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Indian startups stare at two years of funding winter even as investors sit on a $9 billion dry powder

Rising inflation, geopolitical situation and looming recession in the US and Europe deter investors. However, early-stage deals would rebound faster and niche and emerging sectors would gain prominence over the next 12-18 months.

September 28, 2022 / 10:49 AM IST

India-dedicated private equity and venture capital (PE/VC) firms are sitting on billions of dollars of dry powder but a full-blown funding revival in the world’s third-largest startup ecosystem is unlikely in the next 12-18 months as investors tread cautiously in an increasingly challenging macro environment.

PE/VC firms, focused on India, have raised almost $9 billion in 12 months between September 2021 and August 2022 compared to $5 billion in the year-ago period, data collated by Venture Intelligence showed.

However, while these investors made more bets in the 2021-22 period, the cheque sizes seem to have shrunk. During 2021-22, PE/VC firms made 1,470 bets worth $58 billion compared to 1,154 bets of $56.5 billion in the year-ago period.

Ashish Kumar, Managing Partner at Nandan Nilekani’s Fundamentum Partnership, said that as VCs do not have any specific time frame to deploy the funds that they have raised, they might wait for the macros to turn positive before aggressively investing in companies.

“Capital will start getting deployed, but at a slower pace. I don’t think dealmaking will happen at a pace of 2020 or 2021,” said Kumar.

The slower pace of investments, coupled with the huge sums of money that the PE/VC firms have raised, indicates that investors are in a wait-and-watch mode.

A full-fledged rebound will take at least another 12-18 months and, unlike in 2021, they will invest in smaller amounts in fewer companies due to macroeconomic concerns such as rising inflation, shrinking liquidity and global supply chain disruptions. However, investors say early-stage deals would rebound faster and niche and emerging sectors would gain prominence over the next 12-18 months.

“Next year is unlikely to be a year of rebound. We need to prepare for at least two years of funding winter with varying degrees of intensity. A recession looks likely in the US and Europe. The growth forecast is not robust unlike the global financial crisis when China held up growth,” said an industry source requesting anonymity.

“It is true that India is decoupled to a certain extent but if developed markets are sinking, we will be impacted. There are also geopolitical factors at play- from what Putin will do to the rumours swirling around China and Taiwan. Deals are happening because the market is here, but it will not be a return of 2021, will happen at a slow and steady pace. If you look back at the dot com bust of 2000, it took nearly 18 months to bottom out. We will go through a phase of orderly descent,” the source added.

Pushing back on investment decisions

Industry observers believe that PE/VCs would delay investment decisions and their due diligence will take longer than last year as they would be more careful about choosing companies in an uncertain macroeconomic environment.

“There’s no finite period for VCs to deploy capital. In extraordinary circumstances, VCs can always write to their LPs saying that we might need some more time to deploy the fund. So my sense is the pace of deployment in 2023 would be slightly better and I am bullish on 2024, but all this will depend on how macros shape up,” Kumar of Fundamentum said.

Echoing Kumar, Vikram Gupta, founder and Managing Partner of IvyCap Ventures, said he expects investors to go slow on investments and come back only to a few select companies amid the uncertain macroeconomic environment.

“I have seen Series B/C rounds happening at Series A valuations or in some cases even at discounts to Series A. This has pushed back the overall deal flow and so you see fewer deals happening as only startups with dire need of money are raising funds. The ones that have some sort of runway are waiting,” Gupta told Moneycontrol.

“That doesn’t mean just because the capital is getting piled up, all of a sudden investors will have to write cheques and somehow deploy capital. There’s always certain pressure to deploy capital in a certain time frame, but investors would rather delay their investment decisions than just somehow deploy capital,” Gupta added.

Kumar and Gupta also expect early-stage investments to rebound at a faster pace compared to growth and late-stage investments. Both the VCs have raised their largest-ever funds worth $227 million and $214 million respectively and added that they are already witnessing faster deal activity at early stages, especially with larger investors like Tiger Global, which usually invest at later stages, also becoming active at early stages.

Early-stage deals set to rebound faster

Kumar and Gupta have a point. Early-stage deals have already started gathering momentum. Between August 2021 and September this year, investors have made 828 early-stage deals (up to Series A) worth $3.19 billion compared to 631 deals worth $2.02 billion between August 2020 and September 2021. The average size of early-stage deals also rose to $3.85 million during the period from $3.20 million in 2020-21.

“At the early stage, we are already starting to see enough activity and many Seed to Series A start-ups are getting funded as we speak,” said Swati Murarka, Vice President at Athera Venture Partners.

“The growth and late stage deals, however, are still slow with performances catching up with valuations. This could take up to a year or more,” Murarka added.

Murarka’s comments on valuations come at a time when fundraising conversations have stalled over valuations, especially for growth-stage and later-stage startups. For instance, a LightSpeed-backed edtech company that was looking to raise about $10 million in its Series A round struggled to get the valuation it was seeking.

The company was looking at raising the money at over $100 million valuation but Matrix Partners, which had committed to lead the round, told the company to match its revenue projections before agreeing to invest at that valuation. The company has now promised to show better revenue to Matrix by the year-end to get its desired valuation.

Questions sent to Lightspeed did not elicit any response. Matrix Partners denied the development entirely.

“On the Seed and early-stage side, there’s reasonable activity, but on the growth-stage side, there has been a little bit of slowdown,” Anand Daniel, Partner at Accel said.

“People want to watch more to understand how the metrics are shaping up for startups. So people are taking a little bit more time to make those investment decisions. We still see good companies getting funded on the growth but it's a slowdown,” Daniel added.

Niche sectors to gain prominence

Along with early-stage investments, investors also see niche and emerging sectors attracting investments. Sectors like space tech, green technology and drone tech, which are at nascent stages in India, already have fundraising activity jumping, industry experts said.

According to data collated by Venture Intelligence, in the first nine months of 2022, Space Tech startups have raised $107 million in funding across six deals versus $32 million in seven deals in the whole of 2021.

Since May this year, dealmaking in the sector has further gained pace as three companies have raised $69 million versus $26 million raised by four companies in the same period last year, data by Venture Intelligence showed.

ESG startups, meanwhile, have raised $843 million across 46 deals in the first nine months of 2022 against $458 million in 42 deals in the whole of 2021. The average deal size has also gone up to $18 million in the first six months of 2022 from $10.9 million in 2021.

Drone tech startups, too, have seen more deal activity this year. In the first nine months of 2022, drone tech startups have raised $76 million across eight deals against $22 million across six deals in the whole of 2021.

Industry insiders say that new and emerging sectors could get more attention from investors going forward as these companies might be able to raise funds at higher revenue multiples compared to established sectors like edtech, fintech and e-commerce.

“In established business models, like e-commerce companies that we have already seen in plenty, for up rounds to happen, investors would definitely ask for increased visibility on profitability. There will be a reset, I don’t see the kind of madness that happened in 2021 in companies like that,” Kumar said.

“Even in 2021, if you look at past data, let’s say e-commerce companies like Shopclues etc, the multiples at which they were raising money seven-eight years back, even in 2021 they weren’t able to touch that multiple. So there’s always a reset that happens. But looking at the VC and startup ecosystem, every 12-18 months there will be new kinds of business models, new kinds of technology, and wherever there’s exuberance you will see them getting richly valued,” Kumar added.
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Nikhil Patwardhan
Chandra R Srikanth is Editor- Tech, Startups, and New Economy