Five lessons from the unravelling of Byju’s

The ed-tech unicorn Byju’s is in trouble. Its investors have marked down the value of their investments; its auditor Deloitte recently resigned, citing the lack of “audit readiness”; key members of its board have quit; the company has been laying off employees; and, it has defaulted on interest payment on a loan and sued the lenders.

Byju’s is one of the best examples of what’s going wrong with Indian start-ups in general and a few unicorns in particular. Unicorns are start-ups that hit a market capitalisation of more than $1 billion. There are lessons here that can be drawn for the entire sector.

Also Read: Byju's seeks investors for Aakash Education stake

The first lesson is what one may call the ‘Campbell’s Soup fallacy’. Some 15 years ago, I interviewed Pankaj Ghemawat, then a professor at Harvard Business School. Prof Ghemawat talked about Campbell Soup Company, an American company that entered China in 2007. Its entire premise for entering China was based on, “Oh there are a lot of people in China, let’s sell them some of our tomato soup”. They forgot that China had a very developed soup culture itself, and hence, soups were not the easiest food category for a foreign company to enter.

Something similar happened in the Indian start-up sector. ‘India has a population of 1.4 billion and hence, there is a large market’ was the simplistic argument that many unicorns projected, and many VC investors bought into. Of course, to this soup of 1.4 billion individuals, they added the garnishing of India’s digital revolution. There are so many people using Google, Facebook, Instagram, WhatsApp, UPI, and so on, and so Indians are waiting to buy products and services that start-ups want to sell!

Trouble is, a large population does not mean that people have money to spend. That they are on free-to-use websites and apps does not mean they have the ability to consume what start-ups have to sell. In fact, as Nithin Kamath, the founder and CEO of the stock brokerage Zerodha, put it in a LinkedIn post: “The revenue opportunity other than lending is limited to the top 2 crore Indians (~1.5 per cent of India).”

Now, this is not something we came to know suddenly just now. It has been known all along. And therein lies the second lesson. Typically, any narrative is largely set by people who are likely to profit the most from it. So, the narrative of VC-funded start-ups being the “next big thing” in the Indian economy was set by VCs, founders of these start-ups, the investment bankers who were hoping to make big money by taking these companies to IPO, and the media that bought the story.

Also Read: At Byju’s townhall, key questions from employees remain unanswered

There is more money to be made -- real or notional -- by keeping a bubble going than by deflating it. Most individuals or institutions don’t like to be a harbinger of bad news. And given this, basic questions aren’t asked when the going is good. This also explains why the stories of fraud and embezzlement in the case of start-ups have only started to come out now: The going was good until the US Federal Reserve spoiled the party in early 2022 when it started raising interest rates and thus choked the supply of the huge amounts of money that were driving VC-funded start-ups.

And this brings us to our third lesson. Over the years, the central banks in the West drove down long-term interest rates to low levels to drive economic growth in their rather moribund economies. Low interest rates mean low returns for investors. This led to a search for higher returns all over the world, leading to VCs funding the cash-burn business-model of Indian unicorns and start-ups -- in the hope of generating huge returns in the years to come. This model involved taking on losses for a while in order to build scale. VCs could fund this model so long as interest rates were low. That situation has changed. In the current high interest rate regime, they cannot fund cash-burning start-ups.

The fourth lesson here is that in many cases, VCs did understand that they were investing in a company that didn’t have much of a business model. Nonetheless, they invested out of the fear of missing out (FOMO), and the confidence that they would be able to sell on to a greater fool. And that did work for a while.

The fifth lesson was that many of us mistook this surfeit of money coming into start-ups at huge valuations as evidence of the smartness of the founders of these start-ups. The truth was, they were plain lucky to be at the right place at the right time. We confused the ability to build an app with the ability to run a profitable business. That’s the long and short of it.