Experts say that while the government's FDI decision was a required measure to avoid hostile takeovers, offshore capital is paramount for India’s startup ecosystem.

Will the call to boycott China impact funding for Indian startups
Atom Startups Monday, June 22, 2020 - 18:49

The call to boycott Chinese goods and companies has been growing louder. However, some of India’s biggest startups have been backed by Chinese investment, and Chinese funding is present across sectors including e-commerce, fintech, education, logistics and more.

But the government is now looking to curb this as well. There was already a spanner in the works with the government’s change to the Foreign Direct Investment (FDI) policy, which stated that if the owner of any investment belongs to a country that shares a border with India, it will have to go through government approval to invest in India. 

The move could potentially affect smaller Indian startups looking for funding, who were already dealt a blow due to the pandemic.

In 2019 alone, Chinese investors pumped in $3.9 billion dollars into Indian startups, nearly doubling from 2018. Ola, Bigbasket, Flipkart, Swiggy, Snapdeal, Paytm, Oyo, Byju’s, MakeMyTrip and other Indian unicorns have received Chinese investment.

A report by foreign policy think tank Gateway House stated that 18 out of 30 unicorns in India have funding from China, and that a total of 95 startups in the country are funded by Chinese investment. 

Gateway’s report stated that China is most active in India’s startup space.

“Gateway House has identified over 75 companies, with Chinese investors concentrated in e-commerce, fintech, media/social media, aggregation services and logistics. A majority – more than half – of India’s 30 Indian unicorns (start-ups with a valuation of over $1 billion) have a Chinese investor,” it said. 

And this total investment into India by China makes up for just 1.5% of Chinese FDI (including Hong Kong) and doesn’t cover investments made by funds based out of Singapore and elsewhere “where the ultimate owner is Chinese, so the actual investment in India will be higher.”

“Chinese investors are one of the five big pools of capital for Indian start-ups, which is led by American investors like Sequoia and SoftBank," Amit Bhandari, one of the authors of the report, told Boom

Prior to the current situation, following the announcement of the change to the FDI policy, the Startup Association of India had reportedly written to Commerce Minister Piyush Goyal to seek relaxations for Chinese investments. They wrote in the letter that large venture capital funds from China have raised money from the US and other global investors to invest in startups in emerging markets, especially India.

“These investments and the ones that are already in the works will significantly get affected and startups looking to raise capital from foreign destination including China would now need to re-work their strategies from scratch which will cost them time and money (due to FDI restrictions)," SIA reportedly wrote in its letter.

Roma Priya, the founder of Burgeon Law says that while the government's FDI decision was a required measure to avoid hostile takeovers, offshore capital is paramount for India’s startup ecosystem.  

“China has been one of the major power backers of our unicorns. Hence, we hope the government issues detailed guidelines in terms of timelines and procedures for seeking approval or creates certain exceptions for startups,” she added. 

More than just money

Experts are of the opinion that apart from VC firms that are looking for a profit, Chinese investors such as Alibaba and Tencent, who have invested in many major startups, also bring experience and learning to the table. 

As a market, in terms of volume and scale, China is a market that brings a lot of learnings for companies and startup in India looking to build products for the domestic market.

Santosh Pai, partner at Link Legal India Law Services says that when it comes to entering new areas such as e-commerce, ride-hailing, etc, China has been the only market, which India models itself around. This is because other markets simply don’t have the scale.

“Ask any founder of an Indian startup he will tell you that Chinese money comes with a lot of value-added experience and learnings from China. Other markets simply don't have the scale. The learnings that come from China have a very valuable place in the rule book or a playbook of Indian founders,” Pai says.

Good companies always attract capital

However, if there are exciting companies in India, Pai says that they will get funding somehow, whether it is from China or not. 

“When we look at all the investment structure, very little startup capital is coming from China.  It is more like the fund has some Chinese connection, because all these venture capital funds are incorporated in offshore tax havens and the people who pool in money funds come from multiple countries. So, the characterization of these funds as Chinese funds itself is problematic because there is no legal basis to term all these as Chinese,” he says.  

And if it has to come from China, eventually, he says, money can be rerouted in a way that it will be hard to tell where it is coming from. 

“If you start having a negative outlook towards money from China, then the structuring will change in a manner that in six months’ time, money will continue coming into startups, but it will be impossible for us to put our finger into whether this is coming from China or this is coming from a Chinese fund. Venture capital money can be restructured much more easily than the industrial supply chain,” he adds. 

Roma Priya says that to mitigate the current situation with China, startups will have to look for other big-ticket investments from newer areas. “Companies which fall under the portfolio of Chinese investors will also have to look for new alternatives as their transactions will get delayed due to these macro events,” she said. 

A startup founder told Economic Times that even as investments already slowed following the change to the FDI policy, avenues have opened up from other countries. However, another investor told the newspaper that Chinese capital is expected to stay away, at least for the medium term. 

“We will step up and pump in more money if the situation requires us to do so, and in their absence. We have to align with these new geopolitical scenarios,” the investor said. 

However, despite the current situation, Moneycontrol reported that Chinese investors are still bullish on the Indian market. 

"Deal flow from China has resumed and the sentiment recovery is better than expected," Pai from Link Legal told Moneycontrol.

Read: India’s revised FDI policy: Will tightening norms benefit or hurt the economy?

With inputs from Shilpa S Ranipeta

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