Are Indian start-ups in a bubble?

Mon, 20 Apr Pre-Open

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The hottest investment story in India today is clearly the e-commerce space. The amount of money that has been poured into firms like Flipkart, Snapdeal and the like is mind-boggling. Yet they continue to attract the attention of Venture Capitalists (VCs). These firms are still years away from profitability but VCs are not deterred. Thus, valuations of these firms have crossed all limits of sanity. Yet despite this, at least one can try and make a long-term investment case for e-commerce firms. The same may not be true for many of the other start-ups in India.

As per an article in the Mint, large VC firms like Sequoia Capital and Tiger Global have set their sights on many smaller and un-proven Indian start-ups. Usually, VCs enter the fray a little later compared to angel investors. The angel investors are typically less demanding of start-up entrepreneurs and are willing to accept the risk of investing a business with an unproven revenue model. VCs on the other hand enter only when the topline growth potential is proven. Very often they buy out the stake held by early-stage angel investors and are very demanding of the entrepreneurs. They typically have an IPO exit in mind.

What is surprising is those large VC funds are now entering the start-up party in the early stages. The action is not limited to e-commerce either. VC funds have begun flowing into companies like Taxi services like Ola Cabs, food delivery firms like Grofers, TinyOwl & PepperTap, and service market places like UrbanClap & LocalOye etc. Many of these start-ups have not received any angel funding. Instead large VC firms have seemingly begun to bet big on them. This has not only increased the pressure on the entrepreneur to deliver, it has also increased the risk for these investors. The revenue models of many of these tiny Indian start-ups have not even been established. Yet global VC firms that are flush with cash thanks to cheap global liquidity don't seem to care.

We are extremely thankful that very few if any of these start-ups will ever reach the stage to come out with an IPO. Retail investors are well advised to remain away from this game. The Indian start-up space certainly provides many interesting opportunities. However, it is almost impossible to separate the future winners and losers. The failure rate of start-ups is high but the valuations they command are higher. When global liquidity dries up, we do not have much confidence regarding the survivability of most of them.