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There’s little doubt that 2019 was a bumper year for Indian start-ups. Young SMEs raised $14.5 billion (Dh53.2 billion) in funding, a substantial increase from $10.6 billion in 2018, according to Tracxn, an investment research advisory. Last year also saw the emergence of eight unicorns – privately held start-ups valued at more than $1 billion – in the logistics, fintech, mobility and healthcare sectors. Although the country currently hosts just 30 unicorns – compared to more than 200 across the US and China – it is the world’s third-largest start-up market by value.

“More than 1,000 private equity and VC transactions were valued at $45 billion (Dh165 billion) in 2019 – the highest over the past decade – making India the second-largest deal market in the Asia-Pacific,” Dharish David, Research Consultant at the Economic Research Institute for ASEAN and East Asia, tells GN Focus. David also co-authored a recent Asian Development Bank Institute (ADBI) paper on India’s start-up environment. “The startup community raised about $14.5 billion in funding last year, quite a jump from $10.6 billion in 2018, according to Tracxn.”

The ADBI paper highlights 2014-15 as an inflection point for the country’s start-up ecosystem, thanks to the emergence of six unicorns. In order to catalyse the country’s start-up culture, build an innovation and entrepreneurship ecosystem and drive economic growth through the generation of large-scale economic opportunities, the Indian government launched its Startup India initiative in 2016. “With India pushing towards a knowledge-based and digital economy, the government is attempting to deploy ICT infrastructure and provide policy support for enhanced e-governance, investments and technology innovation through research and higher education to support entrepreneurship and spur economic growth,” says David.

With India pushing towards a knowledge-based and digital economy, the government is attempting to deploy ICT infrastructure and provide policy support for enhanced e-governance, investments and technology innovation through research and higher education to support entrepreneurship and spur economic growth.

- Dharish David, Research Consultant at the Economic Research Institute for ASEAN and East Asia

The initiative provides support in three broad areas. The first is by reducing the regulatory burden by allowing start-ups to self-certify compliance with various labour and environmental laws through Startup India’s mobile app, and avoid inspections within three years of their incorporation.

“The initiative also ties in with other financial assistance and subsidies,” says David. “A fund of funds for start-ups at the Small Industries Development Bank of India (SIDBI) with a corpus of Rs100 billion (Dh4.9 billion) was also established in 2016 to infuse more capital into the start-up ecosystem and a credit guarantee scheme. Exemptions are also provided to eligible start-ups on income tax and capital gains tax.”

Finally, the government also provides an enabling environment for incubation and industry-academia partnerships through innovation labs, events, competitions and grants. “For example, start-ups get an 80 per cent fee concession in respect to their patent applications as compared to other legal entities.”

However, 2020 has proven more difficult so far. According to data collated by the consultancy Bain & Co., private equity investments in the country dropped by as much as 40 per cent over the first six months of 2020. Over the same period, venture capital (VC) funding declined 10-12 per cent, according to data from Venture Intelligence (VI), a research company that tracks private company financials, transactions and valuations across India.

David says the impact of Covid-19 really began to bite in March. “Investments dropped by over 50 per cent compared to February,” he says, citing data from Venture Intelligence. “As India went into a lockdown amid already-slowing economic growth, the start-up ecosystem felt the pinch with suppressed demand and stunted supply – this could well be one of the gravest the industry has experienced so far.”

Covid-19 beneficiaries

For Meherzad Kelawala, Managing Director of investment firm DC Advisory India, Covid-19 has changed investor priorities – to an extent. “Basically post Covid-19, you can classify businesses into three buckets: Covid beneficiaries, business-as-usual and Covid-impacted companies.

Right now the clear preference is for Covid-19 beneficiary sectors such as edtech, health tech, gaming, online content and digital-first brands – these are the sectors that are seeing heightened interest.

- Meherzad Kelawala, Managing Director of investment firm DC Advisory India

“Right now the clear preference is for Covid-19 beneficiary sectors such as edtech, health tech, gaming, online content and digital-first brands – these are the sectors that are seeing heightened interest.”

Kelawala’s analysis is backed up by data shared with GN Focus by Venture Intelligence. It picks education as the largest-collecting sector in monetary terms, with $795 million coming in over the first half of this year in 25 deals, with Byjus Classes, Unacademy, Vedantu and InterviewBit Academy some of the biggest gainers. Over the second quarter, fintech was the busiest space with 21 deals from the likes of Khatabook, Aye Finance, Juspay, Setu and Bijak.

“For business-as-usual companies, which are ones that would go back to normal soon, there is limited interest given investors want the business to get back to pre-Covid levels and see that it sustains for a quarter or two,” says Kelawala. “In Covid-impacted sectors, including offline retail and some lending businesses, investors would want to wait it out and see a full revival of the space before they look at opportunities.”

David credits the relative success of the edtech sector to the booming adoption of online learning solutions amid lockdown and an extended period of social distancing.

Financial hurdles

But it hasn’t been smooth sailing either for start-ups prior to Covid-19. The ADBI report cites high domestic lending rates as a big challenge.

David says India’s real interest rates – nominal interest rates adjusted for inflation – are considered quite high compared to many of its emerging market peers. He backs this up with World Bank data, which shows that real interest rates went up to 6.2 per cent in 2017 from 2.5 per cent in 2012. “Real interest rates have gone up over the past five years and many economists believe that the real rates in India are too high.

“The Indian manufacturing sector, for example, pays up to 12-14 per cent bank lending rates annually, one of the highest in emerging markets. Unfortunately, interest rates are likely to remain high as the gap between deposits and lending is widening due to falling saving rates in the economy, while real interest rates have been falling in other Asian countries including China.”

Kelawala explains that most tech start-ups depend on VC funding – equity funding – there are hardly any tech start-ups who opt for or even qualify for debt funding, given they operate asset-light models and have no collateral to raise debt against. “Only companies in their later stages that have turned profitable can look at debt as an option. The only form of early-stage debt is venture debt, which is widely available to a lot of start-ups – however it is only a fraction of the equity funding portion.”