Survivor Island: The Startup Finale, Downsizing to Down Rounds


As funding dries up and survival of the fittest mantra kicks in to the startup ecosystem the ‘winter’ is truly here. Big layoffs are the starting point but what comes next? Byju’s valuation shocker has sent ripples in the system as many now are questioning. Will founders have to bite the bullet and face down rounds? Will tougher times mean looser principles and governance. Pankaj Naik of Avendus Capital and Amit Tandon of IiAS gives us a sneak peak into “Survivor Island: The Startup Finale” Credits: NDTV, Republic World, Times Now, CNBC TV-18, Akash Badre, and Flipkart ET Startup Awards

This is an audio transcript of The Morning Brief podcast episode: The Startup Finale, Downsizing to Down Rounds

Anupriya Bahadur 0:06
Startups are starting to spiral down. And really it's no surprise globally the winter started in summer. And here in India the funding taps are starting to dry as the year closes, with funding falling to a 10 Quarter low. The headlines this holiday season are getting grimmer and gloomier.

BG 0:24
Is it time to sound the bugle on an impending funding crisis for startups is the shine coming off?

BG 0:31
We saw a bloated valuations lead to a wipeout of investor wealth to the stock market when they hit the IPOs. This time around the company called Byjus,

BG 0:40
it seems like the gravy train has come to a halt. We've seen a wave of layoffs, hitting India's startup landscape.

BG 0:49
As we tackle what will be the first downcycle for a lot of very young founders. And of course, what's the investor playbook?

Anupriya Bahadur 0:59
But if you thought the worst was over, think again. CEO at Flipkart Kalyan Krishnamurthy. warns that testing times are still to come,

Kalyan Krishnamurthy 1:07
this is going to be a tough next year. I think a lot of people probably hit the market is my estimate maybe between April to June next year. And that's probably the moment of truth for all of us next 12 to 18 months is where we'll see a lot of turmoil volatility.

Anupriya Bahadur 1:25
But what will the future hold, funding has already collapsed, dwindling down to $3 billion in the last quarter, which ended in September, which is less than half of what was received by the startup ecosystem last year in the same quarter. India's most valued startup Byjus has been schooled by one investor as brings down the valuation of the EdTech payment to just a third from its earlier peak valuation of 22 billion down to under $7 billion. Does this mark a severe reset of valuations as well as mindsets,

Harsh Jain 1:56
we need to have that 2008 kind of mindset where you can't count on funding, six months, 12 months down the line. We're not section head companies so we can be non profitable for forever.

Sumer Juneja 2:09
I think if you don't realize what your true value is, given the new cost of capital, and you keep pushing it out, I think that's a dangerous game to play. valuations have to be reset the reset dramatically in the public markets in India, in tech, and in the US that has to follow through on to the private markets. I think 23 is going to be tough. I think the companies which sought out the unit economics and have an appreciation of what's going on and realize very quickly what they have to do will be in a better position. The others who are not focused on the unit economics and not taking the tough decisions. I think we'll go through a very tough time.

Anupriya Bahadur 2:47
That was Harsh Jain of Dream 11 Sports and Sumer Juneja, the India head and managing partner of SoftBank investments. So as unit economics gets tougher, and the IPO market gets rougher, the entire startup ecosystem finds itself on what seems like Survivor Island, the finale season. What does the climax hold? What next after big layoffs. I speak to Pankaj Naik of Avendus capital as we explore will Indian founders have to embrace down rounds in the next twist to the tail. Unless the stakes get higher? Will governance and principles be passed on by desperate founders? Amit Tandon of IIAS navigates us to the ethics of startup survival It's December 1. I'm Anupriya, your host and you're listening to the startup survival Island. What's next on the morning brief brought to you by the economic times.

Anupriya Bahadur 3:46
It's definitely winds of change for the startup ecosystem. But will it turn into a hurricane or a storm? Well, to get a sense of the on ground reality in fronting perspective, Pankaj Naik from Avendus C apital joins us Pankaj is a seasoned investment banker with over two decades of experience and obviously he's seen his share of ups swings and downturns Thank you Pankaj, for joining us here on the morning brief.

