With the rupee depreciating and the US Federal Reserve continuing to hike interest rates, foreign investors have raised the bar on return expectations from Indian investments in startups.
The Indian rupee’s nine-percent depreciation against the US dollar over the past year has importers worried and exporters rejoicing. Today, the rupee fell to a new record low of 70.52.
The startup ecosystem, too, is experiencing a mixed bag of emotions. For some, the depreciation of the rupee has meant higher costs, while others are benefiting from higher revenue numbers when converting dollars to rupees. However, the fact remains that the forex fluctuations have exposed just how vulnerable startups are, and ill-equipped, to manage currency risks.
The rupee’s recent fall can be attributed to two primary factors: the hike in the US Fed funds rate, and the crash in the Turkish lira.
On June 13, the US Federal Reserve hiked its key interest rate range – which serves as the key lending rate in the economy – to 1.75-2.00 percent from 1.5-1.75 percent. This month, it signalled that a rate hike is likely in September.
The latest rate hike is the seventh since 2015, and the second since January this year. While the move by the Fed serves as an indication of increasing faith in the economy, it also means a shrinking interest rate differential for investors based in the US.
While bigger companies have the financial wherewithal to manage their currency flows with hedging, startups – many of which are seeing such volatility for the first time since their inception – have been caught unaware.
The currency situation has been particularly harsh on entities that generate revenues from the domestic market and have offices overseas. A rupee depreciation implies companies would need to show a proportionate increase in revenue to offset the forex impact.
Entities like Yatra and MakeMyTrip – both listed on US exchanges - which draw revenues from the domestic market, stated in filings with the US Securities and Exchange Commission that movements in the INR/USD exchange rate have a strong impact on their earnings numbers as forex volatility impacts their clients’ overseas travel.
Vikram Gupta, Founder and Managing Director, IvyCap Ventures, says, “If interest rate is going up in the US, foreign investors will definitely expect more returns from their investments in India. Earlier, they might have been looking for an 18-percent IRR (internal rate of return); now they might look for a 20-percent return.”
This rise in expectations is despite a budgeted 6-7 percent annual depreciation of the Indian rupee (INR).
Speaking to YourStory, V Balakrishnan, former CFO of Infosys, and Chairman of Exfinity Ventures, says, “US investors make investments in dollars, and they carry the currency risk on their investments. While investments in the VC space are more on disruptive ideas, and it is not necessarily the revenue that decides the exit value, but probably, they (VCs) will show more rigour in identifying the disruptive ideas.”
Manoranjan Sharma, Chief Economist and General Manager, Canara Bank, believes, “The rupee could gradually go down to 72 (against the USD). Only startup entities focussed on exports will gain from the currency depreciation.”
He adds, “Though the Turkish currency could be a temporary phenomenon, other factors are likely to impact the rupee. There may be new US sanctions against China and retaliatory sanctions, and that may create more global volatility.”
…and the beneficiaries
Startups that could potentially benefit from the rupee fall, including those that get their revenue in USD. Startups negotiating with foreign investors also stand to gain.
Amit Somani, Managing Partner, Prime Venture Partners, says, “The first level of impact will be funding itself, because a lot of funds are international funds denominated in dollars. It also depends on what a startup’s deal is – if it is in dollar terms, the startups might get some extra cash due to the rupee’s depreciation. If it had been done in rupee terms, it might turn out to be more cost-effective for investors.”
Vikram says startups that are negotiating deals over the last few months are likely to have seen deal closures in the last two weeks, and there might be more deal announcements in coming days.
“If the term sheet has already been discussed, and the number has already been frozen, effectively, the investors get more stake in the startup for the same amount of dollar invested,” he explains.
In other words, if the term sheet is finalised and the rupee depreciates, foreign investors effectively get the chance to get a larger stake in the firm for the same amount of dollars if the startup is valued in rupee terms.
This is also a good time for startups to bring back capital parked outside India. Amit says, “For many companies that are headquartered abroad, and have raised money there, this is the time to bring capital into India and be savvier about managing currency.”
Those who may face some heat in the current situation are US investors in exit mode. Says Vikram, “There are dollar investments in existing funds, or in startups directly. Any investor who is in the exit mode will have a serious issue as their internal rate of return in dollar terms will be impacted substantially.”
He explains how, for example, an investor might have factored in an IRR of 13-15 percent. However, with rupees getting converted to dollars, the IRR is expected to be hit and the actual earning would be much lower. Vikram says that during such times, unless investors get an IRR of 25 percent in rupee terms, they may not be interested in investing, thus spelling trouble for the ecosystem.
However, not all share the current alarmist sentiment about the rupee-dollar exchange rate. Madan Sabnavis, Chief Economist, CARE Ratings, told YourStory prior to the latest fall, “The current level of rupee is a temporary phenomenon. The rupee will correct itself and go back to 69 unless some other issue crops up. I don’t think that for a temporary rate, anyone should bring back their funds to India, or take them abroad.”
Of late, many companies have turned to venture debt as it comes cheaper and companies can avail of tax benefits on interest payments. Debt fund also do not come with equity dilution and keep greater control in the hands of startup founders.
The need to hedge
The volatility has again brought to light the need for companies, be they startups or older established ones, to streamline their financial risk management. Balakrishnan says, “Earlier, companies did not focus on managing currencies. With global volatility continuing, I think every company that has some exposure to the global market should start managing their currencies. They should hedge in the forex market and the focus should be on currency management.”
Balakrishnan adds, “Even a company whose revenue comes from India, but is headquartered outside India should hedge, because when the rupee depreciates, it translates to lower dollar revenue.”
So far, IT companies and large companies have taken to hedging, but the reality is that unhedged exposures could put balance sheets under stress.
Whatever the movement of the rupee, someone will come under stress and someone will benefit. The only important aspect, though, is that risks are managed so as to not affect the day-to-day-operations of startups.