Zerodha's Nithin Kamath on root cause of corporate governance issues in Indian startups

Nithin Kamath's comments come in the backdrop of major issues emerging from startups

Online broking firm Zerodha's co-founder Nithin Kamath on June 29 pointed out the root cause of corporate governance issues in the Indian startup ecosystem, while also wondering if someone should have asked what the venture capitalists (VCs) were "smoking" instead of funding startups.

The self-made billionaire's comments come in the backdrop of major issues emerging from startups such as Byju's, Mojocare, GoMechanic, and more, which have brought back concerns around corporate governance and oversight in the booming ecosystem.

In a Twitter thread, Kamath noted that such issues coming to light in Indian startups will only increase with time. "While founders will be blamed, the venture capital (VC) ecosystem is equally to blame," he stated, adding, "The root cause of this is the overestimation of the size of Indian markets by founders and VCs."

Corporate governance issues coming to light in Indian startups will only increase with time. While founders will be blamed, the venture capital (VC) ecosystem is equally to blame
The root cause of this is the overestimation of the size of Indian markets by founders and VCs. 1/10

— Nithin Kamath (@Nithin0dha) June 29, 2023

Elaborating further on the turmoils faced by the new-age tech companies, Kamath said that while India is a fast-growing economy that will hopefully be an economic superpower in the future, it isn't that today. The size of the target market (TAM) by revenue needs to increase significantly to justify the valuations of the startup ecosystem in the country, he mentioned.

"I think most VCs have miscalculated this and maybe oversold the India opportunity to their investors (LPs). In a small market like ours with limited mergers and acquisitions (M&A) opportunities, large exits within 7 years (the lifecycle of a fund within which founders are expected to give exits) are hard," he added.

The Zerodha co-founder also noted that building a resilient business in India takes time. "I can't think of many who have done it in less than 10 years. If VC funds have 7-year lifecycles and push startups for exits within 7 years, how can anyone build a good business? Maybe the fund lifecycles for India should be longer."

Kamath also stated that given what the VC ecosystem is selling to their limited partners (LPs), the founders have to sell a story that syncs to raise funds. "I have seen so many startups funded whose decks were almost delusional. In an ideal world, VCs should help correct this, not fuel the delusion," he added.

Highlighting the same with an example, Kamath said, "I've decks where startups claim 30–50 crore Indians will be investing by 2027, and they can capture 10%+ of that. This is when we had ~6 crore Indians filing income tax returns. Someone should have asked what they were smoking instead of funding them."

Kamath, via data, also explained the "illusory truth effect"--the tendency to believe false information to be correct after repeated exposure.

Illusory truth effect
"The tendency to believe false information to be correct after repeated exposure."

If I could use one line to explain what I think is the root cause of the problem: Believing in a TAM that isn't there yet and then burning out by chasing it. 7/10 pic.twitter.com/uFczQG1Viz

— Nithin Kamath (@Nithin0dha) June 29, 2023

He said, "If I could use one line to explain what I think is the root cause of the problem: Believing in a TAM that isn't there yet and then burning out by chasing it."

Also warning on the turmoils faced by startups, Kamath said that most of the governance issues coming to the fore now and in the future will likely not be traditional fraud but misreporting things to justify the stories founders have oversold to raise capital.

"If the incentive is to constantly oversell, we get what we're seeing. So the blame isn't just on the founder, but also on the VC ecosystem that fueled it," he reiterated, while highlighting that such a discussion is important because India needs continuous capital, not spurts, to be an economic superpower.

"We reduce the odds of that happening if people invest in or build businesses with the wrong expectations, leading to bad narratives, and can slow capital flow."