Expert Speak India Matters
Published on Jun 13, 2018

Market mechanisms — more than policy interventions — are perhaps efficient interlocutors of the success of the startups' ecosystem.

How “Indian” are Indian startups?

Around a year and half back, two poster boys of Indian startup ecosystem, Sachin Bansal of Flipkart and Bhavish Aggarwal of Ola, raised voices wishing for government policies which would be designed to favour homegrown startups against their foreign-origin rivals. Both Flipkart and Ola were under considerable pressure at that time as US giants Amazon and Uber were breathing down their necks.

Urging the government to take astartups more “India-centric approach,” both of them essentially were making a case for replicating the Chinese model of creating an ecosystem that would favour local entrepreunership and help create high value startups in India. China is, apparently reaping the benefit of its protectionist policy, best showcased by the success of the digital trio of Baidu, Alibaba and Tencent — collectively known as the BAT.

This nurture of Chinese startups by their government resulted in a significant $77 billion venture capital (VC) investment during the period from 2014 to 2016. Currently, the Chinese government is pumping money in early stage startups to spawn innovation across industries, in order to dispel the popular notion that Chinese innovation is primarily relying on copycats and counterfeits.

The Chinese government has invested more than $1 billion since 2015 under its “Made in China 2025” plan for early-stage funding to help young startups go commercial. Many Indian startup entrepreneurs also wish for similar kind of government intervention in their favour — as Bhavish Aggarwal emphasised that real fight is about capital and not about innovation. He went on to define a typical “Indian” company by the criteria of nationality of its entrepreneur and managing team, and not by origin of its capital. That is indeed a convenient definition in favour of his argument, but critics would strongly link ownership with the origin country of the capital.

"The Chinese government has invested more than $1 billion since 2015 under its “Made in China 2025” plan for early-stage funding to help young startups go commercial. Many Indian startup entrepreneurs also wish for similar kind of government intervention in their favour."

Ironically more than a year after, US retail giant Walmart has reportedly acquired 77 per cent holding in Flipkart to take over the company, and Sachin Bansal is on his way out of Flipkart. A quick look at the shareholding pattern of Flipkart even before the Walmart acquisition reveals that more than 72 per cent of the holdings resided with foreign multinational VC firms and other companies while the co-founders held around 10.8 per cent stake in the company. SoftBank of Japan and American hedge fund Tiger Global held 20.8 per cent and 20.6 per cent stakes respectively.

The overall trend in Indian startup funding is similar. According to NASSCOM Startup Ecosystem Report of 2017, top ten financing deals alone amounted to around 30 per cent of the overall funding value. This shows that most of the funding are generally cornered by bigger startups, especially the unicorns,  but more importantly, majority of the funding originates from foreign multinational sources — VC and private equity (PE) funds.

Foreign investors accounted for a share of 44 per cent among total number of active investors in India, and active foreign VCs were more in number — 125 foreign VCs were active in 2017 compared to 95 Indian ones. This signifies that foreign VCs tend to finance bigger and more successful Indian startups. In simple words, a successful Indian startup has more probability of getting further funded by foreign multinational financing entities than purely Indian financing sources.

This triggers the important and relevant question — how “Indian” are these so-called Indian startups?

Though often overlooked or not properly understood, financial resource mobilisation in any typical startup works in slightly different way from finance mobilisation in other conventional industries. Any standard company in manufacturing or services usually expand their operations and size by taking loans from banks or financial institutions, and in some instances through the primary markets.

However, in a standard startup company financial mobilisation is achieved by offering stakes or ownerships in the company. So, every increase in startup investment almost always implies larger ownership of the new investors in the company and as a result less stakes of the original owners or founders. Money does not come in the form of loans, rather it comes as direct investment with an expectation of very high return in future. That is how a successful startup rapidly grows its net worth. This is an important point to be noted because any startup may be initiated by Indian founders but once any form of foreign funding comes in, the nature of ownership capital does not remain “Indian” any more.

"In a standard startup company financial mobilisation is achieved by offering stakes or ownerships in the company."

Further, when the startup is sold to another foreign entity, the capital rights obviously shift to that foreign company, like Walmart now will hold the capital rights of Flipkart. Investment through FDI route is somewhat restricted in different sectors due to government policy restriction on investment, but there is no such restriction on VC or PE investment in startups. It is true that startup investment comes with a lot of risk but in the case of successful startups the returns are also significantly higher. This is amply demonstrated in the Flipkart deal where foreign investment funds like SoftBank and Tiger Global are going to make a killing.

Similar dynamics holds true for intellectual property rights (IPR) in startup products, processes and services. Due to delay in long-drawn Indian granting process, quite a few startups opt to apply and get required patent and copyrights from other countries like Singapore, USA and UK. From the first movers advantage angle — that move is justified to a great extent for a startup. But, transfer of startup capital ownership, almost all the times, is accompanied by transfer of these patents and copyrights as well, irrespective of the patent being taken in India or abroad.

Seeking policy protection for homegrown startups has a nationalist appeal and while one may put forward an “infant industry” argument to support this, the reality of startup ecosystem is that it does not take much time to transform a homegrown startup into a foreign multinational owned business — as seen with the Flipkart-Walmart deal. Therefore, the fundamental logic behind such protection does not hold any merit as government is not supposed to protect a company which may later be transferred to foreign ownerships — in the process enriching an individual of Indian origin who has merely created value for an international investor or institution. Market mechanisms — more than policy interventions — are perhaps efficient interlocutors influencing the survival and success of these startups.

Startups valued at $1 billion or more are universally called “unicorns”.

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Abhijit Mukhopadhyay

Abhijit Mukhopadhyay

Abhijit was Senior Fellow with ORFs Economy and Growth Programme. His main areas of research include macroeconomics and public policy with core research areas in ...

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