The Covid-19 Outbreak: Dire Straits for Startups

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The Indian startup ecosystem is facing particularly pronounced challenge to business continuity due to the Covid-19 pandemic. With the nationwide lockdown, warehouses, retail stores, supply chain and delivery operations of many startups have ceased. Those startups who offer goods and services which do not feature in the Government’s list of notified ‘essential services’ establishments are worse hit than others. Besides, the Government’s recent decision to make FDI by any person in countries adjoining India (including China) subject to government approval, is bound to put breaks on fundraising efforts of capital-deficient startups. Many startups today are fending off an imminent existential threat from the pandemic and consequent dramatic macro economic change, market change, restrictive policy initiatives, drop in consumption, choked supply chain, gagged demand and so forth.

Today, with more than 20,000 startups, India is the third-largest startup ecosystem in the world, which was, until the Covid-19 outbreak, expected to witness YoY growth of 12-15%. The Tier-II, Tier-III cities and certain under-served region of the country such as the North Eastern part of India have emerged as the new hubs for startups and entrepreneurship. With the increasing affluence, evolving consumer behaviour and spending pattern and availability of infrastructure support in these regions, many startups have witnessed growth in the last couple of years. However, most of these enterprises are in seed and early stage, and had just started generating minimal revenues, as they have just come off their gestation period from the ‘death valley’ of a startup.

Indian startups suffered a double whammy on April 17, when the Government reviewed its FDI policy for curbing opportunistic takeover and acquisitions of Indian companies due to the economic damage wrought by the Covid-19 pandemic. As per the amended FDI rules, foreign investment by a person (including beneficial owner of an investment) from a country which shares land border with India (namely China, Nepal, Myanmar, Bhutan, Afghanistan, Pakistan and Bangladesh) will require GoI approval. This would impact both capital inflows into and exits from Indian startups (particularly startups that count Chinese and Hong Kong investors among largest backers). With the new FDI restrictions, Indian startups have to look beyond Chinese and Hong Kong investors for funding. The pool of capital coming from the US and Europe is expected to dry out because their own economies are taking a beating due to the Covid-19 pandemic. At such a time, India’s decision to turn off the tap from other countries like China and Hong Kong, which had the ability to invest, is likely to harm Indian startups interests even as it seeks to protect them.

With this sudden and brutal economic turmoil, most of the startups, with business down to near zero in some cases, low cash reserves, and a heavy burden of indebtedness, are clamouring for the attention of policy makers. Survival of startups is also threatened by challenges of working capital shortage and lack of manpower in the wake of the lockdown. The disruption caused by the virus outbreak is also expected to trigger investors to defer their investment plans as it is impractical to project any GMV (Gross Merchandise Value) right now for the startups and they want things to settle down before writing fresh cheques.

The worst-case scenario for startups is impossible to arrive at, and is therefore, unquantifiable. There is a strong likelihood of a substantial revenue disruption, leading to acute cash crunch, which could eventually morph into a solvency crisis for startups. There is an urgent need to stress test startups for solvency risks, financial covenants defaults and material adverse effects.

Mitigating the adverse impact of a global pandemic on economy and national security, while simultaneously keeping a non-discriminatory trade and investment policy is a tough balancing act. The government has to be mindful of domestic as well as external geo-economic realities while formulating its trade and investment polices post Covid-19. It will have to wisely identify the sectors that are critical from a national security and economy perspective going forward and develop innovative legal and institutional tools to support their sustainable growth. If India is to make its way to a $10 trillion economy by the early 2030s, it may find it difficult to do so without a more robust and thoughtful policy for Indian startups.

While the Government must be lauded for taking a series of initiatives to promote the startup ecosystem in the country, there are a few things that could help them weather the Covid-19 storm:

(i) Constitution of a task force to evaluate the scale and quantum of economic impact of Covid-19 pandemic on startups.

(ii) Creation of a dedicated corpus fund to support startups facing revenue disruption and working capital shortage.

(iii) Encourage bank lending to affected sectors, including by amending priority-sector lending norms.

(iv) Tax incentives and compliance relaxation.

(v) Fiscal measures targeted for the revival of startups that are most severely affected.

(vi) Fast track GOI approvals for FDI in startups.

Our view is that it will take a full year, at minimum, to things to go back to normal. A lot of pain caused due to the Covid-19 pandemic is inevitable, but this is an opportunity to embrace a new vision for the Indian startup ecosystem with an endeavour on recovery and retooling of their businesses to respond to a new world post Covid-19. But, whatever has to be done must be done fast.

Dr Tejbanta S Chingtham, CEO of AIC-SMUTBI at Sikkim Manipal University (an incubator of Atal Innovation Mission, Niti Aayog)

The authors are writing in their personal capacity. The views expressed are personal and they are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency, organisation or institution.