Is the start-up funding winter about to end?
VCs, armed with record dry powder in a buyer’s market, are sharpening the focus on unit economics as green shoots in funding activity emerge. Is it signalling the beginning of the end for the funding winter?
Silicon Valley-based venture capital firm Tribe Capital said in a recent report that the total market capitalisation of VC-backed Indian public companies had crossed $50 billion in 2023, from less than $5 billion in 2020. Yet, the share of global VC investments into India had dropped to 3.3 per cent in 2023 from 5.5 per cent in 2019. This conundrum encapsulates the enduring puzzle of India’s start-up opportunity-a canvas woven with challenges and prospects.
While concerns about the lack of global investment flowing into India remain, the current sombre atmosphere is more a result of global macro events. Following a stellar year with $36 billion being poured into start-ups and the birth of 44 unicorns in 2021, a combination of global macro events-including the conflict in Ukraine, rising inflation, a spike in interest rates, and the lacklustre performance of tech stocks in public markets-has made investors jittery. As the mood shifts from exuberance to austerity, VC investors have directed their attention towards companies that exhibit disciplined control over cash burn, prioritise cash conservation and engage in judicious hiring practices. There is a clear preference for backing profitable or profit-focussed start-ups over those which aggressively chase growth. Discussions on corporate governance and internal controls have also become integral components of deal negotiations and due diligence processes.
“After the tumultuous year of 2022, this year (2023) marked a shift towards stabilisation. The focus of the investors [turned towards] re-evaluating approaches, re-defining matrices and to a certain extent, re-designing the investment thesis both to address the challenges like corporate governance and to adapt to the new environment,” says Prateek Jain, Principal at Fundamentum, a VC firm. He adds that forensic due-diligence, so far an exception, became the norm in 2023 and this contributed to decreased deal velocity across sectors where the time period for an average deal to be sealed increased by as much as 60-70 per cent.
The time to seal a transaction now stretches to four to six months-a significant departure from 2021 when founders juggled options and closed deals over weekends. In 2023, deal volumes reduced by about 56 per cent (from 1,295 in 2021 to 569 in 2023), and deal value dwindled to one-fifth of its 2021 zenith, standing at $7.5 billion compared to the previous $35.8 billion, per data from Venture Intelligence. A reflection of this slowdown is the mass layoffs, with start-ups axing more than 15,000 jobs in 2023, per Layoffs.fyi, which tracks this.
Focus on Resilience
Amidst the ongoing market headwinds, astute investors are on the lookout for start-ups that navigate the storm with resilience, relying on the twin engines of adaptability and profitability to thrive. “The cautious environment means we (investors) need to do thorough research, focussing on start-ups with strong basics and disruptive potential. Robust unit economics are crucial, showcasing a clear path to profitability and sustainable growth. An exceptional leadership team is non-negotiable, with a deep market understanding, a proven track record, and effective execution capabilities,” says Pratip Mazumdar, Co-founder and Partner at Inflexor Ventures, a tech-focussed VC firm.
Nao Murakami, Founder & General Partner at Incubate Fund Asia, emphasises the need to strike a balance between profitability and long-term growth. He cautions against blindly cutting costs, highlighting the risk of stifling innovation. He adds that achieving profitability should not come at the expense of ethical practices or environmental responsibility. “Embracing sustainable business models that create shared value is crucial for building trust and ensuring long-term viability,” he says, adding that the success of this shift relies on a supportive ecosystem, incentivising responsible growth and providing access to capital for sustainable ventures.
Pratip Mazumdar,
Co-founder & Partner at Inflexor Ventures
The good news is that green shoots are emerging, particularly in the later-stage funding landscape, as the substantial rounds raised by Lenskart, Udaan, Zepto, and GreyOrange in 2023 show. “There is a massive shortage of quality companies in the later stages, those ready for IPO or wanting to raise $100+ million rounds,” says Rahul Chandra, Founder & MD of Arkam Ventures, adding that investors with large deployable pools are waiting for firms in that range. Inflexor’s Mazumdar concurs, noting that this phase unveils quality opportunities for investors. “It’s a buyer’s market, giving us (investors) a chance to invest in high-quality companies at potentially good prices.”
However, investors are treading cautiously, even as the deployable capital at their disposal is at record levels. According to research firm Preqin, 70 India-focussed PE and VC houses closed funds in 2022, raising an aggregate $8.5 billion, which is the highest-ever annual fundraising by value. In total, PE/VC dry powder increased to $15.6 billion at the end of 2022 from $11.1 billion at the end of 2021. Though only a fraction of the previous year, a handful of India-focussed VCs-including Epiq Capital, RTP Global, Nexus Ventures and Vertex Ventures-closed funds in 2023, adding to the existing dry power.
“There is a massive shortage of quality companies in the later stages, those ready for IPO or wanting to raise $100+ million rounds”
Rahul Chandra,
Founder & MD of Arkam Ventures
“The true marker of valuation has shifted from being growth-focussed to enabling profitability. At Indian Venture and Alternate Capital Association (IVCA), we identify such start-ups to be ‘performicorns’. Their robust foundational strengths, resilient unit economics, and clearly defined road map to profitability… will enable them to tap into the record dry powder,” says IVCA President Rajat Tandon.
He foresees a substantial upswing in funding activity in 2024, particularly coinciding with the upcoming elections in India and several other countries globally. “Historically, election years can introduce a level of caution… However, the early signals from recent state elections in India suggest a potential for stability.”
The ongoing market correction for start-up valuations is anticipated to extend into 2024, impacting various sectors. Unicorns such as Byju’s, Swiggy, Ola, Pine Labs, PharmEasy, and Meesho have seen valuation markdowns by investors. The evolving landscape will indeed influence investors as they reconsider and revamp their strategic approaches. “For VCs, the impact [of shrinking portfolio valuation] is evident in a decline in IPOs and increased caution in potential mergers and acquisitions, resulting in extended investment holding periods. This has prompted a reorientation of strategies, emphasising a shift from late-stage to early-stage investments,” says Incubate’s Murakami.
Nevertheless, founders continue to embrace optimism and confidence in the potential of this ecosystem, and, if anything, their enthusiasm is steadily growing. Per VC firm Elevation Capital’s ‘Founder Pulse 2023’ report, 83 per cent of surveyed founders believe that now is a good time to be starting up a business in India, with 50 per cent feeling there has never been a better time than the current moment to pursue entrepreneurship. Founders are optimistic that the next five years will usher in record-breaking levels of IPOs and M&As.
“The true marker of valuation has shifted from being growth-focussed to enabling profitability”
Rajat Tandon,
IVCA President
It is this optimism and unwavering belief in India’s opportunities that drives the ‘BT Upstarts: India’s Coolest Start-ups’ featured in this issue of Business Today. Mirroring this enthusiasm, the VC community, too, envisions a turnaround in funding dynamics, hinting at a possible end to this winter spell.
“Inflation is looking under control and interest rates seem to have plateaued [in the US]; it will move downwards at some point,” says Arkam’s Chandra, adding that whenever interest rates soften, the shift to equity and other riskier assets is immediate and massive.
As resilient start-ups navigate the challenges, steadfast investors, holding firm faith in India’s long-term potential, are gearing up to amplify their support, signalling that the comeback of prosperous times is just around the corner.
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