India's booming tech sector has suffered a major blow this year as startup darlings Byju's and a former affiliate of Paytm have been plunged into crisis amid a regulatory scrutiny.
"There's been a bit of a reality check for the last couple of years in terms of how to keep corporate governance practices up at a level which is sustainable and at a world class level," said Karan Mohla, general partner at venture capital firm B Capital Group.
Paytm Payments Bank has been mired in controversy after the Reserve Bank of India ordered the unit to stop onboarding new customers with immediate effect. Indeed, the larger fintech firm Paytm on Friday slashed some ties with the troubled banking unit in an attempt to address the compliance concerns. The banking arm isn't controlled by Paytm but has been processing much of its payments.
A subsequent audit of Paytm Payments Bank "revealed persistent non-compliances and continued material supervisory concerns in the bank," the central bank said on Jan. 31.
Starting from March this year, the banking unit was not allowed to continue accepting fresh deposits in its accounts or its digital wallet.
Yet to be profitable, the unit is also reportedly being probed by the federal anti-fraud agency on possible violations of foreign exchange laws.
On Feb. 26, One97 Communications, the parent company of Paytm, said in an exchange filing that founder and CEO Vijay Shekhar Sharma had resigned from the board of Paytm Payments Bank.
"Venture capital investors and founders have a greater responsibility to make sure that governance in the company is sound," said Ashish Wadhwani, co-founder and managing partner of IvyCap Ventures.
Byju's, India's most valuable startup at one time, is also struggling. The Indian edtech startup has seen its valuation plummet from $22 billion to $1 billion, and faces a series of problems including alleged accounting irregularities and purported mismanagement.
The unprofitable company, which offers services ranging from online tutorials to offline coaching, attracted billions of dollars from investors during the pandemic when traditional classrooms were shuttered.
The company is under scrutiny after the Indian government reportedly ordered an inspection into Byju's finances and accounting practices, according to Bloomberg on July 11.
"I think that the sector is going to be permanently scarred because of the development with Byju's, because people are not going to look at that as an isolated problem. They will look at it as a larger edtech viability problem," said Bhavish Sood, general partner at India-based venture capital firm Modulor Capital and former research director with consulting firm Gartner.
Inflated valuations
The Covid-19 pandemic accelerated the digital revolution in India.
From online education and food delivery to online shopping, tech companies saw a surge in demand for their products and services.
The government recognized more than 14,000 new startups in 2021 — compared to only 733 between 2016 and 2017, according to India's Economic Survey for 2021-2022.
As a result, India became the third-largest startup ecosystem in the world after the U.S. and China, the survey showed.
In 2021, a record 44 Indian startups achieved unicorn status — valued at $1 billion or more, taking the overall tally of unicorns in India to 83.
Venture funding into Indian startups hit a record $41.6 billion in 2021, according to data from global startup data platform Tracxn.
But the tide has since turned.
Funding for Indian startups plunged 83% in 2023 from the record high $7 billion in 2021, as global venture funding dried up amid rising macroeconomic uncertainties, such as increased interest rates.
Byju's valuation plummeted 95% after investors cut their stakes in multiple rounds. It was most recently slashed to $1 billion, after BlackRock downsized its holdings in Byju's last month, according to media reports.
The regulatory crackdown on Paytm Payments Bank had hit Paytm hard earlier this year, slashing $2.5 billion off its market value by early February. That's a sharp decline from the nearly $20 billion valuation when it was listed in November 2021.
"There is no doubt that valuations were very stretched in 2021, early 2022," said Wadhwani from IvyCap Ventures. "Some companies have done IPOs at valuations which were just not tenable and that caused a lot of stress in the market."
Byju's is facing a cash crunch, announcing in January that it was raising a $200 million rights issue of shares to clear "immediate liabilities" and for other operational costs. The firm is reportedly struggling with debt repayments and paying staff salaries.
"Companies which don't have cash are being forced to do down rounds," said Wadhwani, referring to funding rounds in which firms raise capital at a lower valuation than a previous round.
"Companies which don't have a sustainable model are obviously going to go out of business because no one is going to fund them at crazy valuations," he added.
"But also again, businesses which are run on fundamentals will continue to get funding."
Correction: This story has been updated to clarify that Paytm Payments Bank was ordered to stop onboarding new customers and is reportedly being probed by the federal anti-fraud agency.