia, whose firm holds $3.4 billion in Indian assets.

"India is not for the faint hearted," Somaia said. "But India is worth it."