Pankaj Naik 4:06
Thanks, Priya. Thanks for having me here.

Anupriya Bahadur 4:14
Pankaj we just heard a few of the speakers from the ET startup awards that were held recently in Bangalore, you too were part of that event. There was a lot of talk of reset of valuation conservations of cash survival of the fittest, give us an insider's view of behind the scenes. What is the funding scenario really looking like right now?

Pankaj Naik 4:32
Yeah. So look, I was there. And obviously there is always a lot of talk about, you know, the funding winter and down rounds and cash strapped companies, etc. I think you have to look at things a little differently because 2021 was a year where a lot of good companies and great founders raised quite a lot of cash. And so a lot of those companies are not coming to the market or actually have a runway of almost like two to three years those companies are sitting tight on a cash. There are companies who did not manage to raise cash in 2021. And also, you know, had a high burn businesses, those obviously have to revisit how their business models are looking and whether investors are as attracted to them or not. And those companies obviously or the companies that are closer to go to the IPO. And they think that they will raise a lot of money in the IPO and will continue to burn quite a bit of capital. I think those are the companies are going back to the drawing board. And we'll see some of the challenges that you mentioned, not all the companies are in the same zone. And some companies are doing pretty well. And some companies have always been profitable, they're doing fine. In any case,

Anupriya Bahadur 5:39
you know, Pankaj, I'm going to look back once again a little bit later on what it means to really going back to the drawing board. But I want to come from the founders perspective, to the funders perspective, what's happening to money movement at this point, when you're talking to VCs across the board, angel investors, what is the sense you're getting on deployment at this point? Where is the allocation going? Is it coming in or not coming in?

Pankaj Naik 6:02
Actually that's a very good point. If you look at in later 2021, lot of funds actually had raised India specific funds or tech funds, also a lot of private equity had raised a lot of capital to be deployed in India. So there is a lot of capital that is available, the bar to invest capital into companies has, you know, gone up substantially. Also, in 2022, most of the investors are not being questioned if they actually don't invest at this point of time, especially the global investors whose ICs are, you know, in the US, where their worldview is largely through the lenses of the US ICs, they are not being pushed to actually make an investment. So people are not taking calls easily to actually make the investments happen. Unless somebody who's been around in this market for a long time and has enough, you know, empowerment to actually take calls, I think the rest of the people are being pushed back. Some of the late stage funds, sovereign wealth funds, or, you know, pension funds are still very active private equity funds are also active. Also, the growth funds of venture capital funds are active, but the bar to invest into companies has gone higher. I think the people who are, like less seen in the market are the crossovers or hedge funds, who were looking to invest into companies and you know, eventually enjoy, quote, unquote, the IPO pop, those investors are absent from the market.

Anupriya Bahadur 7:34
Okay, so obviously, at this point Pankaj, we'll be looking at some of the newly listed company so now below the pre IPO, peak valuations and are down a good 60 70%, in some cases, to their listing values, that has really hit sentiment across the board for investors and for founders that are in late stage,

Pankaj Naik 7:51
you raise a very good point because when these companies went public, their pre IPO rounds, obviously were attractively priced and their IPOs were even premium to those attractively priced rounds. I mean, when I say attractively reasonably good valuations, and then all those companies have corrected in the valuation, how does that impact private market, right? So when investors do their analysis of their return profiles of the companies that they want to invest in, they take an exit case, which is usually a capital market exit, right, three years down the line five years down the line. So when they're looking at the exit case, obviously, the comparables in the public market are what they're going to look at. The comparables are not trading, as you know, the valuations that they were trading off 2021 level then your exit multiples are obviously going to be lesser than what people would otherwise would have thought they could get. Obviously, that impacts the entry valuations because your exit valuation underwriting is not at high multiples. And so, that could impact your entry valuations assuming you know the return requirements remain the same, which also in some cases, because of you know, tightening of the money supply and obviously FED rates have gone up your requirement of return is also higher. So, a your exit multiples are lower and your return requirement is higher. So ideally, it should have some impact on the entry level valuations. At the same time. If the companies are growing well and their businesses are performing well, then a lot of companies are possibly will get into their valuations as well by the time they actually would go to the market and raise capital. So it's the tussle between the external validation of valuation versus you know, inherent business and its growth.

