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Why Is Foreign Capital Dominating Indian Startups In e-Commerce and Tech?

It is not just the quest for easy capital to expand their businesses that makes the founders of these startups cede control to foreign shareholders, but the overall policy in India itself encourages this.
Why Is Foreign Capital Dominating Indian Startups In e-Commerce and Tech?

What do Flipkart, Snapdeal, Paytm, Ola, Zomato and Swiggy — top players in the consumer internet segment in India — have in common?

All of these six startups (or start-ups) with valuations of over $1 billion began as domestic companies but have since given up majority control to foreign shareholders.

Recently, American retail giant Walmart bought 77 per cent of the stake in Flipkart, India’s biggest e-commerce company. But even before the Walmart deal, the majority of shareholders — close to 90% — in Flipkart were foreign firms.

In fact, 15 of India’s largest e-commerce and technology startups have significant investment by foreign firms. What’s more, there is remarkable overlap in shareholdings among these companies by just 10 foreign investment firms, as reported here .

These 10 investment firms are — Softbank, Tiger Global, Sequoia Capital, Bessemer Venture Partners, Nexus Venture Partners, DST Global, Alibaba, SAIF Partners, Foxconn and Tencent Holdings.

These firms are either Venture Capital (VC) funds or Private Equity (PE) firms. VC funds — such as Japan’s Softbank —provide financing to startups and small companies believed to have high growth potential, while PE firms invest specifically in private, non-publicly traded companies and businesses.

But why is foreign capital dominating India’s biggest tech startups?

The Indian Express cites the reason that Indian investors are wary of investing in this “investment class” of tech startups as it “operates on a non-traditional business model focusing more spending towards marketing than building assets.” This is more so the case with startups in the consumer internet segment — as they work on a different model, where the money is spent not in creating physical or tangible assets (like setting up a factory) but rather in marketing and human resources.

Also Read: Walmart’s Acquisition of Flipkart and What it Means for India

Startups looking to scale up their operations require capital investment, and it is the easy accessibility to capital from these foreign players that makes Indian startups turn to them — while progressively ceding the controlling stakes in the company.

But the larger reason why these startups are either already controlled — or are inevitably on their way to be controlled — by foreign shareholders boils down to policy, which encourages this phenomenon. And in such a scenario, the ultimate take-over of these startups by foreign investors or businesses is inevitable.

Speaking to Newsclick, economist Surajit Mazumdar said, “Ultimately, you have a policy that allows and encourages foreign financial investors to invest more and more in India. Throughout the world there are financial investors who seek assets to invest in with the sole purpose of cashing in on the appreciation in the value of those assets. It is all a game of valuation of these entities. And then you have industrial and startup policies in the country which promote that, allowing such investments to happen in India.”

For example, 100% Foreign Direct Investment (FDI) is allowed in e-commerce under the ‘marketplace’ model — which means a company acting as a facilitator between buyer and seller by providing an online platform, as per guidelines issued by the Department of Industrial Policy & Promotion via Press Note 3 (2016).

He said these startups are expanding to a great extent on the basis of burning money, many are not even profitable at the moment, and these foreign investment firms are providing the financing for these startups to expand. “This model requires high levels of financing, but whoever invests is interested in cashing in,” he said.

“So money comes in like this, but ultimately foreign shareholding becomes very large, because of the policy encouraging creation of businesses where foreign ownership becomes the eventual result,” he said.

“These firms are not just lending money to investors, it’s not like subscribing to the shares of a company or simply financing it, whereby they will get an interest or a dividend, and be happy and go back.”

In order to cash in, a financial investor needs to find a buyer, this buyer is either another financial investor or a firm in that particular business that is interested in taking over that business and not just investing financially.

Giving the example of the Walmart-Flipkart deal, Mazumadar said, “The original foreign investors have made their money with Walmart taking over.”

In any case, these startups are unlisted companies — that is, not listed publicly on the stock exchange whereby lots of entities and people can buy shares of the company. This is where the VC funds and PE firms come in for financing.

Softbank, for instance, has the highest exposure among investors to Indian unicorns (startups valued at more than $1 billion), as IE reports.

Also Read: Investment Summits: All Dressed Up and Nowhere to Go

So, these startups do not have a large number of shareholders with small holdings, but a small number of shareholders with very large shareholdings. But in an unlisted start-up, sale usually means or leads to change in control, as Mazumdar said.

As it is, real investment (in tangible and productive assets like plant and machinery, as opposed to financial investment in securities or other financial instruments) in the country has also stagnated.

“Since the beginning of this decade, the Indian economy is facing a stagnation in real investment in real assets, this is particularly true of the manufacturing sector. Data from the National Accounts Statistics will tell you that,” he said.

Mazumdar said this foreign financial investment was not “augmenting your national resources or promoting national development. It’s not like you’re acquiring capabilities (such as technology) through them.”

If anything, we have Amazon and we have Flipkart taken over by Walmart — for example — both foreign companies, promoting online retail at the cost of our indigenous retail sector.

“What is your purpose? To promote national development that will provide livelihood and employment opportunities to people, increase their incomes, etc. But this is only encouraging foreign profits and control. Then why would you, as a country, be interested in encouraging this?”

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