From BYJU's to OYO: Why retaining investor confidence is the new battleground

The year is 2020. The start-up ecosystem is growing like never before. Indian founders are dishing out stories of their start-ups over gourmet food and cocktails at fancy hotels, to the country’s- and the world’s top investors. The stories are garnished with two ingredients—the proliferation of internet connectivity in India, and the potential of this digital revolution.

The result? Everyone is enamoured. Investors are happily lapping up the stories. Cheques get signed in a matter of days, and valuations become veritable jumping jacks. Everyone is happy to be a part of the next great Indian unicorn and start-up story. Funding deals reach their peak in 2021.

Cut to 2023. Many start-ups and their founders—once billed as the flag bearers of India’s start-up growth story—are either mired in controversy, under the scanner for corporate governance lapses, laying off staff, or worse. “We cannot function like this. We have to grow sustainably,” is what is being heard across boardrooms today.

A prime example is edtech major BYJU’S, which was once hailed for achieving a valuation of $22 billion in 2022. But today, it is getting panned for everything from not complying with local laws, not releasing its financial results, and engaging in aggressive sales tactics, among other things. Not only that, many of its marquee investors have marked down its valuation by more than half from $22 billion on their books; do note that these are not a result of any down round.

Other names that have joined the mark-down party include hotel-room booking platform OYO, ride-hailing service Ola Cabs, food delivery app Swiggy, medtech start-up PharmEasy and fintech services provider Pine Labs, among others. All these firms were once widely celebrated for becoming unicorns (start-ups with a valuation of $1 billion or more) and decacorns (valued above $10 billion), not too long ago.

But now, compared to the dream run start-ups were on in 2021, 2023 seems like a house on fire whose flames can singe any start-up that is not careful.

That raises a fundamental question: Is the era of unicorns over? More importantly, have start-ups realised the pitfalls of chasing valuations?

But first, a low-down on how investors and founders arrive at valuations. Most experts agree it is as much an art as it is a science. “Valuation depends on how we see the future. Many internal and external factors within the company influence it,” says Gaurav V.K. Singhvi, Co-founder and CEO of WeFounder Circle, a community-based investment platform. He adds that many times, with companies that are at an early or growth stage, adequate data may not be available. In such cases, investors often rely on future performance and forecast numbers to arrive at a suitable valuation. There are several methods, a mix of which investors use to determine the value of a company. (See chart The Valuation Game.)

Agrees Anuj Bhargava, MD of venture capital firm Lightspeed. He says, the method used by investors also depends on the size and scale at which a company is operating. “The more evolved a company is, the more information you have about its metrics, and you can evaluate the company better.” What makes valuations interesting, and tricky at the same time, is the fact that the concept is extremely subjective. “What may be valuable to one person may not be valuable to another,” says Sahil Kanuga, Co-head of International Dispute Resolution & Investigations Practice at law firm Nishith Desai Associates.

Over the past few months, several start-ups have seen their valuations being slashed. For instance, the US-based investment management firm Neuberger Berman marked down the valuations of two of its Indian portfolio companies—Pine Labs and PharmEasy. In its latest regulatory filings, the mutual fund house has reduced the fair values of API Holdings—that operates PharmEasy—and Pine Labs by 21.6 per cent and 39 per cent, respectively, to $4.3 billion and $3.1 billion.

Further, investment management firm Invesco also slashed the valuation of Swiggy to $5.5 billion from $8 billion in May this year, after it had cut the company’s valuation to $8 billion from $10.7 billion in January 2022.

Even travel-tech platform OYO, which has been gearing up for an IPO for some time now, saw its valuation drop to $2.7 billion—after key investor SoftBank reduced the value of its stake in it—from the initial $10 billion valuation it had achieved in 2019. Again, there haven’t been any down rounds. But does this mean that start-ups are not living up to investors’ expectations? Partly yes.

Valuations of venture capital (VC) investments are closely tied to the prevailing market dynamics, says Bhargava, whose VC firm Lightspeed is an investor in Oravel Stays—the company that operates OYO. Further, Kanuga says the growth of a company is directly proportional to the increase in its valuation. “There [could be] a time when its performance may not be good, that’s when the valuation goes down,” he notes.

Experts also point out that valuations are slashed when start-ups find it difficult to raise funds. “Suppose X fund has invested in a company at a valuation of $100 million but the new investors are not accepting this valuation. The new funds believe the valuation of the company should be no more than $50 million. In such cases, the existing investors have to go back to the market and say ‘We are valuing the company at $50 million’,” says Singhvi, adding that VCs also have to inform their LPs or limited partners about the value of their investments.

Of course, such dynamics are bad news for start-ups in the short-term, but it also leads to a correction. Investors that BT spoke to say they are not worried about the mark-downs, as they are crucial in paving the way for fresh investments to come into the ecosystem. “While it is true that a few companies have experienced a decline in their valuations, it is important to note that there are also several others that have managed to maintain valuations, or even registered an increase,” Bhargava says. He cites some of Lightspeed’s portfolio companies that have seen an increase in their valuations. But as the deals are still in progress, he declines to share details.

Singhvi, who has invested in companies such as fintech firm BharatPe and PharmEasy, defends the latter’s mark-downs. “As a patient and long-term investor, I am not worried. Start-up investing is not for those who are impatient. Sometimes it takes four years, sometimes seven years, to hit profitability. We are okay with that.”

