With around 40,000 registered startups and over 5,000 active investors, India is the third largest ecosystem for startups. The Indian startup ecosystem has weathered many storms including the dotcom bubble, 2008 financial crisis, IL&FS crisis, and GST implementation but the impact of COVID promises to be far reaching and long lasting.
While the first venture capital investment in Indian company was reported in the late 1980s, the startup ecosystem as we know it took off in the mid-2000s and gathered speed in the last 10 years.
In terms of timeline and maturity, it can be best considered to be in its adolescence. Moving from adolescence to young adulthood signifies some significant changes physically, mentally and emotionally for any person.
The years approaching adulthood of the ecosystem are likely to bring a shift in approach toward basic tenets of entrepreneurship, funding, social and environmental consciousness and nature of financing instruments used.
What would these changes mean for a startup ecosystem, which is coming of age at the back of a raging pandemic – a once in a lifetime crisis unforeseen by all. I see and hope for some significant shifts:
1. Growing social responsibility: Converging profit with purpose has been part of investment strategy for a niche set of investors for over a decade or so. This strategy, widely known as impact investing, is defined as investments made with the intention to generate positive, measurable social and environmental impact alongside financial return.
Impact investors have invested over $10.8 billion in 586 enterprises since 2010. The impact investments were largely dominated by the financial inclusion and financial services sector, with other impact sectors such as food and agriculture, education, health, clean tech, water and sanitation constituting only 24% of the share of investments in 2010.
However, this has increased to 57% in 2019. In addition to the changing sector focus, with growing awareness of climate risk, growing inequities and recent challenges due to COVID, there is a shift of investing focus from “do no harm”, driven by exclusion list, towards a “do the right thing” by focusing on affirmative action by choosing to invest in more impactful sectors.
With some impact sectors demonstrating comparable financial returns, it has attracted a wide variety of investors, making impact investing more mainstream. This trend is likely to continue as Gen Z, who are current customers and future investors, are choosing to vote with their wallet for more environmentally friendly products and inclusive ways of delivery.
2. Celebrating responsible growth: The startup ecosystem in its adolescence had whooping celebratory war cries for receiving funding and reaching valuation milestones. This alone gave a startup a “unicorn” status – a coveted podium finish for most startups.
The role model for any startup entrepreneur was a founder who had raised the most quantum of funding at the highest possible value. Making the funding last, frugal innovation, and retaining the valuation was not something which was widely celebrated.
Growth always stumped profits and the cost of achieving this scale and how sticky this scale was did not get evaluated. In the wake of the recent pandemic as business models get disintegrated and new ones are created, the importance of cash has been brought forth again.
The new icons of this young adult startup ecosystem will be celebrated for running sustainable responsible businesses and achieving growth with a path to profitability
3. Openness to new funding options: Equity as a funding source is well known and aspired for but poorly understood. Equity seems like a no cost resource with little accountability to return the funding.
This leaves several successful entrepreneurs left with lesser stake and control in the startup with every successive round of equity financing. As the startup ecosystem matures, founders will be able to recognise the true cost of equity and understand that funding the startup requires a well thought out capital strategy beyond just the equity fundraises.
Equity funding is necessary, but it should be used frugally for long term business building purposes and not for recurring requirements such as working capital which should be ideally funded by debt.
Debt helps founders retain control without diluting equity and improves long term valuation of their business. Debt also helps in bringing discipline in managing cash. The increasing understanding will empower startup founders to get a combination of financing strategies which will match the purpose and quantum of funding requirement with funding sources.
4. More equity but of a different kind: Inequities, especially for funding outcomes for women founders, and lack of diversity in investment teams are well known phenomena globally and more so in India which fares poorly across gender equity indicators.
The absence of this form of equity is detrimental to the quality of the startups and the ecosystem simply because it prevents several high-quality professionals from contributing as per their true capability.
As these gaps and inherent weaknesses are getting highlighted, a quiet revolution is brewing across the ecosystem with increasing women-entrepreneur-focused pitching, mentoring and accelerating opportunities. With emerging positive role models of successful women entrepreneurs, the road to gender equity has just been laid.
While there is a long way to go, the greenshoots of diversity and equity are likely to grow roots in the coming decade as the startup ecosystem takes its confident strides to adulthood.
I look forward to these positive changes. I hope that as the startups and the ecosystem matures as a responsible adult, they don’t leave behind the curiosity of childhood, risk taking ability of adolescence, idealism of youth, ability to make mistakes and learn from them as these are pillars of innovation, creativity and entrepreneurship.
Avishek Gupta is investment director at Caspian Debt. Views are his own.