Rethinking the start-up economy

This is a good time to give another thought to the place of start-ups in the world of finance and business

The excitement in the Indian start-up world is overstated. Building a genuine business is hard, and the few get-big-quick stories have had an exaggerated impact upon the imagination. The US Fed started tightening policy from February, and this has impacted risky and illiquid assets worldwide. Exchange-traded equities — worldwide and in India — have been more discerning in judging these firms.

There is a lot of optimism on start-ups. We should not overstate their role. The Indian workforce is about 400 million people. There are perhaps 10,000 start-ups, with an average of 50 employees each keeping half a million employed. Alternatively, the broad market value is about Rs 267 trillion. Each 100 firms at a market value of $1 billion add up to a market capitalisation of Rs 8 trillion. These magnitudes — Rs 267 trillion vs Rs 8 trillion, and 400 million workers vs 0.5 million workers — help us stay grounded.

The fascination is more a human-interest phenomenon. Each individual in the world of business looks to maximise wealth, and is inundated by messages about the twenty-somethings who have a personal wealth of above Rs 0.1 trillion. There is a psychological problem here which is similar to that seen with social media: Everyone else seems to be having a better life. The handful of individuals who made it past Rs 0.1 trillion in their twenties are lionised, while the poor outcomes for the remaining 10,000 firms remain in the shadows.

At its peak, the hype around the start-up world was inducing difficulties in the economy. Anecdotes abound from the labour force doing IT product development, where the size of the start-up economy is material compared with the overall economy. This workforce is disproportionately young, and many young people drifted from one start-up to another, hoping to hit the jackpot. Alternatively, young people from famous universities have exploited the credentialism of investors, and made money for a few years, but this comes at the cost of the learning that comes from complex organisations and mentors. These problems have hampered IT product development in India, which faced a peculiarly footloose and low-skill workforce. It was also bad for the knowledge development of many individuals, who lost out on the possibility of building capability by digging into one problem for many years and from learning opportunities.

Some in the leadership teams of mature firms lost their nerves, wondering whether they should be in the get-big-quick game rather than the slow process of building organisations. To this extent, the hype around the start-up world has detracted from the resourcing and sustained attention for the marathon-running that goes into building organisations.

The Indian venture capital (VC) and private equity (PE) industries got to great success with many IPOs (initial public offerings). But the world of listed equities has been more discerning. The public market features millions of traders, and it is harder to fly on fumes here. Many richly priced IPOs have fared badly after the listing date. This has, in turn, made it harder for others to list at rich valuations. This is feeding back into the funding environment at earlier stages.

Alongside this, the financing conditions worldwide have changed. From early 2022, rates started going up in developed markets. This triggered a retreat of global capital from illiquid and risky assets worldwide in favour of well-understood developed market assets, such as government bonds and index funds, causing turmoil in many exotic assets, ranging from cryptocurrency to start-ups.

Illustration: Ajay Mohanty

Some famous firms in the West have led the way with poor performance. Theranos had a valuation of $9 billion in 2015, and has closed with the founder in jail. WeWork peaked at $47 billion in 2019, and dropped to $3 billion in a year. Klarna peaked at $45 billion in 2021, and stood at $7 billion last month. Similar problems have unfolded for some famous firms in India. There are similarities between the start-up scene worldwide and in India, through commonalities of human psychology and the shared exposure to monetary tightening.

The hype around the start-up world was inducing difficulties in the economy. Conversely, the present difficulties are bringing about greater common sense. The start-ups will be less jittery and hype-driven: They will worry more about the burn rate, buy inputs in a saner way, and focus more on actually building a business. The IPO market will be more discerning, preferring firms that actually have an organisational capability. The IT product development labour market will become more sensible. There will be fewer got-rich-quick stories in the press. This will improve the focus of the leadership of large firms upon their basic task: Running the marathon of building an organisational capability in large complex firms. New kinds of strategic thinking are required in finance, on sensible levels of risk and reward, and on the appropriate role for start-ups, venture funding, PE, IPOs, family offices, and established business groups.

Ultimately, two analogies are at the heart of the optimism. Are the start-ups of today analogous to Google and Netflix in the US — innovators who transformed the world and profited enormously? We, in India, seem to be mostly doing more trivial things like delivering food, and scaling is impeded by the Indian institutional environment of rule of law and policy risk.

Or, are the start-ups of today analogous to TCS and Infosys — firms that were once offbeat and unusual in the eyes of the old economy, but now command a market capitalisation of Rs 12 trillion and Rs 7 trillion, respectively, which laid the foundation for IT to become India's biggest industry? First, neither is a get-big-quick story: TCS began in 1968 and Infosys in 1981. It was a journey of careful organisation building, unlike the behaviour of many young firms today. Secondly, there was a business model at the foundation of these firms — to hire Indian talent and serve the world — which made immense sense, and had an essentially infinite upside.

The writer is a researcher at XKDR Forum