He adds that PharmEasy has efficient founders and is a good company. “However, it will take them 24 months to bounce back to normalcy. The founders have an understanding of the ecosystem and I want to stay invested.” Reports have also suggested that the medtech company is planning to raise $300 million in fresh funding through a rights issue at a 90 per cent mark-down from its previous valuation. If the deal goes through, PharmEasy’s valuation would nosedive to around $500-600 million, from the $5.6-billion valuation it had received during its previous fundraising round in October 2021. Its other investors have also marked down the company’s valuation. For instance, US-based investor Janus Henderson had slashed the company’s valuation by half to around $2.8 billion in its regulatory filings in December last year. Earlier, Neuberger Berman had slashed its valuation in February.

However, Singhvi says the company’s valuation mark-downs may be a challenge but its acquisitions, including that of Thyrocare Technologies, have been contributing towards the company becoming profitable.

I ndian start-ups, sources tell BT, have gone into crisis management mode. They are combating several challenges at present, including lay-offs, corporate governance issues, and a lack of funding, besides their valuations being marked down.

BT shared a questionaire with several Indian unicorns but none of them had responded till the time of going to press. However, to understand how they are coping with the current crisis, BT spoke to many employees across different start-ups at various levels. The most common answer that came forth was that companies are reducing their marketing spending and consumer discounts to conserve cash. Employees of firms such as Ola, OYO, Unacademy, and others told BT that there was “panic” at the beginning of the year, but now they are working to sail through.

“There was panic because there was immense pressure from investors to run the business in the right manner. The founders had gone in for risky behaviour, but decided to course correct once they realised there was so much uncertainty around where the next round of money will come from,” says an employee of a food delivery platform, requesting anonymity. Other steps that start-ups have taken after the mark-downs include shutting down unprofitable business lines, hiring chief financial officers to keep a track of expenses, and increasing the pricing of some of their products, among other measures.

An employee working at edtech company Vedantu tells BT that the “situation is not very different from what is there in the media. Online numbers have dropped. So we are doing multiple experiments to understand how we can get more students on board.”

A senior official from Unacademy tells BT that the company is focussing on operational stability. “Our strategy is not to curb marketing expenses suddenly, but to spend where there is a clear return on investment.”

Sriharsha Majety, Chief Executive Officer and Co-founder at Swiggy, wrote in a blog post in May that the company has turned profitable on an operating basis. However, he did not reveal any numbers.

While surrounded by challenges, and taking various measures to mitigate them, one thing is certain. Start-ups are not giving up the fight just yet. For instance, Gaurav Munjal, Co-founder and CEO of Unacademy, has time and again spoken about how the edtech firm’s senior leadership is taking salary cuts, and they have also cut down on employee costs. All that with a view to turning profitable, a target they expect to achieve soon.

On the other hand, BT had earlier reported that Swiggy has closed off all its non-viable businesses in order to cut down expenses. For instance, it had pulled the plug on its pilot programme for premium grocery delivery called Handpicked, which was functional in several parts of Bengaluru. It had also shut down its meat marketplace vertical in January and laid off 380 employees as part of a company-wide restructuring activity in the same month.

Investors, too, have had an epiphany of sorts, and transformed as a result. While initially, their focus on growing the top line was supremely important, conversations are increasingly veering towards balanced growth and profitability now. “Today, investors are placing greater emphasis on finding a balance between growth and profitability when it comes to valuations,” says Lightspeed’s Bhargava. “By considering a broader set of parameters, including a focus on capital allocation, investors aim to gain a comprehensive understanding of a company’s value proposition and potential for long-term success.”

A top Indian investor who did not wish to be named told BT that investors have often been swayed by the charisma of founders. “Investment within the start-up ecosystem was earlier personality-driven. Their start-ups may not have established business models but investors have invested in them because they [the founders] are eloquent and charismatic, invite the top stakeholders for drinks, and organise lavish parties for them. The only chatter during parties is around valuations.”

Investors need to stop getting carried away by the passion of the founders and judge the company by its business model and how it is contributing to the economy, says the investor quoted above.

“I can resonate [with what the investor is saying],” says Singhvi, admitting that he sometimes goes all out when it comes to betting on the founders. “In my eight years of investing, I must have taken a bet on the founders when I know that the business or the plan he is sharing doesn’t make sense. Sometimes founders have proven to be worth the risk, but at other times, they have not.” He adds that while judging the founders now, he has added a few more layers of due diligence, that includes his or her knowledge, attitude, and experience, apart from their passion for their projects. “When things go haywire, your attitude shows a lot about how you handle the situation.”

Kanuga adds that investors, founders, and the board of directors need to come together and handle the crisis at hand. They need to be responsible and make sure that adequate checks and balances are put in place. “If the performance of the company is flat, then there is no apparent reason for the valuation to go up,” he asserts, adding that VCs need to justify how the valuations have gone up when the growth prospects of the company have been negative.

That brings us back to the original question: Is this the end of the era when start-ups were achieving unicorn status almost every other week? “Absolutely not!” says Bhargava. “The era of unicorns is still very much alive; however, the standards for achieving the ‘unicorn’ status may have become more stringent, which in my opinion, is good for the ecosystem.”

Experts believe handling the current crisis with care and foresight can bring the mojo back for start-ups and help strengthen the ecosystem. After all, who doesn’t like a revival story? 

@bhavyakaushal2