Unlocking the Potential: Investing in India's Startup Ecosystem

The pandemic has catalyzed digital adoption globally, facilitating cross-border investments by granting investors swift access to information about foreign startups and their operational landscapes. Simultaneously, overheated western markets, led by legacy investors like Tiger Global, Andreessen Horowitz, and Sequoia Capital, are driving startup valuations to unprecedented heights (The Economist, 2021). As a result, many global investors are now exploring the vast and booming startup markets in emerging economies, especially in China and India.

Exploring India's Booming Startup Scene

While significant attention has been given to the Chinese startup landscape, India's startup ecosystem holds immense promise and warrants further exploration. India ranks third globally in terms of the number of startups, with over 60,000 startups spread across 642 districts. As of April 2022, India is also home to an impressive 65 unicorns across various industries, attracting substantial investments from foreign backers.

However, despite the optimism surrounding Indian startups, statistics show that approximately 90 percent of them are likely to fail within their first five years. Global investors must exercise caution and identify potential pitfalls before diving into this market.

Socio-Cultural Dynamics: Understanding Indian Entrepreneurs

Indian entrepreneurs exhibit distinct differences in their outlook compared to their western counterparts. They tend to be more hesitant in sharing information and take longer to establish trust with outsiders (Harriss, 2003). Additionally, there have been instances of early-stage Indian startups mismanaging investors' funds (Rajagopalan and Zhang, 2008). This contrasts sharply with western countries, where stricter socio-ethical norms encourage entrepreneurs to treat investors' money with utmost care. The recent allegations of financial impropriety against the founders of BharatPe, an Indian fintech startup, underscore the importance of considering these cultural differences. Moreover, due to the significance of close-knit family ties in Indian society (Warner, 2014), it is common for Indian startups to have family members holding key leadership positions. Replacing them can be challenging, potentially leading to governance conflicts if the founding family is unwilling to relinquish control even to investors with substantial ownership stakes.

Navigating the Market and Understanding the Customer

India's vast population of 1.4 billion, including around 600 million individuals in the "middle class," presents an alluring market potential. However, appearances can be deceiving, given the actual size of the Indian market. For instance, in the realm of consumer technology, a 2020 report by the Internet and Mobile Association of India reveals that there are 622 million active internet users in India. Still, many of them possess basic smartphones lacking processing speed and memory. Additionally, the purchasing power of the Indian middle class is considerably lower than that of developed economies (The Economist, 2018). Indian customers also exhibit a significant distrust of online transactions (Sahney et al., 2013), preferring traditional neighborhood stores accepting cash payments. The Indian consumer is highly price-sensitive (Mukherjee et al., 2012), leading to ongoing challenges in customer retention and contributing to cash burn in the form of discounts and deals.

Navigating Regulatory Complexity

Contrary to popular belief, the issue that affects Indian businesses is not the lack of regulation but over-regulation, resulting in opaque administrative processes (India Economic Survey, 2021). Under-implementation is another common regulatory challenge. Startups often operate in uncharted regulatory territories (e.g., the absence of comprehensive regulations for self-driving vehicles), and this problem is amplified in India. Indian startups also face regulatory flip-flops (The Economist, 2020), where sudden policy changes can cause significant disruptions to their business models. Moreover, India's market is not uniform, but rather a collection of micro-markets delineated by state-specific regulations, income levels, regional economic development, and cultural norms. This creates a labyrinth of legal complexities that startups must navigate to thrive (David et al., 2021).

Beyond Academic Pedigree: Identifying Entrepreneurial Potential

Foreign investors often favor startups founded by alumni of prestigious Indian Institutes of Technology (IITs) and/or Indian Institutes of Management (IIMs), considered the Indian Ivy League universities (Nigam et al., 2020). However, relying solely on academic pedigree as a proxy for entrepreneurial ability can lead to poor investment decisions. Instead, investors should look beyond degrees and assess other critical factors such as social capital, technological competence, founding team experience, startup alliances, patent applications, access to government grants, and affiliations with third parties or venture capitalists (Colombo, 2021). Partnering with local incubators and accelerators also provides foreign investors with valuable insights into the Indian startup landscape.

Planning for the Exit

In the excitement of investing in a promising startup, foreign investors must not overlook the importance of having an exit strategy. Exiting the Indian market can be challenging (Dominic and Gopalaswamy, 2019). While some high-value acquisitions have occurred, most startups do not achieve such lucrative deals, often being valued far beyond their actual worth (The Economist, 2020). Conducting a successful IPO is also no easy task. Though 2021 saw a surge in IPOs, the number of startups going public in India remains lower than in the US or China. The Indian capital market's relative underdevelopment, coupled with tepid retail investor participation (Giannetti and Koskinen, 2010), leads to post-listing stock price declines, making investors question the valuations. Consequently, many startups reconsider their IPO plans, making it even more challenging for investors to secure a profitable exit.

Conclusion

India's startup ecosystem boasts tremendous potential, attracting significant investments and fostering rapid growth. However, foreign investors must approach this landscape with a keen understanding of the socio-cultural dynamics, market complexities, regulatory challenges, and the need to identify entrepreneurial potential beyond academic pedigrees. By navigating these intricacies thoughtfully and planning for potential exit scenarios, investors can unlock the vast opportunities presented by India's thriving startup scene.