A cautionary tale for startups

THE Indian startup ecosystem is in a state of shock. Its poster boys are in trouble and mighty decacorns (valued at $10 billion) have hit rock bottom in valuations. In the spotlight is Byju’s — the venture that was considered top of the heap for a long time, with a gigantic valuation of $22 billion. For years, it consistently topped the charts as the most successful startup in the country. Now, the former decacorn is facing multiple lawsuits along with cases filed in the National Company Law Tribunal (NCLT), while both domestic and foreign investors are clamouring for the removal of founder Byju Raveendran from the helm.

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The drying up of venture capital funds is a global phenomenon, but in India’s case, there are concerns over startup valuations that have dipped sharply.

Meanwhile, the ubiquitous Paytm had to face the closure of its popular wallet facility for millions of consumers earlier this month. This followed stringent directives from the Reserve Bank of India, which declared that the closure was a consequence of repeated violations of earlier orders. Paytm founder Vijay Shekhar Sharma, widely considered to be the harbinger of the digital payment revolution in the country, has stepped down as chairman of the Paytm Payments Bank in a bid to stem the tide of criticism.

Right now, Byju’s is the startup in the soup. The story of this celebrated edtech company is well known. It was originally an offline concern when it was launched in 2011. By all accounts, Raveendran is an excellent teacher who developed innovative, interactive ways of learning when it turned online in 2015. The company came into its own during the Covid-19 pandemic when there was an urgent need for online education. It offered tutoring for all classes right up to college level and had millions of students signed up during this period.

Domestic and foreign investors pumped funds into the company. Reputed venture capital names like Sequoia Capital, Prosus and Blackrock, along with Qatar Investment Authority, backed the venture. The valuation shot up to $22 billion by 2022. It then rapidly acquired several edtech firms specialising in different areas. As a result, a hugely successful offline company like Aakash, along with Great Learning and Epic, was taken over by a Byju’s company, Think and Learn. In retrospect, analysts claim that there was little method in the random acquisitions but one does not recall much criticism at the time.

It was in the post-Covid era that the company’s fortunes began to decline. Media reports surfaced of arm-twisting of parents by Byju’s marketers to sell online tutorials. Home schooling also began to decline as physical schools resumed classes. The demand for online education fell, affecting not just Byju’s but the entire edtech sector that had thrived during the pandemic.

Financial mismanagement began to be alleged as the company not only ran into losses but faced disputes over non-payment of dues to a host of companies. During the Covid era, the firm had sponsored the Indian cricket team and even hired football superstar Lionel Messi as a brand ambassador. Investors alleged that there was opacity over financial issues, which led to the resignation of auditing firm Deloitte. Investors are now seeking complete withdrawal of Raveendran and his family from the firm, while the founder is fighting a rearguard battle to stay on as CEO.

The situation reached a flashpoint last week, with shareholders led by Prosus convening an Extraordinary General Meeting seeking to remove Raveendran. A high court stay on any such decision, however, has kept these moves on hold for the time being. Meanwhile, complaints of oppression and mismanagement have prompted hearings by the NCLT, while the Corporate Affairs Ministry has launched its own investigation into the company’s affairs.

In other words, the celebrity decacorn is on a sticky wicket. For the startup community in general and the edtech sector in particular, there are many lessons in this episode. First, good governance and close investor-founder relationships need to be developed in startup ventures. Second, acquisitions need to be carefully appraised by financial experts before taking large funding decisions. Third, founders who are excellent in one field, as Raveendran was in teaching, are not necessarily the best business minds. They need to be guided by experienced and trusted financial advisers.

In this case, as in that of Paytm, the need to follow guidelines laid down by the regulator must be paramount. The RBI has pointed out that the radical decision to suspend operations of the Paytm Payments Bank followed the company’s failure to abide by a series of earlier directives regarding monitoring of accounts. There are reports of money laundering by customers relying on Paytm’s lax enforcement of KYC (know your customer) guidelines. The brilliant success of some startups can embolden founders to think that rules can be bypassed with impunity. The crackdown on Paytm has rightly sent a clear signal that the regulator will not allow rule-breaking that can lead to financial malfeasance.

These controversies have occurred in the midst of a funding winter for startups that began in 2021. The drying up of venture capital funds is a global phenomenon, but the reasons in India’s case include concerns over startup valuations that have dipped sharply in many cases. Funding received in 2023 dipped to $7 billion from $25 billion in the previous year, according to a Traxcn report.

In this backdrop, the Byju’s case is a cautionary tale for all startup founders. It could lead to fears among venture capitalists about the viability of investments in this country. This is unfortunate, given that so many Indian startups have developed into efficient corporate entities. More than ever, it is now imperative for investors to provide greater support in terms of financial expertise for high achievers in the startup ecosystem. The overused Spider-Man phrase is apt in this context — with great power comes great responsibility. Both startup founders and investors have the responsibility to keep a sharp focus on financial stability.