This article has been published by Hritwik Chaudhary, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
It has been published by Rachit Garg.
The startup industry has always been a major driver of economic growth. By providing access to capital, technology, and resources, startups enable new businesses to emerge and grow. Startups in India have come out as one of the top emerging areas in the country with the help of the Government of India’s flagship programme, Startup India which aims to foster innovation through promoting sustainable economic growth. The Indian Government hopes that this effort would enable startups to flourish via creativity and innovation. However, the rise of startups has been accompanied by a rise in mergers and acquisitions (M&A) across the Indian subcontinent, which is also a part of a company’s strategy to grow market position, develop geographically, lessen competition, profit from patents, or even enter new markets. However, what impact do they have on startups and their funding, what is the cause of the rise in M&A, and how do the top leaders take this situation are questions that will be discussed in this article.
The start-up funding environment in India
With an estimated 26,000 firms, India boasts the third-largest startup ecosystem in the world, with 26 “unicorns”, startups valued at over $1 billion and aggregated inflows of over $36 billion over the past three years. The seed, angel, venture, and private equity funds, along with government, incubator, and accelerator funding, have all played a significant role in the rapid expansion of the Indian startup ecosystem. Through its flagship Startup India project, which went into effect in 2016, the government, for its part, is fostering an atmosphere that is favourable to entrepreneurs.
The government is attempting to deploy ICT infrastructure and provide policy support for enhanced e-governance, investments, and technology innovation through research and higher education to support entrepreneurship and propel economic growth as India pushes towards a knowledge-based and digital economy. According to data, the growth of the startup ecosystem has mostly concentrated on large (Tier 1) cities and states with a strong economy, notably in IT-enabled industries like e-commerce, transportation, and banking. Small businesses outside of major cities may not be fully aware of or enrolled in programmes that offer tax benefits and other government incentives to new firms.
Exits and M&As were scarce even as the startup environment developed. This changed in 2018 when Walmart, in the largest e-commerce M&A deal ever, paid $16 billion for a 77% interest in Indian e-commerce behemoth Flipkart. The transaction demonstrated the size and rate of expansion of startups in India. India’s startup ecosystem is still in its early stages, despite its rapid growth and liveliness. For a long time, Indian businesspeople didn’t prioritise using cutting-edge technologies or addressing regional issues. This hesitation can be partially related to the dearth of investors with significant financial resources, commitment, and patience, which prevents daring venture funding. The diversity of stakeholders in a democratic and decentralised organisation, as well as changes in consumer behaviour, low price points, lengthy gestation periods, and cash burn, prevented reforms from being implemented at the same rate.
Why do companies keep acquiring other companies/ startups through M&A
In today’s business world, startup companies are often acquired by larger companies. There are many reasons why a startup might be attractive to a larger company. The startup might have developed a new product or technology that the larger company wants, or the startup might be a threat to the larger company’s market share. Acquiring a startup can help a larger company to become more adaptive, gain a deep understanding of its customers, and develop new products and technologies quickly. In a competitive market businesses always tend to take advantage of situations when companies are underperforming or willing to sell their stocks or assets. And due to the fact that many of these businesses lack the financial resources to compete with larger and better-funded rivals, M&A deals come into play.
The following are the main reasons for a larger company to acquire a startup or underperforming company:
1) Gain a jump start on new technology or innovative products and services and tightening of funds.
2) Gain new skills and capabilities.
3) Quickly gain a foothold in a new market or sector that they may otherwise have struggled to enter.
4) Improving productivity, broadening product lines, or diversifying offerings.
5) It is a successful plan to overcome or acquire rivals.
When a business is up against the competition, it either innovates while cutting expenses, or it must buy up rivals to eliminate them as a danger. To expand business also use M&A by acquiring additional product lines, intellectual property, human resources, and customer bases. One of the main reasons for the rising competition in the mergers and acquisitions sector is the changing environment brought about by the increased availability and use of the internet. Businesses in the eCommerce sector are heavily impacted by heightened market competitiveness. Some of the most aggressive mergers and acquisitions in recent years have been made possible by this sector.
The following are the stats that show the current status of the rise in M&A of startups in India:
1) In the first nine months of 2022, M&A activity in India reached an all-time peak of $148 billion. BusinessLine research stated that it was 58.2% greater than in 2021. (BL). Domestic M&A activity in India increased by more than 190 percent to $105.6 billion in 2022. India surpassed China in terms of PE-backed M&A activity for the first time since 2008.
2) In May ’22, 40 M&A transactions totaling US$ 11.9 billion were reported. The startup industry took the lead in the activity with 11 deals totaling $70 million, or 27% of all deals. The Private Equity (PE) deal volumes for May ’22 were also driven by startups, accounting for 60% of all PE agreements with a total investment value of US$ 0.7 billion.
“M&A and consolidation are definitely going to be the flavor of the season, if I may call it that. It is a direct fallout of the squeeze on late-stage funding,” says Anup Jain, Managing Partner.
