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The Start-up Run to Jump over Interest Rates Hurdle

Falling interest rates pushed more money from bonds to equities, especially in start-ups in the past two years, fuelling their valuations manifold. Now, when the central banks all over the world are beginning to tighten interest rates to curb inflation, rising interest rates may see a reversal in their fortunes if not tackled properly.

On April 8, the Reserve Bank of India announced measures for gradual sucking out of excess liquidity and is clearly on the path to hiking the main policy interest rate in 2022. In a rising interest rate scenario, the cost of funds usually goes up very fast for smaller enterprises than for big corporate.

The development comes at a time when India is witnessing a start-up boom, a culture that would further drive economic growth, support entrepreneurship, and enable large-scale employment opportunities. While it is too early to gauge how this will impact the low-cost fund dependant entrepreneurs, they need to prepare a counteraction plan to stop the erosion of their valuation.

While it will be challenging, one effective way to deal with this situation will be to increase free cash flows that a business generates. That’s because, rising interest rates will result in lower future cash flows, causing a lower valuation and funding problems.

This was acutely visible recently in tech IPOs worldwide including One97 Communications (Paytm), which raised Rs 18,300 crore in November 2021. As against IPO issue price of Rs 2,150 per share, One97 Communications’ share price is hovering around Rs 642 a piece (April 11, 2022). The problem may get accentuated for start-ups as rising interest rates will cause a reset of the fair market value expectations as capital flees to safer havens for higher returns.

India at present has more than 61,000 start-ups and 84 Unicorns (each valued at over 1 billion USD), one of the highest in the world. During the Covid-19 pandemic, India created 44 Unicorns most of which have been in the services sector.

Today’s start-ups can be tomorrow’s industry leaders. Without startups such as Zoom and WhatsApp, the world would have probably been less productive and stranded during the pandemic. Indian start-ups are disrupting the world, especially in new emerging areas of health, Internet of Things (IoT), robotics, artificial intelligence, analytics, nutrition and agriculture.

But, the Indian IT industry is also witnessing wage inflation after a gap of many years which has made investors a little apprehensive about the profit growth expectations.

Recognized startups in India are spread across over 640 districts of India and have reported creation of more than 7 lakh jobs. This shows that enterprises built by innovators are essential to revitalizing economies, which is why the government should take more proactive steps to protect them.

The union government has launched various schemes including Rs 10,000 crore Fund of Funds for Startups Scheme spread over the 14th and 15th Finance Commission (till FY26) cycle based on the progress of implementation. This is to provide a much-needed boost to the Indian startup ecosystem and enable access to domestic capital. However much more needs to be done to sustain the start-up culture.

When interest rates are rising, both businesses and consumers will cut back on spending.

Giving more direct grants and zero-interest loans to start-ups to tide over the funding crunch that may arise in a high-interest rate environment could work wonder. State governments can also pitch in with region-specific support schemes. For example, Tripura recently announced a proposal for a constitution of Rs 50 crore fund for start-ups in the state.

Indian start-ups received USD 2.5 billion worth of private equity and venture capital investments in February 2022 across 85 deals. It was worth USD 1.1 billion across 61 deals during the same period last year, going by a IVCA-EY report.

Independent observers opine that India’s position as an attractive destination for PE/VC investments is expected to remain strong in 2022 going by its high growth, macroeconomic and policy stability. However, the year ahead is as challenging as interesting to watch for.


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