Unicorns staring at fund woes, drop in valuation amid Covid-19 outbreak

Curbs on investment by Chinese investors a major roadblock

Amid the Covid pandemic, India’s start-up unicorns such as Oyo, Zomato, Ola and Swiggy are likely to face delay or find it challenging to raise follow-up funding from global investors, especially the Chinese ones, owing to the government’s restriction.
 

China’s firms such as Tencent, ByteDance and Alibaba, apart from several other global ones, including SoftBank, Visa, Naspers and various sovereign funds, are quite active in the Indian start-up space, having invested billions of dollars.
 

Venture capital and private equity firms, the primary drivers of investments into start-ups, rely on foreign sources for their capital. The Indian government’s recent changes in foreign direct investment (FDI) policy and implementation of strict
measures to curb opportunistic takeover due to the Covid-19 crisis is expected to have a significant impact on investment by Chinese players like Alibaba, Tencent and Xiaomi in unicorns for follow-up funding.

This would have a huge impact on the businesses of unicorns, resulting in salary freeze, layoffs, pay cuts and a drastic reduction in their valuations. It may also lead to consolidation through mergers and acquisitions in the next few months, said analysts. Chinese tech investors have cumulatively pumped in an estimated $4 billion into Indian start-ups. Such is their success that, over the five years ending March 2020, 18 of India’s 30 unicorns are now Chinese-funded.
 

“In the post-Covid-19 scenario and with the recent FDI policy changes aimed at scrutinising Chinese investments, large start-ups and unicorns are going to find it difficult to raise follow-up funding rounds. There is a huge sense of concern and panic among Chinese investors,” said Salman Waris, managing partner at New Delhi-based specialist technology law firm TechLegis Advocates & Solicitors.
 

To make matters worse, there are investors from other regions such as the US, Middle East and Europe, who in a global economic depression ideally tend to direct capital internally.

In desperation to raise very large follow-up rounds from investors to meet their growth requirements, top Indian start-ups are expected to take aggressive investor courting approach by agreeing for conservative valuations to make the deals more attractive, according to analysts.
 

“For if they are not able to raise capital to fund future expansions and growth, they face the ultimate threat of going bust. It is with this fear that many companies have already started cutting down operations, risky growth plans and laying off staff,” said Waris.
 

“Everybody is in a state of shock and discovering what this pandemic means. We expect the foreign funds would face disruption,” said a co-founder of a unicorn company – which is backed by foreign investors and it is laying off many employees. “We expect that later-stage funding rounds would be hardest hit. A lot of companies are going to come under stress,” the person added.

Arun Natarajan, founder of private equity and venture capital deal tracker Venture Intelligence, said investors, including those from China, would be looking to invest large funding rounds in companies that are observing strong tailwinds from Covid-19-related demand.

“For example, edtech company Byju’s has been profitable. Most of the other firms are switching business models like delivering groceries or suddenly pivoting into other spaces,” said Natarajan.

Experts said investments from China to India will be under greater scrutiny on investments into more sensitive sectors. For example, a Chinese mainland company looking to invest in fintech or media will be under greater inspection, compared to say an investment in a high-end shoe company. “Unicorns, even with their billion-dollar valuations, record pretty heavy losses,” said Amit Bhandari, Fellow, energy and environment studies programme, Gateway House.

Atul Pandey, partner at law firm Khaitan and Co, said there are no options of raising money on the FDI front without approval, but companies could consider ECBs (external commercial borrowings), and domestic lending backed by a guarantee by the foreign company.
 

Another option they can consider is getting an omnibus approval from the government to raise funds from Chinese investors in tranches of say, $100 million or $200 million, progressively.