Nakshatra Gujrati
The Indian Startup Ecosystem is thriving, with about 111 startup unicorns valued at a whopping $349.6 billion, as per Invest India Statistics. While startups are celebrated for their innovation, job creation, and economic contributions, we often overlook the importance and need of their governance. To nurture entrepreneurship and elevate the startup scene in India, the Government launched the Startup India scheme in 2016. This article sheds light on the challenges faced by startup unicorns and emphasizes the crucial steps needed at this juncture.
What is a Startup?
Startups are typically defined as young companies that are in the initial stages of development, often founded by entrepreneurs seeking to provide innovative solutions to existing problems through their products or services. Legally, startups are considered privately owned companies. The roots of Indian startups can be traced back to the 1980s, primarily with the emergence of IT service giants like TCS, Infosys, and Wipro. However, the significant rise of Indian unicorns began with the establishment of Think and Learn Pvt Ltd in 2011, better known as ‘Byju’s’. Byju’s was founded by Byju Raveendran, who initially worked as an engineer in a shipping firm. In 2003, while assisting friends in preparing for the CAT exam, he discovered a passion for teaching. Despite achieving a perfect score himself, he declined MBA offers and instead found himself inundated with requests for guidance from others preparing for the CAT entrance exam. This overwhelming demand prompted him to establish Byju’s in 2006, which eventually evolved into Think and Learn Pvt Ltd in 2011.
The Life Cycle of a ‘Startup’
Startups are inherently volatile and often face a high rate of failure. The success of a startup hinges on its ability to offer a compelling value proposition through its products or services, effectively addressing a specific problem or need. For the purpose of this article, we’ll categorize the life cycle of a startup into three phases:
- Identification of the problem: This phase involves recognizing a significant problem or need in the market that the startup aims to address with its product or service.
- Raising funds: Once the problem is identified and a solution is conceptualized, startups often need to secure funding to develop and scale their offerings. This phase involves pitching to investors, securing capital, and managing finances to support growth.
- Going public: In this phase, successful startups may choose to go public through an Initial Public Offering (IPO), allowing them to raise additional capital from the public markets and provide liquidity to early investors.
Phase – I: Identification of the Problem
The initial challenge for any startup is determining whether it can create a product or service that resonates with people. If the answer is affirmative, the startup founders require initial capital to fund for the prototype product and basic operations. Funds are typically collected from family members, friends and sometimes maybe Angel Investors.
Byju’s, for instance, began as a tuition class with the founder aiming to revolutionize the approach to competitive exams, emphasizing a value proposition of fostering a love for learning. Byju’s innovative approach, breaking down school curriculum into interactive videos, quickly gained traction.
Phase – II: Raising Funds
The second challenge for startups involves scaling manufacturing, distribution, and sales of their product or service. This requires substantial funds, but as startups are privately owned, they don’t have access to public markets. Instead, they turn to private equity markets for investment. Venture capitalists and private equity investors become pivotal in this stage. Startups approach them to secure funding. These fundings occur in rounds, where the startup dilutes its equity to attract investment. These rounds are typically denoted by series labels, such as Series A, B, or C, and occur whenever there’s a need for additional capital to fuel growth and expansion. Byjus secured its first funding from Aarin Capital in 2013 which played a crucial role in its operations growth.
Phase – III: Going Public
The capital structure of a private company indeed becomes intricate when raising funds from venture capitalists and private equity investors. However, as the company grows, its capital needs may surpass what private investors can provide. This is where capital markets step in, offering vast potential. Ultimately, many startups aspire to go public, seeking a listing on stock exchanges. This move not only unlocks access to larger pools of capital but also enhances visibility and credibility, facilitating further growth and expansion.
Byju’s and Paytm: What Went Wrong?
Byju’s soared to a $22 billion valuation in 2021, becoming the world’s largest ed-tech company. However, by the latter half of 2022, amid a funding shortage in the startup landscape, the company struggled to secure investments, resulting in layoffs of over 2500 employees. Compounding the challenges, Byju’s faced auditor resignations due to difficulties accessing financial documents. The turmoil escalated in June 2023 when global investors resigned from the board, leaving only the Raveendran family, primarily citing legal issues including lawsuits and FEMA violations. This marked a turbulent period for Byju’s, underscoring the volatility inherent in the startup ecosystem, even for industry leaders.
Once hailed as the poster boy of the Indian fintech revolution, Paytm captured the nation’s attention with its ubiquitous slogan “Paytm Karo.” Founded in 2010 by Vijay Shekhar Sharma, it initially gained popularity as a prepaid mobile and DTH recharging platform. In 2017, Paytm expanded its services by launching its Non-Banking Financial Entity, ‘Paytm Payments Bank,’ allowing users to open bank accounts from the comfort of their homes. However, this innovation was met with resistance from the Reserve Bank of India (RBI), which in 2018 barred Paytm from onboarding new users. The RBI cited violations of KYC norms, failure to maintain the required net worth of 100 crores, and exceeding the end-of-day limit of Rs 1 lakh per account as reasons for the action. In January 2024, the RBI dealt a significant blow to Paytm by barring it from offering its core services, effectively crippling the majority of its business operations. This action was primarily taken due to Paytm’s failure to adhere to the regulatory compliances prescribed by the RBI.
Problems Outlined
Both Paytm and Byju’s have faced challenges related to compliance with directives from regulatory bodies such as the RBI and FEMA, highlighting a common issue. In the case of Byju’s, the board composition has been predominantly the Raveendran family for the past year following the departure of other board members. This underscores a broader issue within startups where a fervent focus on increasing valuation often comes at the expense of sound corporate governance practices and robust audit mechanisms.
In India, corporate governance is regulated by various laws including the Companies Act 2013, SEBI Guidelines, Standard Listing Agreement by Stock Exchanges, Accounting standards by ICAI, and Secretarial Standards by ICSI. However, it’s important to note that not all of these regulations are applicable to private entities. Under the Companies Act 2013, private companies are mandated to appoint an internal auditor, who can be a chartered accountant, cost accountant, or other professionals decided by the Board, to conduct internal audits. However, this requirement is not applicable to private companies at all, except those that borrow at least INR 25 Crores from public institutions.
Conclusion & Suggestions
The focus should now be on highlighting the significance of corporate governance in startups. Startup India’s biannual startup fests could include sessions led by corporate advisory law firms to stress the importance of establishing robust governance frameworks. Additionally, diversifying startup boards with independent directors and individuals from varied backgrounds is essential for effective decision-making. A revamp of the companies law is needed to better suit the growing startup ecosystem in India, ensuring regulatory frameworks support innovation while maintaining transparency and accountability.
Similar to crops thriving in favourable conditions, startups flourish when regulations facilitate easy entry and exit, providing a guarantee for investor protection. Startup unicorns, are crucial not only for investors but also for job creation. These companies play a vital role in shaping a country’s economy by contributing significantly to its GDP.