Anupriya Bahadur 9:38
You know, Pankaj, you automatically bring me to my next question, the inherent valuation point. We've seen in the headlines quite recently, India's biggest and most valued startup Byjus getting written down in one investors book from holding a 20 to $23 billion valuation in most investors book is now being marked down. In one investors book down to almost $7 billion to simply ask how does that even work? How can there be an investment which is markedly so different? In different investors book? What does it really mean? To see such big variations in valuations across the board?

Pankaj Naik 10:11
Okay, look, I won't be able to comment on individual case or a company, but I can show you not talk about broadly how these things work. And then different funds actually have different benchmarks in terms of how they value their investments internally, when they present to their LPs, to some people do a fair value based on the public, you know, market comparables out there. Some people you know, believe that, you know, there are no other comparables to this company. So they kind of hold on to the similar valuations, which were there in the last round. And some people probably will figure out a certain way of looking at, you know, indices going down and doing a fair bit of work with respect to particular industries, multiples, how they are trading either in public market and private market, and evaluating their portfolio in their books, when they present to their LPs. I think some of the companies when they actually hold financial investments in a listed company, they probably are under more scrutiny. So they are, you know, forced to do some evaluation and take certain calls. But it is not necessary that every fund will have to do it. At the same time, just because somebody else has done it, then you're not forced to do it. As long as you probably able to kind of communicate to your LPS what you're doing is right or wrong, and that's very much a fund specific. Now, a few years ago, you know, some pre IPO or public type investors have marked down their holdings in one of the large tech company in India. And we all know how it ended up later, the valuations almost doubling or tripling at a time of exit. So I'm hoping that its just a phase, people will come back with much stronger, you know, businesses and eventually, people will still be in the money or make good returns on their investments.

Anupriya Bahadur 11:59
I want to pick up on that point and down valuations, Pankaj. Globally, we've seen many examples through this year, starting with Clamp, the European FinTech that was once valued at $45 billion. And when they went ahead and raised money this summer, they brought it down almost 70 80% down to being a six and a half $7 billion company. Now, the CEO recently spoke at the startup slush event, where he said we knew what we needed to do, because the market realities were different. And they weren't the only one Stripe has done it globally. Instacart has done it. So down rounds do not have the stigma globally. But somehow in India, that is not picked up pace. I was looking at some data which showed that in 2008 to 2014, the last massive downturn, over 1400 companies had down rounds. And almost 90% of them showed a success rate of surviving through the downturn because of it. But somehow in India, bringing down the valuations almost becomes an izzat ki baat across the board. Do you see that changing? Do you see the downloads becoming an actual option for founders to keep in the survival game?

Pankaj Naik 13:06
Look Anupriya we've seen this in the past right in the Indian founders have taken down rounds, you just yourself mentioned all the statistics, I don't think that people have come to a fork where they have to make a decision in terms of whether they could down round or just close the company or do anything at this point of time. Also, the third alternative that became available in 21. And a certain part of 2022 is structured investment or convertible bond investments, or there are high yielding convertible bond investments. Now, a lot of founders have chosen to, you know, go and do this high coupon convertible bond investments, in my view, that's actually more dangerous than you know, doing a down round, because you're almost taking a debt type obligation, you're continuing to pay a high dollar paste coupon. And you know, at the same time, all those have their caps and the floors of valuation, which are ultimately are anyway capping your valuation to your existing valuation, or maybe some discount to that. So rather than doing something structured, and taking debt like complication, I think people should be able to swallow the bitter pill once and for all and move on in life. If you know push comes to shove at that point of time, if they have to do down round, actually, people will think about it. But what people are hoping is that businesses are going well, they have got enough time to make sure that their business metrics are well in line and their path to profitability is visible. So when they actually go to the market, their businesses will grow into their current valuation. So that you know they don't have to do down round. Now, when these companies will go to the market, we will figure out whether that's actually true or not.

