Inflated Valuation of Unicorns Reminds of Dotcom Bubble

India is home to 105 unicorns—start-ups with a value of more than $1 billion—dominated by familiar names such as Zomato, Swiggy, Ola, Oyo, Paytm, MakeMyTrip, BigBasket, etc. 

Any mainstream account on unicorns inevitably ends up in a discussion about their valuations. That is, in fact, the crux of the definition of the term ‘unicorn’. But few talk about real worth of valuation or more aptly ‘hyper-valuation’ of these start-ups. The total valuation of Indian unicorns is estimated at $341 Billion. 

This column is in continuation of a column published in Newsclick a few days ago which discussed the phenomenon of rapidly emerging unicorns in the country. 

The previous column highlighted the manner in which the government and the financial elite of the world have been making wishful claims that this newly emerging start-up ecosystem will transform India’s economy over the next decade. However, the report asserted that the relatively new and fragile start-up ecosystem is not a solution to the larger problem of a prolonged slump in demand that has been the reason for the sinking Indian economy since before the pandemic. 

The phenomenon of hyper-valuation has reached a stage where there is constant flooding of digital start-ups with speculative capital by the venture capital industry. The funding of any entity depends on its valuation by the funding bodies. In the case of start-ups, the funding bodies comprise venture funds, hedge funds, mutual funds and other private investors. 

In theory, the valuation of a firm ought to depend on factors such as the business model of a firm, its capital and debt structure, cash flow, etc. However, since the 1990s, the financing of the tech industry by seasoned and big-shot venture firms is motivated by twin objectives:  short-term and low-risk high returns and the promotion of monopolisation and rentierism. This is a part of the larger process of financialisation of global capital. The process has played an important role in the development of the digital economy around the world. 

Venture capital funds are investment funds that invest in start-ups and small-to-medium-sized enterprises. Some of the biggest venture funds that have been investing in Indian start-ups include Tiger Global Management, Sequoia Capital, SoftBank Vision Fund, etc. 

The undertakings of SoftBank are illustrative of the philosophy with which venture capital firms work. The core investment philosophy of Softbank is to create monopolies. In an interview with CNBC, former SoftBank executive Nikesh Arora said, “There is evidence that if you throw enough money at a company in the consumer space at the outset, it could, in theory, outgrow all its competition and leave it in the dust.” 

In the mid-90s, Masayoshi Son-led SoftBank Group invested billions of dollars in hundreds of tech firms. One of these hundreds of tech firms was a small Chinese online marketplace called Alibaba. In 2001, when the first Internet bubble burst, Son lost close to $70 billion. But the loss borne by him was more than made up by profits from Alibaba, which was valued at more than $700 billion in 2020. Softbank’s stake in the firm at that time was more than $100 billion. 

Past experiences with this kind of investment activity resulted in the creation of what had been referred to by the House Antitrust Subcommittee in the US as ‘kill zones’ for new and small enterprises. In addition, an investment towards monopolisation allows for extraction of surplus from labour and monopoly rent from others, including consumers. 

The kind of inflated valuation of unicorns is yet again reminding observers of the dotcom bubble from the 90s. This was a time when the US economy came firmly within the grip of financialisation. 

Financialisation is a process in which financial markets, financial institutions and financial elites gain significant influence over economic policy and economic outcomes. It has been defined as “a pattern of accumulation in which profits accrue primarily through financial channels rather than through trade and commodity production”.

The process of financialisation generates a pattern of growth in which the rate of growth of financial assets in an economy is higher than the rate of growth of wealth in the country. In the larger scheme of things, there is a diversion of socio-economic resources towards the creation and circulation of financial assets. 

The avaricious and blind pursuit of profit leads capital (including human capital) to flow into opportunities with the highest risk-adjusted returns. In a virtuous cycle, capital begins to feed on itself with higher asset prices inducing more investment and generating still higher prices while creating a misallocating process that feeds on itself—until the bubble bursts. 

Highlighting the resulting misallocation of resources in this process, a report by the Kauffman Foundation argues: “Capital misallocation can lead to inflated (deflated) asset prices, lower productivity, less innovation, less entrepreneurship and, thereby, lowered job creation and overall economic growth. The mechanism that creates each of these effects is, of course, the flow of capital in the economy as exacerbated and distorted by financialisation.” The process ends up in a detachment of the financial economy from the real economy. 

In the 80s and 90s, the information technology sector was a significant capital consumer in the US. As a result, companies were created, financed and eventually went public. The returns on capital invested in these companies attracted capital allocated by new financial firms, ranging from brokerage firms, venture capital firms and private equity partnerships. Their assets saw a massive expansion and the process continued until financing unprofitable young companies became an end in itself. 

The process continued and ultimately broke down during the dotcom bubble of the late 1990s. The decade leading up to 2010 saw massive job destruction and the returns to the venture capital industry plunging.

Observing the changing patterns of investment in India, Kaushik Jayaram, a former senior official at the Bank for International Settlements, notes that the share of foreign venture capital investors has risen sharpy post 2018. Simultaneously, the net FDI and net portfolio investment into equity, debt and other capital market instruments has declined in relative terms. He also highlights that investment in stocks seem to have shifted in highly volatile portfolio investment. Moreover, investment in unicorns is largely concentrated in financing e-commerce and fintech—avenues for quick and high returns. 

As highlighted in the previous column, these developments will not help rescue an economy troubled by declining purchasing power in the hands of the working population of the country. If anything, the process of financialisation of global capital will keep feeding on itself helping the financial elite to multiply their wealth exponentially. In this process, the resources meant to be flowing into the brick-and-mortar economy and socio-economic development of the country will continue to be diverted towards the spiral of speculative finance. 

The writer is a researcher and author. She is currently pursuing PhD in International Development at the London School of Economics and Political Science. The views are personal. She can be reached on Twitter @ShinzaniJain