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  • Writer's pictureThe JSBF Report

Bankruptcy of Startup Companies

Updated: Feb 7

- By Tanishaa Banerjee and Vasu Gupta

The objective of this research paper is to investigate the bankruptcy of start-up companies in depth. It seeks to examine the factors that contribute to bankruptcy, its significance, the outcomes, legal responsibilities and regulations, as well as possible approaches to mitigate the risks. We used a mixed research method for this paper, combining quantitative analysis of data to understand startup company performance and qualitative analysis to examine the aftermath of bankruptcy. Through data collection, simplification, and graphical representation, we gained insights into failure rates, financial indicators, and performance during challenging periods. By sorting relevant information, we explored bankruptcy procedures, laws, origins, and support provided. This comprehensive analysis addressed our research question, providing both visual and theoretical aspects of our understanding. This study aims to provide valuable insights for entrepreneurs, investors, policymakers, and academics who are interested in understanding the dynamics of startup bankruptcy. By analysing statistical data and studying real-life examples, the research aims to contribute to existing knowledge and assist in making informed decisions within the startup ecosystem.

The ultimate goal is to identify the variables that lead to startup bankruptcy and explore preventive or management techniques to address financial difficulties. Bankruptcy offers a chance for individuals or businesses to make a fresh start by relieving themselves of debt burdens. During this process, creditors may receive some payment based on the assets that can be converted into cash. The option to declare bankruptcy has positive implications for the economy as it grants individuals and companies another opportunity to access credit and rebuild their financial standing. Additionally, it enables creditors to recoup a portion of the debt owed to them.

In India, all bankruptcy cases are overseen by the National Company Law Appellate Tribunal (NCLAT). A bankruptcy judge is responsible for making crucial decisions such as determining the eligibility of debtors to file for bankruptcy and deciding whether they should be relieved of their debts. Bankruptcy, traditionally viewed as a negative outcome for companies, may not always be a complete failure. Startups aiming to make groundbreaking advancements often face challenges like securing funding and building teams. In such cases, bankruptcy can offer a useful solution, allowing startups to exit without legal obligations. Notably, several renowned companies such as Converse, Marvel etc, have rebounded from bankruptcy and achieved profitability again.

Start-up companies often encounter challenges related to limited financial resources and ineffective capital management. Securing adequate funding, particularly during the initial stages when revenue is scarce, can be a significant hurdle for many new businesses. Inadequate management of cash flow, excessive spending, and insufficient financial planning can rapidly deplete available resources, making it difficult to meet financial obligations and sustain operations. Bankruptcy in businesses primarily stems from a combination of poor decision-making, adverse market conditions, and various other factors.

This research paper has conducted a comprehensive analysis of the bankruptcy of startup companies, providing an in-depth examination of its causes, significance, consequences, legal obligations/regulations, and potential mitigation strategies. Through the examination of case studies and the analysis of statistical data, the study aimed to offer valuable insights to various stakeholders, including business owners, investors, policymakers, and scholars, who are interested in gaining a thorough understanding of the complexities surrounding startup bankruptcy.

The Corporate Insolvency Resolution Process (CIRP) in India comprises six stages. Firstly, creditors file a petition to the National Company Law Tribunal (NCLT) when a company defaults on payments. If the petition is deemed substantial, the NCLT admits it, initiating the process. An Interim Resolution Professional (IRP) is appointed to oversee the subsequent steps and ensure the company's operations continue. A moratorium period begins upon admission, prohibiting suits, debt recovery, and imposing various obligations on the corporate debtor. The IRP analyses claims and forms a Committee of Creditors (COC). The COC invites resolution plans from interested parties, and the plan with over 75% approval is presented to the NCLT. If approved, the resolution plan becomes binding, but if not, or if no plan is finalized within the specified period, liquidation is ordered.

The Insolvency and Bankruptcy Code has brought structure and streamlined the insolvency process in India. The impact of startup bankruptcy extends beyond the entrepreneurs and investors involved, affecting the broader economy and the innovation ecosystem. It is essential to comprehend the factors contributing to startup failures and implement effective strategies to mitigate these risks to foster a thriving startup ecosystem and promote sustainable economic growth. It should be noted that while startup bankruptcy is often seen as a negative occurrence, the research highlights that it can also have positive aspects. By adhering to proper legal obligations and procedures, bankruptcy can offer a way for startups to navigate a challenging situation more smoothly for both the company and its stakeholders. Moving forward, further research in this field should continue to explore emerging trends and developments in startup bankruptcy, considering the evolving dynamics of the entrepreneurial landscape.

The main goals of the Indian Bankruptcy Law are to aid firm recovery and ensure timely creditor payment. Accepting a resolution plan assists in both firm revival and debt settlement. Unlike the US, where the debtor retains management control, India and the UK have stricter regulations regarding the takeover by an Interim Resolution Professional (IRP). Our research suggests that India should allow the knowledgeable Managing Director (MD) to make decisions alongside the IRP for firm revival. The timeframe for completion, currently 180 + 90 days, is crucial. Offering incentives, such as tax breaks, to share buyers during insolvency could expedite resolutions.Policymakers and regulatory bodies should also consider the insights presented in this research when formulating strategies and regulations to support the resilience of startups and create an environment conducive to entrepreneurial success.

Our research paper utilized two case studies to solidify our thinking regarding the dos and don'ts of the startup culture. The examples of StayZilla and Doodhwala demonstrate the errors they committed and provide insights on how to avoid those mistakes. In the case of StayZilla, they originally began as a straightforward online hotel booking travel service. On the website, they included both high-end and low-end hotels as well as other lodging options including homestays, bed & breakfasts, hostels, etc. StayZilla's collapse was caused by a lack of foresight and long-term thinking, as well as mismanaged finances and neglecting customer retention. Despite operating for 12 years and raising over $30 million, the company abruptly shut down within a couple of months. Their substantial marketing investment, including significant discounts, failed catastrophically due to practices like round tripping and the costly referral scheme. StayZilla's focus on discounts without addressing customer retention, while competitors implemented innovative features, further contributed to their downfall. Additionally, their finances were in disarray, leading to desperate attempts to secure more funding. Despite cost-cutting measures, StayZilla failed to attract investors and ultimately collapsed.

In the case of Doodhwala, it was a smartphone app that made it simple for consumers to buy goods and fresh milk. In addition to milk, Doodhwala also delivered fresh dairy products, confections, bakery goods, juices, fruits, and vegetables, as well as other food consumables,

personal care items, and many other necessities of everyday living to your door. Doodhwala's downfall can be attributed to multiple factors. They faced financial challenges due to excessive cash burn and operating on low margins. The high cost of customer acquisition strained their resources, and their overreliance on discounts and cashbacks affected profitability. Additionally, Doodhwala lacked a distinct competitive advantage and faced intense competition from both startups like Ninjacart and established players such as Big Basket and Grofers. Ultimately, the absence of fresh funding from investors further contributed to their inability to sustain operations.

By presenting these cases, we aim to guide the readers of this paper in preventing the repetition of similar errors. By deepening our understanding of startup bankruptcy and taking proactive measures to address its underlying causes, we can strive towards a more resilient and prosperous startup ecosystem. This will create an environment where innovative ideas can thrive, and the potential for entrepreneurial success can be maximized.

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