Anupriya Bahadur 14:52
I want to pick up on the IPO market. Now this has been a very tough game because the retail reality of the valuations are have really hit hard. We also had Nithin Kamath talk about how now startup founders have to really think about why they want to come to the market, it can't do it for fanfare, they can't do it for the badge of honor. But really, because the business requires it. So in that aspect, what does 2023 look like? Do you think it's going to be a real litmus test for the ecosystem?

Pankaj Naik 15:20
You raise a very interesting point, we actually recently had a workshop for a few of our clients where we actually had invited one of the public investors and he raised some very good points, he said, the first and foremost is to decide whether you really want to take this company IPO or not. Because you know, taking the company IPO is not just you know, a one time event, corporate actions you take, what kind of guidance you give your ability and freedom to kind of start stop businesses go acquire something, everything has an impact on, you know, the stock price. So I think people have to decide whether they really want to do IP or not, you know, in last three years, we had created almost $10 billion of private secondary, as compared to the total capital that has been raised in IPO, the private secondary market has given larger exit, to actually the private equity and venture capitalist investors compared to the public market has given so the option of not going public and actually the shareholding changing hands, going to the later stage investors is still available. I think that more and more people will be more disciplined about when would they want to go public? And what is the reason they really want to go public? And so I'm seeing that 2023, the people who are very disciplined their systems, you know, and processes. That's true about existing companies that have gone public. But I saying that we're very clear about why do they want to go public not because, you know, some people on the board saying that let's go public, let's go public, or, you know, somebody wants to go and ring the bell. Those are not the motivations why people should go public. So my sense is people be more disciplined about whether they want to go or not go.

Anupriya Bahadur 17:02
Pankaj it's been a roller coaster year. Now we're entering December, what's on the other side of 2023, the bigger opportunities or challenges that lie ahead.

Pankaj Naik 17:11
I'm an eternal optimist. So I always see opportunities in 2022 was slow 2023, I see actually fresh allocations to the funds, most of our smart founders actually going to make their businesses leaner again, and will be far more attractive to you know, the investors to invest money. So that one part second part is obviously, there will be secondaries on the private side, that will happen, in my view, because people did not take enough capital out in 2021, people will probably go and do some private secondaries. And so I'm quite bullish about 2023 being a reasonably active year with respect to fundraising and capital changing hands. I think we will figure out at that point of time, whether whether it's going to be at the same valuation, higher valuation, lower valuation, and it's not an answer, that there won't be one answer that that fit all I mean, we are in the market. Couple of companies that we are to take the market we are doing round setup premium to what the last one valuation is. And not because the multiples have expanded, it's just that business has done well. So you will get all sorts of you know, different flavors that you will see in 2023 with respect to funding funding environment will be very active. That's my view.

Anupriya Bahadur 18:35
The word on the street is loud and clear. Only the lien and possibly given the layoffs the Mean Machines will see this through. But in a bid to survive will many founders get creative? We've already seen tales from Zelingo, Bharat Pe, Trell . And investors were already getting shocked by resignations and late disclosures, even in the regulated listed firms to guardrails and governance needs to be tightened as new businesses find new ways to stay afloat. Amit Tandon founder of India's largest institutional investor advisory firm IIAS joins us in the morning brief to talk about some of these red flags. Welcome, Amit.

Amit Tandon 19:14
Thank you for inviting me.

Anupriya Bahadur 19:18
I miss you it held a conference in governance in startups a while back and even developed a metric for some the listed lot. What is it really showing you?

Amit Tandon 19:26
We developed a corporate governance measurement we call the corporate governance scorecard. And we developed this along with IFC and the Bombay Stock Exchange. And we kind of been scoring the top 100 companies with regard to governance and we kind of decided that why don't we score some of the companies which will just got listed and we found without fail that the company which had recently been listed, scored well below the companies which had been listed for a longer period of time. So we believe that for a lot of the unlisted companies, they're focus is entirely on getting the technology right getting market share, getting, you know, more footfalls, getting more eyeballs, whatever it is. And they're not focused enough with regard to the governance which once you list becomes a very important ingredient, and a very important input as far as how the market view you as a company.

Anupriya Bahadur 20:23
Before we move ahead here is Uday Kotak, one of the OGS of the startup world at the IIS conference and his advice to the New Age founders, especially on governance.

