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.

The story so far…
In recent years, there has been a momentous rise of Indian startup ecosystem driven by factors such as funding galore (both domestic and FDI), consolidation activities, evolving technology, conducive regulatory environment, institutional support (from incubators, accelerators, venture capitalists and the Government), large internet user base and a burgeoning domestic market. Government of India’s flagship Startup India initiative, launched in 2016 to build a strong ecosystem for innovation and entrepreneurship, encouraged states to make their own startup policies. These state policies feature a host of benefits like capital investment, IT infrastructure support, incubation centers, R&D labs, services like patent registration, accounting, legal, investment banking and more.

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.

Financial ravages of Covid-19 on startups
Perhaps the biggest ever lockdown in the history of mankind, as announced by our Prime Minister on March 24 sent a spine-chilling tizzy to the founders and staff of many startups. Like demonetisation and the hasty roll-out of the Goods and Services Tax, this lockdown completely ignores what could befall India’s startups, particularly the smaller SMEs. The government’s ₹1.7 trillion relief package, too, has nothing for them, neither for their founders or staff. Further, RBI’s ₹3.7 trillion-plus effort to flush credit around might not reach to save these small enterprises. There is no clarity and certainty as to what the PM-CARES Fund will do for these startups.

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.

What needs to be done?
Startups are an integral part of the Indian economy. How they tide over these times of crisis would have an impact on the other parts of the Indian economy. Any adverse impact on startups would imply a surge in joblessness, fewer opportunities for youth and more challenges on the demographic dividend aspect.

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.

About authors: Rupesh Mishra, Vice President - Legal, Private Equity, Everstone Capital.
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.

The thoughts and opinions shared here are of the author.