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Indian startup unicorns: when mergers seem an inevitable death-defying gamble

Raj K. Mitra
27th Aug 2016
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With Uber throwing in the towel in China and allying with Didi, Indian media is abuzz with speculations whether Flipkart-Snapdeal or Amazon-Snapdeal should merge. In the digital age, where product or service differentiation is negligible, barriers to entry non-existent, and customer loyalty a relic of the past, the question of relevance at this point isn’t whether they should, but when and how fast.

Last year when I wrote, “Are Indian startups headed for a bubble burst?”, I was accused of being naïve and too pessimistic about the unfolding India startup story by some, while others attributed it to my inability to see the big picture. “Everyone burns cash in the beginning,” they would say. Even venture capitalists (VC) gave carte blanche to their portfolio founders. Reality is finally catching up.

Notable acquisition

With the glorified term sheets no longer serving up dollops of vanity metrics, it’s just a matter of time before sanity is restored. But that doesn’t mean that the cycle of hype should be curtailed at cost. Such a cycle is the product of a futuristic vision seeing an opportunity. However, over-expectations related to the speed of adoption need to be subsequently rationalised to avoid massive flameouts that leave everyone burnt.

Those who follow my writings or comments on Indian startups will recall that the underlying theme has always been: entrepreneurship is less about raising money, and more about building a viable sustainable business. Failure shouldn’t be a taboo. But the need for speed to scale and outrun everyone should be reassessed at regular intervals. Death is natural. But death despite a correct diagnosis is far more unfortunate.

Simply put, what’s unfolding now worldwide and likely to gather steam in the days to come with India playing catch up seems straight out of intellectual provocateur Peter Thiel’s playbook. “The lesson for entrepreneurs is clear: If you want to create and capture lasting value, don't build an undifferentiated commodity business.” Adds Thiel, “All happy companies are different: Each one earns a monopoly by solving a unique problem. All failed companies are the same: They failed to escape competition.”

To understand the Indian context better, I turn to my friend Nikhil Gupta, Head of Asset Allocation, Client Associates (one of India’s largest multi-family office setups). “The wave of markdowns, tighter funding for late-stage deals (after an insane 2015) are forcing VCs to focus more on profitability of portfolio companies. When everybody is struggling for incremental capital, the case for consolidation becomes stronger.”

According to CB Insights, 40 percent of companies that raised a seed or seed VC round in 2009-10 raised a second round; 225 (22 percent) of companies that raised a seed in 2009-10 exited through M&A or IPO within six rounds of funding (one exited after the sixth round, for a total of 226 companies); nine companies (0.9 percent) that raised a seed round in 2009-10 reached a value of $1 billion+ (either via exit or funding round). 77 percent are either dead, walking dead (bad outcomes), or became self-sustaining.

However, it’s not just the newfound focus on profitability or the struggle for incremental capital that’s pushing these supposedly once unthinkable consolidations between arch rivals. “There’s a very strong Pyramidal Ownership Syndrome where most of these unicorn rivals are owned by a limited (sometimes common) set of influential VCs, who in turn are pushing for these consolidations,” says Lovkesh Kapoor, Head of Investment Banking, Client Associates.

The imminent wave of consolidation in startups across the world re-asserts a fundamental principle of investing - no firm can infinitely attract capital simply by the expansion of operations without yielding commensurate returns. It is not coincidental that the second age of internet (post-Facebook) has also seen falling technological productivity in developed countries. In a low-yield world of quantitative easing, private capital has frantically chased startups in the hope of them being the next big thing.

Whether a consolidation is an end to this phase or not, we can't really say, but at least some of the investors are less dreamy-eyed about the next entrepreneur in a turtleneck sweater who promises to transform the world. The rational route to sanity goes through value and not valuations. In that context, a Flipkart-Snapdeal merger makes much sense to take on Amazon. The new unicorn survival mantra could very well be – losers compete, winners ally!

Special thanks to Shailesh Jha, Senior Economist, Abu Dhabi Commercial Bank, for his insights.

(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)

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