Uday Kotak 20:33
I think governance is much more about substance then about form. Unfortunately, in recent times, because many companies have not adhered to the substance of governance, we are getting a lot of form, and the form has come in, because fundamentally, the concept of principles based regulation versus rules based regulation, has given may to more rules based regulation, because principles based regulation has been misused by the system in many, many cases. But I would only advise that as the startups grow, be cautious, because the tendency at times is being fast and loose with regulation. My advice would be that have an aspiration to grow, to touch the skies. But remember, the walk from planet Earth to infinity comes with many snakes and ladders, but use the ladders well. But keep in mind along the way, there will be snakes. And your ability to spot the snakes early is as crucial.

Anupriya Bahadur 21:46
Well Amit one of the snakes or slip ups in governance has been disclosures, especially when it comes to key personnel leaving startups or newly listed companies. We've seen the news coming in, in social media or even on official handles before it even hits the exchanges. The contentious point seems to be what is recognized under regulation is key material management and whom they need to inform about using there's a big regulatory gap that startups or newly listed companies right now, skirting

Amit Tandon 22:14
It's interesting you bring this up, because SEBI has just come up with discussion paper in terms of what needs to be disclosed when but on some aspects, there is no clarity in terms of materiality, what is materiality, someone could say that it is 10% of turnover, another company can define it as 5%. Another company can define it and SEBI is now saying that it needs to be 2%. Is it disclosed at the end of the day? Is it disclosed at the end of the board meeting? Is it disclosed instantaneously? These are some of the things where there is no consensus and therefore, in part, the fact that, you know, Sebby is kind of set out a discussion paper and is hoping to address some of these issues. It's welcome. So the way to think about it is that look, if there is anything which might impact the market price, it's good to disclose it sooner rather than later, the more you delay disclosing it, the more contentious the issue can become. And in this context, Narayan Murthy said that, okay, if you're not sure whether to disclose it or not, it's best to disclose it. So that's a good policy to follow for companies. But again, we're talking about startups a lot of the startups are coming from is that they've got their investors and by that I'm referring to private equity investors sitting in the room with them, it is the private equity investors who are driving the business or kind of, you know, suggesting deals and then ensuring that funding is available and the deal is structured, right? And the deal happens at the end of it. Now, in the public market, you don't have that comfort, there are boundary conditions with regard to who you can speak to when can you say it. So you kind of enter or walk into a completely different way of doing things or if I may say, you're in a completely different room once you're listed. And therefore some of the practices which are there as a non listed entity have to change very dramatically, once you become a listed entity, and some of the problems surfaces from them. Some of it, as I mentioned earlier surfaces from the mindset which companies have some of it surfaces from just the unfamiliarity with what is happening?

Anupriya Bahadur 24:30
Let's pick up the headline of the recent news of a big CFO resignation coming in from Nykaa after the botched up bonus issue, how does an investor really dissect such information? And how should one then evaluate the corporate governance of such a company?

Amit Tandon 24:45
Look With regard to the bonus issue, you can say that it was argued that it was a little bit strategic or the fact that you know, they didn't come into it with clean hands. And having said so, you know, it's very difficult for companies to kind of take into account what The tax implications would be in all instances, though, here, of course, you know, the magnitude in the scale was a little bit high. But having said so it can get a little bit tricky. As far as the resignation of the CFO is concerned, I for one, don't believe that this would have been the decision which would have been, you know, taken by the CFO, this was would have been pretty much taken by the board and the promoters, the CFO may have been kind of he might have suggested it, he may have steered the whole conversation and the whole process forward, he may have pushed aggressively for it. But at the end of the good day, it's a call which the promoters take, it's the call, which the board would have taken, so I will, at this stage, my personal view is it might be reading too much into, you know, the resignation.

Anupriya Bahadur 25:52
Amit right now, as you look at the ecosystem, what are some of the biggest red flags that you're seeing?

