With the advent of increasing numbers of startups holding sky high valuations, there begs two very fundamental questions that whether these companies are truly worth their valuations and do they have an effect on the competition and overall health of the economy. According to a study in 2019 an average unicorn company ( Valuation of $1 Billion or more ) is overvalued by the extent of 48%. Companies like Uber, Tesla, Byjus do not have the numbers aligning with their sky high valuations. In a recent interview the CEO of Softbank Vision Fund signalled that private markets might be heading towards a rebalance given the fact that many in the VC world believe that there is a Pre-existent bubble which may burst anytime and may be bigger than the crisis of 2008. Yes, Overvaluation of startups do widely affect the competition and the overall health of the economy. Overvaluation may have some benefits in the short run which can include economic growth or job creation but in the long run it is going to have adverse effects as discussed below.
Economic Growth -. Investment into Indian startups have increased exponentially from $400 Million in 2011 to more than $10 billion in 2018 according to IVCA. Startups have a huge effect on the macroeconomic factors. According to Invest India, India’s startups ecosystem has over 92,683 startups recognised by DPIIT. These Companies/startups have the potential to contribute 4-5% annually to the country’s Gross Domestic Product (GDP) over the next three to five years. As per an article of mint.com in the year 2022 Indian startups have attracted a whopping $42 billion in funding which is approximately 2.5 times the funding received last year. The Indian government’s roadmap to making India a $5 Trillion economy is fueled by the increasing investment in the Indian startup ecosystem. As per Vaibhav Kaushik, CEO and Founder of Navgati - a leading fuel aggregator startup, "The EV market is expected to reach 17 million units sold by 2030. Today, over 486 EV startups are exploring opportunities and challenges in charging infrastructure, battery recycling, and energy storage solutions to enable green mobility in the country."
In the fintech sector which is one of the most disrupted sectors in India with 87% adoption rate. The fintech sector in recent years has included customers from Tier 2, Tier 3 and rural areas strengthening the overall financial technology market opportunity which is estimated to reach $1.3 Trillion by the year 2025. Navneet Singh, Founder and CEO of leading EV company Avsar said that India’s export in software services was hitting $156.7 billion in the year 2021-22. Current trends further suggest a 45.06% increase in the total investments in health tech startups, encompassing telemedicine and telecommunication services, robotic surgeries, AI based medical solutions that assists based medical solutions that assists in detecting diseases and more as per an article published in mint.com.
Effect on Public Markets : India has been a hotbed of startup activity in recent years with increasing investment and formation of new and new companies. Some of these companies have extraordinarily innovative business models which are sustainable as well. On the contrary there are some businesses which do not have sustainable business models but increased investments in these startups inflate their valuations and keep them going. Nevertheless, whether the business model of a company is sustainable or unsustainable, the fact that it affects the public market or stock market stands true.
Whenever a startup goes public, it releases its shares to the public for the first time, This is called an Initial Public Offering or commonly referred to as an IPO. This further creates an opportunity for the company to raise funds and an opportunity for the public to invest in a company. The success or failure of a startup has a ripple effect on the stock market. Even if that particular venture is not publicly listed and it goes bankrupt then the market price of shares of its partners and creditors start to sink.
Let's consider a notable example of the crisis of the company IL&FS or Infrastructure Leasing and Financial Services. It was started in 1987 with three financial institutions owned by the government of India namely the Central Bank of India, Housing Development Financial Corporation (HDFC) and Unit trust of India (UTI) . The reason for its formation was to provide credit for major infrastructural developments. Though it was registered as a state funded company it acted as a shadow bank and an NBFC ( Non Banking Financial Corporations ). As of 2018 IL&FS had 91,000 crore INR worth of debt. But that was not a problem as it owned assets of 1.15 lakh crore. The real crisis was a liquidity crisis. As per an article on linkedin the main reason for the liquidity crisis is that IL&FS own infrastructure projects in roads and ports which have cost overruns amid delay in land acquisitions and approvals.
Let us now consider the impact that this crisis had on the Indian stock market. As of 2018, Life insurance company or commonly referred to as LIC held 25.34% of IL&FS. It also had SBI and many mutual funds as investors. When the crisis hit, 2 things followed a) IL&FS and other Non banking Financial Corporations were hammered brutally. For Example, Dewan Housing Finance Corporations Ltd. stock plunged from 610.55 INR to 350.00 INR (approx.) in a matter of weeks. The stock kept on falling and within a few months it plunged to a low of 33.70 INR. b) Life Insurance Company went down 17 % in one month.
