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Why Indian startups are headed towards consolidation?

Introduction

The Indian startup industry has seen a remarkable increase in deals over the past few months as larger organisations look for expansion and cash-strapped startups hunt for sustenance. The Indian startup milieu has advanced and flourished in recent times, which has led to many enterprises in related or similar industries joining forces and becoming large entities in their particular sectors.

It is likely that the number of startup mergers and acquisitions in 2022 could be twice as much as in 2021 given the current rate of deal-making. The majority of these deals are formed through a combination of cash and stock, with startups utilising their equity as a valuable bargaining tool. This year has already seen a record of 189 M&As, a much higher amount than the preceding two years.[1]

To comprehend the legal aspects, let us examine why the Indian startup ecosystem is consolidating and why this is the next logical step, considering the fact that multiple startups have been funded by investors in recent times. Simply put, it is all tied to the structure of the startup ecosystem and the investment contracts entered into between companies, founders/promoters, and investors, at various stages of growth of companies when receiving funding; eventually, the investors seek exits.

What Caused the Consolidation Wave?

The past two years have been greatly dominated by economic volatility. Markets all over the world have been pressured to sell due to the current political unrest. Inflation has made a dramatic impact. The American and Eurozone countries have witnessed an 8% rise in inflation rates and this trend is expected to continue until 2022[2]. Executives who have never dealt with an inflationary market needed to re-evaluate their due diligence process. This included evaluating and predicting the potential inflation scenarios and using data analysis to estimate the effect of inflation on the organization and its profits. Consequently, the most prudent strategy is to acquire either potential competitors or chances for new business, which has been the leading factor in the M&A boom across numerous industries.

Recent Market Scenario

Over the past year, Indian entrepreneurs raised a record-breaking total of $42 billion in fundraising. On average, two new unicorns were established every month during the years 2019 to 2021. However, governance issues, dwindling venture capital and correction of valuations have drastically changed the situation. Consequently, venture capitalists have become more vigilant.   The extensive due diligence has been conducted following the internal audits of the fintech company BharatPe and the fashion commerce business Zillingo, which came as a surprise to investors. Moreover, the public markets for technology stocks are currently experiencing a general decline, as seen in the drops of Paytm, Nykaa, and Policybazaar. India’s private markets have mimicked this, as startups have encountered considerable inflation in valuations in recent months. SoftBank and Tiger Global, two major India funds, have encountered considerable losses in their investments in the last two quarters, leading to a withdrawal of large-scale investments, yet a revived interest in smaller seed and series a funding.[3]

Effects of consolidation

The increase in inflation caused by a rise in commodity prices has made central banks tighten their monetary policies and hike interest rates. Recession fears could lead to more than expected losses for high-growth startups, especially as consumers reduce discretionary spending. As a response to the current economic situation, startups are seeking out established organizations and businesses as a way to exit.

Corporate governance concerns, a reduction in venture capital, and overpriced private market valuations have all caused a shortage of cash and now, startups must either cut back on spending or find other sources of financing. The instability in the market has prevented startups from having the necessary funds to survive consolidation across industries. Additionally, a worldwide lack of funding has caused small businesses to have difficulty raising funds or expanding, making them easy targets for bigger companies aiming to accelerate their growth. Often experienced in fintech and edtech, where companies have no moat and essentially offer the same features and services.[4]

Prime growth opportunities post-acquisition

Acquisitions can be a great way to fuel growth for your business. By buying another company, you can instantly expand your operations, enter new markets, and gain access to new products and technologies. In an economy where the labour market is highly competitive, larger organisations have thought about taking over other businesses in order to expand their technical teams and recruit the most qualified engineering staff. With the fall in costs resulting from the pandemic, making deals has become a practical way for existing firms to make strategic acquisitions that are related to their business and consolidate their position in the market. M&A within the industry can be advantageous to the acquirer as emerging companies appraise existing companies for an exit. Takeovers generally enable companies to boost market share, generate income, obtain access to technology or know-how, and decrease costs as the Covid-induced gains diminish.[5]

