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Why funding is expected to remain scarce for startups for the next one year

Early stage funding in technology startups in India hit a 12-month low in May 2022

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The year 2021 was a phenomenal one for startups, with many referring to it as the year of great deals.

Venture capitalist (VC) funding in India reached a record $38.5 billion, with over 90 mega rounds worth over $100 million, led by global VCs.

India’s maturing and robust digital infrastructure has been one of the key reasons for increased investor interest in Indian startups. However, the year 2022 is likely to see a pace and quality shift in terms of deals.

As per market reports quoting data from Tracxn, early stage funding in technology startups in India hit a 12-month low in May 2022. There was even a drop in late stage funding which came down below $1 billion in a month for the first time in a year.

“Investor interests are subject to several environmental factors, and 2022 has come with a host of them, making VCs more cautious. Global economic slowdown, as well as geopolitical tensions due to the Russia-Ukraine conflict and the impact thereof especially on technology stocks, has been one concern, slowing down the pace of new investments. The subdued investment climate is further exacerbated by the recent spree of layoffs and cost-cutting measures by startups, as well as restructuring of businesses around growth areas, resulting in further downsizing, showcasing how ineffective many startups were in managing their runway. Underwhelming stock performances from unicorns, which have delayed listings from other players, further added to it. VC funding is largely getting mired with a combination of these factors and an overall environment of uncertainty,” said C.S. Murali, chairman of the entrepreneurship cell, SID at IISc (Indian Institute of Science) Bangalore.

Murali feels that the Indian startup ecosystem is resilient and the slowdown is only expected to be a temporal phenomenon. “The focus for startups now is to outpace the slowdown itself, through effective capital management, streamlining cost structures and operations as well as monetization models at an aggressive pace. While 2022 is not expected to outpace the year before in terms of the actual VC investment, the environmental factors are likely to spur about newer innovating business models that focus on sustenance.”

Experts say that in a matter of months, things have turned topsy-turvy and the situation has changed suddenly. It has so happened that VCs have been recently pushing hard on growth at all costs, and in a month or so, the same VCs started saying how companies need to look at unit economics, and have stronger EBITDA.

“If we look at the older business houses, the mantra has always been 'run profitable businesses'. The VC firms have been led by people from the best business schools who are supposedly pushing companies into this crazy cycle of growth at all costs. Yes, there will be dearth of capital at least for the next 6-12 months, and valuations will get a reset. But the fittest will survive. The entire world will look back at India to invest, and money will come back. But the money managers this time around will be more cautious and will invest in businesses which have stronger fundamentals. In the near term, companies need to extend their runways by cutting their expenses and turning towards running profitable businesses. One thing every entrepreneur and investor should note is capital is to grow the business and not support operations. Good companies will survive with or without investors,” Sathya Pramod, CEO, Kayess Square Consulting Private Limited. told THE WEEK.

Market analysts believe that after great bull runs of impressive funding and magnificent valuations in the last two years, the phase of exuberance appears to be waning. This is due to the interplay of a host of macroeconomic and geopolitical factors induced by sporadic lockdowns across the world, leading to supply chain disruptions and economic heat and inflationary pressures generated by Ukraine-Russia war causing rise in interest rates.

“In times of global instability, investors are being more conscious and cautious about viability and sustainability of the tech product while digging deep into their pockets. While the downside risks to big cheques for start-ups will have major implications, it also presents the opportunity to the startups to rationalise their operations that are burning cash, and adopt a more focussed approach, product wise and geographically, till the funding eases out. The funding is expected to remain scarce for the next 12-18 months to say the least. And the startups are expected to extend their runway while minimising the collateral damage in terms of layoffs,” pointed out M. Viswanathaiah, Director- IFIM College.

The increased funding by angel investors, low cost of interest leading to greater capital, a buoyant equity market, and chasing of new but unknown business valuations were so disruptive that traditional norms of valuations based on cash flows or earnings were ignored.

“It is much on the likes of what happened in the dot com surge based on 'eyeballs'. While the wealth of the world moved to intangibles driven by the success of listed peers such as Apple, Alphabet, Tesla, Meta, Netflix, and their likes, the onslaught of digital made many believe they had the next Apple in their hands without realising basics like cash flow or distribution models or even the actual sale of products and services. The impending greed to pass one set of valuations from a private equity player to another or to the public in an offer for sale was taken to the skies. New heroes were created as benchmarks in a combination of technology with a story telling, ignoring that the overall market space has many entrants, the impending crash in valuations based on earnings or cash flows and the burnout of cash leaving many starving for fresh funds with negative returns,” pointed Safir Anand an angel investor, brand evangelist, IPR lawyer and a senior partner Anand and Anand.

He further pointed out that the parallel moves on cryptos also induced a false narrative that everything new and untested is god’s gift to valuations, only to reveal the tap dry once the party ended and reality set in.

“We ignore efficiency is a tool and has to be in proportion to its user. As old economy, stocks were ignored on the basis of which new economy supposedly thrived. Some of such excesses are now rightfully correcting with a decade long tested norms on valuations, drying up of liquidity, the inevitable correction that has set in on platforms in some cases even without networking effects, the absence of a chase with other asset classes soothing and the increase in the cost of capital and interest. I see more room for valuation comfort across private equity,” said Anand. 


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