Job opportunities : There are several reasons for a startup to get funding. One of the major reasons for a startup to raise funds is to expand and scale. The process of expansion or scaling involves staffing or hiring new people. As per a study conducted by ET Prime in 2021. There are nearly 70 unicorns - startups valued over $1 billion or more or 8300 Crores INR (approx.) in India. These companies are likely to generate 1,25,000 - 1,60,000 white collar jobs over the next year. The finance Ministry of India in its latest review of the Indian Economy, brought out a report titled, “The Indian Economy : A review January 2024”. In the report the department of economic affairs of india said that 1.14 lakh startups recognised by the government under the ‘Startup India Initiative’ created more than 12 lakh jobs as of October 2023.
Despite facing global challenges in 2023 like valuation issues, fewer IPOs (Initial Public Offering), regulatory changes and macroeconomic and geopolitical trends, India remains the third largest tech startup ecosystem globally with over 950 tech startups founded in the last year alone. According to a recent report by Nasscom in collaboration with Zinnov, The cumulative funding for more than 31,000 tech startups has exceeded $70 Billion from 2019 to 2023.
Market bubble : In an article published on medium.com titled “All that glitters is not gold - Growing valuations bubble of Indian startups” . The following is observed : a) That the average funding size has increased to $25.21 million, up from $14.94 million in 2020. There have been 402 funding rounds until April itself against 1,114 deals in 2020. b) Now, this push toward absurd overvaluation has been a result of the negative interest rate environment. Post the period of global financial crisis which was up until 2016, it is observed that there has been an exponential increase in lending and borrowing. The main reason behind VC firms laying so much money on startups is to find the next Facebook, Tesla or Apple.
With reference to the same article we can observe how absurd the valuation game is. As per a report published in Forbes, prior to 2020 Tesla Motors - the flagship Electric Vehicle manufacturer’s return on invested capital was negative. However in 2021 it rose to 14% then to 23% in 2022 and then dropped again in 2024. Thus in the last three years Tesla did not earn more than its cost of capital . As per a report of JP Morgan Tesla Motors’s situation has changed. Tesla’s deteriorating fundamentals relate to deceased demand for its vehicles. As per New York times Tesla is facing stiff competition from players like KIA, BYD, etc. At the end of 2023. BYD, a chinese EV manufacturer, was the largest seller of EVs all over the world.
In 2015 when square inc. took out its IPO it was valued at roughly $3 Billion dollar which is half of which (then valuation $6 Billion.) it was valued by private investors a year before. Even in the WeWork fiasco, the company tried to go for a $47 Billion listing but ended up getting corrected to $8 Billion. One more domestic example is Byju's which was once the world’s most valuable ed-tech company. Byjus at the time it started its operations it was the only major player in this industry working in India. Its unique content which was animated attracted students and parents but the real problem was pricing. The product of byju was highly overpriced and Indians couldn't afford to buy it. So Byju's partnered with several big players to provide EMI and took high valuations by showing huge Receivables in its books. But people started missing out on payments and byjus kept on taking loans on its receivables which led to its situation now. The Indian landscape has a lot of companies whose business model still has to pass the test of sustainability but are highly overvalued. Some of them include CRED, CARDEKHO, etc.
“The apprehensive loop of growing valuations” says an article published on medium.com. The indications are too familiar. Large markets, illustrious founders, rapid growth, and top early stage VCs for companies are all signs for a time like 2008. And when major acquisitions are made for unproven companies and valuations double or triple in a matter of months. There is always a challenge that people realise the fact that we are in a bubble after it has burst. Rich valuation multiples have also spread from the typical suspects - consumer internet companies to enterprise software providers. Softbank recently invested in MIndTickle last year, valuing it at $500 Million based on ESTIMATED revenue of $20 million. Startup sentiment in India is widely affected by the activities in the United States. Because of the huge quantity of money available investors are willing to value the company higher. Investors/VCs need to carefully analyse the risk return tradeoff and consider a variety of qualitative and quantitative factors before coming to a number. But this process has to be done in a very judicious manner as startups are a key factor in shaping the Indian economy in the years to follow.
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