As an example, BYJU’S has disbursed over $2.5 billion on a series of purchases, which were strategic in nature and included Aakash Educational, Tynker, and EPIC. Another noteworthy acquisition that got considerable attention in 2022 was Sharechat’s takeover of MX Takatak at a valuation of $ 700 million. MX Takatak, having more than 150 million active users in 10 languages, experienced a surge in its fame following the government’s ban on Tiktok in 2020.[6]

Several renowned startups have been negotiating deals or have taken part in acquisitions or strategic investments to propel their growth. Not only are the domains of Ed-tech and eCommerce gathering attention, but so are fintech unicorns Red and Razorpay, mobility-focused Ola and Spinny, food delivery Zomato, and fantasy sports Dream11. Companies with high market value such as Unacademy, Pharmeasy, BYJU’S, and Zomato, among others have acquired 47 companies to branch out into new segments, gain access to new territories, bolster offline capabilities and scale their existing operations.[7]

Importance of M&A transactions to Investors

Many people view mergers and acquisitions (M&A) as a way for companies to grow quickly and expand their operations. However, M&A can also be an important liquidity event for investors. In addition, M&A can provide investors with a way to exit their investment in a company. For investor exits, consolidation can be a very viable alternative to an IPO, which can take decades and is dependent on numerous economic factors. Stock-only acquisitions allow investors to invest in high-growth companies, which can be beneficial for some companies. In turn, investors reinvest their profits by participating in new deals or investing in founders as angel investors. M&A can also have a positive impact on the overall market. Startup ecosystems benefit from these M&A deals by strengthening them, making them more self-sufficient, and increasing their innovation potential. Overall, M&A is an important tool for companies and investors alike.

Conclusion

There’s no doubt that dealmakers now face a higher bar for success. In spite of this, we remain optimistic that M&A will continue to be a strategic priority, helping companies transform, grow, and build a new foundation for future success. Dealmakers are adapting to a new business climate where short-term volatility is developing into longer-term trends. In order to unlock future growth, it is essential to reset M&A priorities and approaches strategically. Now is the time to make bold moves and set the stage for the next five years. M&A is used to pursue opportunities that can deliver value to their business or portfolio in a challenging economic environment.

Author(s) Name: Shivani Singh (University of Calcutta)

References:

[1]. Hemant Kashyap, ‘Indian Startup Ecosystem Heads Towards Consolidation; M&As Hit A Century In Q1 2022’ (Inc 42, 04 April 2022) <https://inc42.com/features/indian-startup-ecosystem-heads-towards-consolidation-mas-hit-a-century-in-q1-2022/> accessed 04 December 2022

[2] ‘Global M&A Industry Trends’ (PwC, 2022) <https://www.pwc.com/gx/en/services/deals/trends.html> accessed 06 December 2022

[3]Anand Sanghvi, ‘M&A Wave: Indian Startup Ecosystem Headed Towards Consolidation’ (Inc 42, 12 June 2022) <https://inc42.com/resources/ma-wave-indian-startup-ecosystem-headed-towards-consolidation/> accessed 04 December 2022

[4]‘Will M&As define 2022 startup ecosystem?’(Deccan Herald, 09 May 2022) <https://www.deccanherald.com/business/will-mas-define-2022-startup-ecosystem-1107568.html> accessed 07 December 2022

[5]Shivani Shinde & Peerzada Abrar, ‘Mergers & acquisitions on rise as startups diversify into newer spaces’ (Business Standard, 26 July 2022) <https://www.business-standard.com/article/companies/mergers-acquisitions-on-rise-as-startups-diversify-into-newer-spaces-122072601217_1.html> accessed 07 December 2022

[6]Astha Oriel, ‘It’s Raining Weddings In Start-ups’ (Outlook India, 01 July 2022) <https://www.outlookindia.com/business/startups-merger-and-acquisition-startup-consolidation-zomato-acquires-blinkit-sharechat-acquires-mx-takatak-gupshup-startup-funding-it-s-raining-weddings-in-start-ups-news-206004> accessed 05 December 2022

[7]Payal Ganguly, ‘Startup M&A activity improves in H1 2022, momentum likely to continue’ (YourStory, 23 August 2022) <https://yourstory.com/2022/08/startup-mergers-acquisitions-2022-consolidation-equity-deals> accessed 05 December 2022