How Rupee’s Dollar Depreciation Will Impact Startup Funding & Valuations

The Indian rupee, which has been testing new lows for the last few days, crossed the key psychological barrier of 80 per dollar intra-day on Tuesday. 

The rupee has lost 7% value against the dollar so far in 2022 amid consistent fund outflows, according to Bloomberg. Highlighting the capital flight, Kotak Mahindra Asset Management Company, in a note said, “FIIs sold $6.4 Bn worth of Indian equities in June 2022 and $0.5 Bn in July 2022-to-date. With tenth straight month of selling, FII ownership of Indian equities is now near decadal low of 17.4%.” 

According to reports, dwindling forex reserves are also a matter of serious concern which can compound the rupee woes. Widening trade deficit also weighs on the rupee.

With fund outflows continuing unabated, the domestic currency is certain to continue to slide despite the Reserve Bank of India’s attempts to boost the rupee. Motilal Oswal Financial Services said USD-INR is expected to trade in the range of 79.70 and 80.20.

Significance Of Weak Rupee For Startups

Faced with a funding winter, startups will keep a tab on currency movements in the forex market as a weak rupee will have some impact on investments and valuations. Long-term global investors typically factor historical trends in currency depreciation in their decision making. 

According to Manu Rikhye, partner at growX Ventures, such investors are unlikely to be deterred from their India-focused investment strategy in view of the present depreciation in rupee.

Besides, the fact that the rupee is one of the more stable currencies in the emerging markets augurs well.

As far as valuations are concerned, there could be a longer-term negative impact only if the dollar slides down, noted Dara Kalyaniwala, executive director – investment banking, Prabhudas Lilladher Capital Market.

A falling rupee may not really set alarm bells ringing for startups as their cost base is mostly rupee denominated, but they are not immune to the impact of a weak rupee on the economy as a whole. 

Rupee depreciation, therefore, cannot be seen in isolation. It should be viewed in the context of changing investor behaviour amid fears of global recession and high volatility in markets. Investors now have their focus and attention firmly on break-even and profitability.

“Startups can expect delays in raising investments due to higher diligence from investors and disagreements with respect to investment terms and valuations,” said Arvind Agarwal, co-founder and CEO of C4D Partners, an impact fund manager.

An interesting implication of rupee depreciation is that foreign investors will now need to invest fewer dollars for the same ownership/stake in startups they have been negotiating for. This may, however, lead to a strong difference of opinion between founders and investors.

Hedge Currency Risks If You Are Raising Dollar Funds

For startups raising funds in foreign currencies, the risk of currency volatility is real. If the startups have availed cheap dollar loans, it would turn really expensive due to steep rupee depreciation.

Large enterprises, like software exporters, have their hedging strategies in place to mitigate the currency risk. Narayani Ramachandran, associate professor – finance, SKVM’s NMIMS Bengaluru, noted that forward contract derivatives (traded over the counter) from banks is the first option for companies to mitigate the currency risk. Exchange-traded currency futures and options can also be used if the volume and value involved are justified.

But unlike software exporters, startups do not have the scale to engage in effective long-term hedging strategies. “They are better served by creating effective commercial terms and financial management – timing of payments, for example – to mitigate the impact and manage the risk,” Rikhye said.

Ramachandran also cautioned that “over-the-counter products will cause more harm if rupee rates moved against them”.

Unicorn Story May See Some Twists

India’s unicorn story is unique. As many as 105 startups have made their entry into the elite club so far. They are collectively valued at $340 Bn and have raised over $93 Bn in funding. 

A weak rupee, however, may rescript this unicorn story. As operation costs shoot up and sales come down as a consequence of weakness in rupee, valuations may see massive changes. One shouldn’t be surprised if a small number of unicorns get dislodged from the podium.

Soonicorns will be disheartened too. Those having their revenue base in rupee will require longer time now to become billion-dollar companies.

“As investors are being extra cautious with respect to valuations, the startups can expect lower revenue and multiple valuation offered by investors. This means the startups will have to walk the extra mile to achieve a billion-dollar valuation due to rupee depreciation,” said Agarwal of C4D Partners.

Considering that big-ticket, cross-border investment will be few and far between in these volatile times, it may be quite a stretch for the soonicorns. “But they can tame it with prudent currency risk management,” opined Ramachandran.

Weak Rupee Adds To The Woes Of Beaten-Down New-Age Stocks

For investors, the 80-a-dollar level for the rupee is psychologically important. It will bring the already beaten-down new-age stocks under further selling pressure. Of the 11 listed startups, eight continue to trade way below their IPO price. But the worst is probably yet to come for these stocks.

Rupee depreciation can result in lower revenues and higher operational costs for many startups, impacting their margins. “These factors will negatively impact the price of new-age stocks and considering the recent global market developments, the worst is yet to come for them,” said Agarwal.

Foreign investors invested in new-age stocks too will take a heavy hit as the rupee’s fall continues.

“The price may get impacted to the extent that a foreign investor may have invested when dollar was at INR 75, but when they now sell and repatriate in dollars, they will get fewer dollars to remit,” said Kalyaniwala of Prabhudas Lilladher.

Different Implications On Different Startups

As Ramachandran opined, investors fleeing from Indian assets will have a “sentimental” impact on the startup universe. The consequent rupee depreciation will have different implications on different startups.  

A weak currency boosts exports and, hence, new-age companies building products and solutions for global markets will see growth in businesses and their dollar pricing will be more competitive.

Startups in the SaaS space are a case in example. “A falling rupee could lead to strong tailwinds for Indian SaaS companies building global products and further accelerate the growth of the sector,” said Rikhye.

While the global economy is heading into a recession, and SaaS being one of the sectors which is witnessing a steep drop in valuation, the rupee depreciation has provided some support, noted  Ankit Oberoi, CEO & founder, Zelto Inc. A 5-6% difference, however, isn’t much for high-growth companies in the early stage, he added. 

While observing that Indian software companies billing from India are seeing a slight uptick in revenue, he said growth rates, on the other hand, have been hit. 

“A lot of Indian SaaS is headquartered in the US and is using India as a services arm where the revenue doesn’t change but the cost of the India centre went down and helped improve margins,” he explained.

Startups dependent on global sourcing could face headwinds in the short term. Rikhye cited the example of hardware-focused sectors such as electric vehicles (EV) that import component.

However, falling commodity prices will likely act as a cushion for players in the EV space.

“The largest components of EV imports are cells which will impact raw material costs. As commodity prices are reducing, the overall import cost of EVs may not go up. They might even decrease if the world enters a slowdown and overall demand of commodities comes down on account of rate tightening by central banks around the world,” said Anand Kabra, vice-chairman and MD, Kabra Extrusiontechnik. 

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