Exclusive | Startup deals trip on China FDI rule

Indian startups, struggling to raise money because of the coronavirus pandemic, now face uncertainty over fresh investments and top-ups, with new FDI rules requiring the government's approval for investments coming in from China.

The recent tweaks in the foreign direct investment (FDI) have thrown dozens of investments and top-ups from Chinese companies into doubt. For some of the start-ups, a funding round is all that stands between surviving and doom and layoffs and salary cuts, according to investors Moneycontrol spoke to.

“Lots of deals are now stuck and may not even happen but it is finally a matter of luck because some startups need the capital far more than others. If these firms can’t close a round soon, they will face an existential crisis,” said a partner at a venture capital fund, requesting anonymity.

Online education firm Toppr was in talks to raise funds from CDH, a Chinese fund but discussions ended after the FDI rule came in. Similarly, budget hotel firm Treebo was in talks to raise $5-8 million from its existing backers-led by Hong Kong-based hedge funds Ward Ferry and Karst Peak, three sources told Moneycontrol, requesting anonymity

“Treebo’s deal was in the final stages, with documentation ready and only investor signatures pending. But the new FDI rule at the last minute broke down the deal since the lead investors are Chinese. They are relooking what to do now and will have to change the agreements again,” said a person involved in discussions, requesting anonymity.

Toppr CEO Zishaan Hayath did not respond to an email seeking comment. Treebo’s co-founder Siddharth Gupta said, “This is incorrect. Can’t give you any more details.”

CDH did not respond to a mail seeking comment.

Treebo needs the capital badly, given that travel and hospitality sectors have been one of the worst-hit sectors, with lockdown restricting the movement of people. Many hotels and transport companies are bracing for a prolonged period of zero to negligible revenue.

The Bengaluru-based startup fired 120 employees in July 2019 after a funding round from the French hotelier Accor Group fell through.

Toppr, which runs an app providing educational content for students from Class 5 to 12, has seen its numbers spike during the lockdown as students stay at home.

But, the Mumbai-based company, which has been in the market for funds for a few months, faces huge competition. It is up against players like Byju’s, one of the country’s largest consumer internet companies last valued at $8 billion.

“…if a founder was raising pure growth capital-already has two years of money in the bank, and among incoming investors, only one is Chinese, he can afford to see the investor pull out. Although not ideal, at least he still survives,” the investor said.

Chinese connection

Chinese investments have played a huge role in the growth of Indian startups.  China’s Alibaba has invested in payments firm Paytm, online grocer BigBasket and ecommerce player Snapdeal, among others.

According to Tracxn, a startup data tracker, the Chinese invested around $2.5 billion in 2019.

Within days of the government calling for greater scrutiny of investments coming from China, which was not named, the Indian Venture Capital Association sought some clarifications. The industry body for private equity and VC funds also asked for minority investments to be kept out, as the changes were aimed at preventing buyouts of Indian firms by the Chinese.

The government has not clarified the meaning of “Beneficial Owner”. This could mean that if a company has even a single Chinese investor or an investor has a single Chinese backer, irrespective of size, it could come under the scanner.

As reported by Moneycontrol on April 14, American PE fund Alpine Capital is in talks to invest $25 million in regional languages news aggregator Dailyhunt. However, investors told Moneycontrol that they were wondering if the investment would still go through.

Though it is a Cayman Islands-based fund with American investors, its manager is Haifei Zhang, a person of Chinese origin who is also the founding partner, according to regulatory filings with the US Security and Exchange Commission.

The startup industry is hoping for some respite and some clarifications were expected from the government in the next few weeks, people cited above said.

While some funding rounds, such as Treebo, may eventually close, the timing also matters when capital is short, revenue is zero, and the short-term future looks bleak.

“Often, everything depends on that one fundraise. It goes awry and panic ensues,” an investor said on condition of anonymity.