Amit Tandon 25:56
Look At the moment, whenwe look at it, the biggest red flag is the charter documents or the memorandum and articles of association of the company. What is happening here is that there are certain rights be to the founders, the promoters, and most of them call themselves founders and stop being classified as promoters. So let's use the word founders for the remainder of this discussion. And for the private equity investors get embedded in the charter document. So it will say that the private equity investor will sit on the audit committee, certain decisions will not be taken if the nominee of the private equity investor is not on the board, attending the board meeting. Or you could turn around and say that look, so and so is the founder. And they will have a right to, you know, appoint the CEO and one other member of the board, as long as they continue to hold on predefined amount of the equity. Now, these are certain rights, which we believe, and certainly for the private equity moreso for the private equity. But also, in the case of founders, which we believe should drop off, the moment the company is listed, you know, the company is not listed, the private equity investor has a choice of exiting the stock, if they weren't, they've chosen not to, but they're kind of still sitting there. And I think as people who still control are in control and are driving the process, that to my mind doesn't apply once you've kind of got listed because there by choice, you could have sold the shares. Therefore, that is one area of conflicts which we see and which is why you have some amount of I would say tension, creative tension between how the public market investors are behaving and how some of the private market investors are behaving,

Anupriya Bahadur 27:52
this creative tension that you talk about. I want to extend that further when it comes to the problem points with irrational compensation, especially via Esop's, there seems to be a nexus between the big investors when it comes to rewarding the CEOs, even after the company is listed. How do you read into it,

Amit Tandon 28:10
the private equity investors may have got their returns, and therefore they're happy to reward the CEOs buy for the founders by giving them Esop's, which can be at par. But today, if the equity is mistreated, it's very difficult to justify why shares should be or Esop's should be converted at par, if the share price is 100 rupees or 150 rupees, you know, it's very difficult to justify why it should be 10 rupees. And the fact that you know, it kind of gets converted to equity for just showing up at work. At the very least, if you're kind of looking at Esop's at such steep discounts, then it shouldn't be linked to certain targets, which is that the company will be profitable, the company will start declaring dividend or the company will grow its market share. So there should be some tangible measures on account of which these Esop's get converted at a steep discount that they are getting. But at the moment, what you're seeing is the private equity investors, having made a truckload of money or now happy to ensure that the promoters themselves kind of partake in some of these benefits as public market investors there's very little buy in for. So if you kind of look at these resolutions, which come up for voting, you find that a majority of the public market investors vote against the resolutions, but because the private equity is there, they hold a large chunk of the equity, they support the resolutions and they get carried. So that again, is an area of some friction.

Anupriya Bahadur 29:46
Amit what about related party transactions? There have been some concerns that have been raised where new companies have had related party transactions, brothers, wives and founders and friends. Is the governance of this falling through the regulatory gaps right now,

Amit Tandon 30:01
as of now, we've not seen enough instances of related party transactions. But you know, we'll have to wait and watch and start to see some of it. Some of it could be just the way it was structured, some of it could be regulatory, like, you know, a payment bank and the ownership of a payment bank has to be different from individual and the company and so on and so forth. So some of those are regulatory challenges and some of these related party transactions, investors will have to kind of accept and hope that there are sufficient checks and balances or engage with the company to ensure that they are not egregious. It's all within certain boundary conditions, else they'll have to find ways of unwinding some of these structures to ensure that there is smooth sailing going forward.

Anupriya Bahadur 30:53
Downsizing to down rounds to dodgy decisions, it is about bite finale for the startup edition of Survivor Island. From fast and loose to cautious and miserly. The tune on the soundtrack for startups has seen a geondra shift. But as Pankaj pointed out, it's not all gloom and doom. Cash may be coming in sparsely, but watches were filled over the last 18 months. So tough, brave and hopefully ethical decisions will be made. And that will separate for the lack of a better phrase, the boys from the men. The countdown begins now as we kick off December. But before I sign off on a programming note, a very special episode drops tomorrow on Friday by my colleague Kiran Somvanshi she discusses disability inclusion in the workplaces the chances and challenges ahead with that it's a wrap for me Anupriya and a big shout out to the team that helped put this episode together. On sound Indranil Bhattacherjee whose done wonders despite my sore throat produces Sumit Pande and Vinay Joshi and executive producers Arijit Barman and Anirban Chowdhury remember to follow and like our podcast in the platform you choose to hear us on.Thank you for listening in.

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