According to Vikram Chandrasekhar of Bain & Company, buyers should not wait it out and should have a strategic playbook for acquisitions if they have good balance sheets and cash on hand. According to past experience, Indian businesses that integrated and divested during the 2008 financial crisis outperformed their peers in terms of earnings by a 2:1 ratio once the turmoil subsided..
The current funding winter is expected to last through the April to June quarter of 2023, which will in turn increase startup M&A activity in the ensuing quarter. According to Tracxn Geo Quarterly Report, India Tech Q3 2022, Indian startups acquired $3 billion in Q3 2022 (July-Sept), which was 80% less than Q3 2021 ($14.9 billion) and 57% less than the prior quarter.
How M&A is the shark to startups who have fallen prey to funding
Domestic entrepreneurs saw an unparalleled funding boom last year (2022), which is now being followed by a scramble to buy smaller players as the financing market cools. Due to the fact that many of these businesses lack the financial resources to compete with larger and better-funded rivals, consolidation is also a possibility. Numerous unicorns and private companies valued at $1 billion or more have either purchased businesses or are in the process of doing so.
According to at least a half-dozen industry experts, investment bankers, fund managers, and founders, this is intended to increase market share, develop revenue sources, and get access to technology, geography, or talent. Among others, the beauty and personal care company The Good Glamm Group, the fintech startups Cred and Razorpay, the player in the edtech space Scaler, and the online marketplace for used cars Spinny have all made acquisitions, while others, including the ride-hailing company Ola, the startup for business-to-business commerce OfBusiness, and the fantasy gaming platform Dream11, are in the process of doing so.
Recent notable purchases include Chalo-agreement Vogo’s in the mobility sector and a number of buyouts by The Good Glamm Group. Bigger deals, like the one between Zomato and Blinkit (previously Grofers), are still in the works and haven’t been formally revealed. These transactions were also brought about by a wider correction in the financial market, which prevented the target companies from raising new funds or made them particularly vulnerable to the Covid-19 pandemic. The consolidation theme for the industry as a whole is being played on by Cred’s acquisition of online investing platform Smallcase and Razorpay’s ongoing negotiations for a prospective acquisition of Ezetap.
Dealmakers involved in these transactions claimed that following a fundraising boom, the market always experiences consolidation as larger firms look for M&A targets amid a liquidity shortage. Investors in the target companies are pleased with the outcome as well because they receive a little part in a rapid growth company given that the majority of businesses use their stock to buy smaller ones.
Reasons for fall in startup funding
In the past few years, M&A has become a major concern for startups. The acquisition of smaller startups by larger companies has significantly affected the funding of startups. Starting a business is often a challenging task, but it can be even more challenging when the funding is insufficient. Many businesses fail due to mismanagement; the owners don’t have the money to pay their employees. In these situations, employees look for other jobs since the owners aren’t paying them enough. This can put everyone out of work if they have enough people to quit. You can avoid this by making sure your business generates enough income before you seek funding. Investors globally have become cautious in recent months as the market reverses most of the gains. As a result, startups are increasingly finding it difficult to raise new funding rounds at a valuation higher than the previous round.
With USD 2.7 billion across 205 deals, start-up funding in India fell to a two-year low in the third quarter of CY22. In the period from July to September of 2022, just two firms in India achieved unicorn status, echoing a global trend in which the number of new unicorns has been declining recently. When compared to Q2 CY22’s USD 6.6 billion and Q3 CY21’s USD 2.7 billion, the value of funding activities has significantly decreased (11.4 billion).
M&A transactions are firmly established as one of the most effective ways to address current issues and advance the growth of businesses, but they must be executed wisely to prevent failure. Over the past century, M&As have been a significant driver of business expansion and a true locomotive. Domestic enterprises appear to have benefited from corporate restructuring primarily through M&A, operating at a larger scale, and other synergy effects to increase their efficiency and competitiveness in the global market. However, the arrival of foreign businesses through M&A appears to have increased competition in the domestic market, forcing businesses to improve their competitiveness.
As growth rounds become scarcer, according to industry experts, the momentum in startup mergers and acquisitions will continue into the second half of the year. For startups, the financial winter may be a difficult period to endure. To move through this difficult area, for firms that don’t want to be bought out by a powerful competitor the first should be to analyse and understand what other than financial winter fall caused the fall in funding. For instance, reasons specific to the sector or company or changes in strategy. And once the root cause of the problem is identified, it is important to make the necessary changes to avoid a repeat in the future. It is also important to be creative and find different ways to raise money and get attention. They can create a plan for financing that includes different sources of funds such as:
3) Angel Investors
During this phase, startups can also focus on expanding the user base for their goods because a great product and a solid customer support system can go a long way otherwise startups can become a part of M&A deals but before they should be able to analyse whether they should go for it or can they sustain through this tough period. Although M&A can increase the competition among companies and local businesses but would help India to grow its economy by attracting foreign investors.
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