Monthly VC deals down 20% this year, exits halve as bullish sentiment wanes

The average number of venture capital (VC) deals has fallen by a fifth or 20% to 130 deals a month so far in 2022 as the much-talked-about funding winter has gripped India’s startup ecosystem, a report by Indian Venture and Alternate Capital Association (IVCA) and Bain & Company showed.

Average VC cheque sizes have also declined from $25 million in 2021 to $20 million so far this year. Moreover, exits have slumped 56 percent over the last year to $5.9 billion for a similar duration and the exit activity is expected to weaken further, according to the report. In 2021, exits had grown 300 percent or fourfold to $36 billion, the IVCA-Bain & Company report showed.

“The bearish sentiment in public markets coupled with the younger portfolios of top funds could see exits dip to pre-2021 stages again. Even though the pace of deals is slowing down, large funds like Baring, TPG, ChrysCapital, ADIA and Warburg Pincus continue to keep pace with their activity over last year, vindicating confidence in the fundamentals of the Indian market,” the authors said in the report.

The global economy entered 2022 coping with macro stresses of runaway inflation, global political uncertainties and escalating tensions, supply chain disruptions, and calls for urgent climate action, the authors said.

The market sentiment has been further dampened by the crash in blue-chip tech stocks in the public markets, which has eroded the optimism around tech and internet businesses that saw them at extremely high valuations in the fourth quarter of 2021, the authors added.

“The war in Ukraine, escalating global tensions and the bearish economic sentiment have made 2022 a sobering year after the exuberance of 2021,” Sriwatsan Krishnan, Partner, Bain & Company, and co-author of the report, told Moneycontrol.

“We see top funds continuing to bet on good business models, and the slowdown should be viewed as introducing much-needed caution and temperance into the ecosystem,” Krishnan added. 

According to the report, funds in India are anticipating corrections from last year’s high valuations and frenetic activity across deals and exits.

“We anticipate a significant tempering of pace as these macro and micro trends converge, but see this as an opportunity for the consolidation of last year’s gains which should make India see annual PE-VC deal values of around $50+ billion more frequently,” the authors said.

However, the IVCA-Bain & Company report showed that private equity (PE) funding continued to India’s companies with deal count per month growing around 27 percent over an annualised base of 165 deals.

The average realised cheque size of $168 million this year keeps PE deals within the range of $150–$200 million seen over the last five years, the report showed. It bolstered the overall PE-VC activity as more than $24 billion across 630 deals were raised by Indian companies so far in 2022, against $19 billion in 775 deals in the first five months of 2022.

2021--Banner year for PEs, VCs deals

The IVCA-Bain & Company report showed that PE-VC investments in 2021 hit an all-time peak of $69.8 billion, growing 96 percent over the previous year’s deal values, excluding the mega-investments of Reliance Retail and Jio Platforms. Deal volumes, too, nearly doubled to 2,000 from an average of 1,100 deals over 2019 and 2020, with the growth in volumes contributing nearly 96 percent to the growth in deal value seen in 2021, and deal size expansion contributing less.

VC and growth equity zoomed 4x to reach nearly $40 billion—reaching a 55 percent share of overall PE investments, the report showed. Buyouts also picked up in 2021, crossing $16 billion in value, with a significant expansion in the size of cheques. However, the number of deals in 2021 was tempered compared to 2020. 

The volume of large deals (more than $100 million) expanded significantly, growing by 95 percent, while the average cheque sizes remained similar to last year. About 11 investments greater than $1 billion happened in 2021 against six in 2020. The average value of the top 15 investments grew by 50 percent to $1.5 billion, the report showed. 

Consumer technology and IT (information technology) or ITES (information technology-enabled services) accelerated the momentum from the last year and accounted for greater than 60 percent of 2021’s deal value, according to the report. The growth witnessed in just the two sectors accounted for approximately $32 billion of the $34.1 billion growth in overall deal value. 

Consumer technology saw a surge in interest in VC and growth equity, with verticalised e-commerce, fintech, and gaming subsectors growing more than fivefold, the report showed. IT or ITES investments were driven by big-ticket investments in IT/BPO (business process management) subsectors, with the top five deals accounting for about $10 billion in deal value. 

Traditional sectors such as real estate and infrastructure, manufacturing, energy, and telecom slowed down, witnessing muted deal activity, the report showed. Top funds stepped up their investment outlay from the moderation seen in the last year, and they increased the average size of deals, according to the report.

IT/ITES sector sees robust growth

IT/ITES saw investments of $14.2 billion in 2021, which grew by $11 billion over the previous year, the report showed. PE investments in IT/ITES have grown from $2 billion to $12 billion in the past five years, and large deal volumes are increasing, according to the report. In 2021, the sector saw five deals greater than $1 billion, a tremendous increase from the last two years that saw a single billion-dollar deal.

The sector’s attractiveness has picked up due to post-COVID shifts in business operations, the need for business continuity amidst uncertainties, and a pivot to digitally enabled models focused on improving unit economics, the authors said. 

This has created increased demand for offshoring and outsourcing, automation and digital, and cloud services. The shifts are expected to last as the world embraces a ‘new normal’ moving into the endemic phase of the pandemic, and IT promises to provide the backbone of these shifts, the authors added.

Valuations in IT saw a significant rise, with the large deals in ITES closing at 20–30x EBITDA (earnings before interest, tax, depreciation and amortisation) multiples, much higher than historical multiples of approximately 15x and BPO reaching multiples of 13–14x, growing from the range of about 10x, according to the report.

The sector also continues to see significant buyout activity and accounted for nearly 40 percent of buyout deal value at almost 20 percent of buyout deal volumes over the last three years, the report showed.

Healthcare sector, too, picks up in 2021

The healthcare sector grew 1.5x in 2021, with providers growing 2x after the slowdown in 2020, and pharma maintaining the strength gained on the back of COVID-led expansion. Within providers, multi-speciality saw an over 300 percent growth followed by diagnostics and single-speciality, the report showed. The Manipal and Apollo deals drove a significant chunk of the deal value, the authors said.

Multi-speciality hospital deals are largely driven by scale and consolidation, as private players seek to dominate local presence and improve the share of high-value cases. Platform play is also an emerging thematic area of focus, the authors said in the report.

Single-speciality niches have proved mettle not only with customers but also with investors, as various asset-light, highly replicable models emerge in different clinical specialties and find scale, the authors added.

India’s diagnostics market has been given a fillip by COVID, and diagnostic chains are expected to reap the growth with an expected growth over the next five years of close to 17 percent, according to the report.

Top funds chase India’s top companies

India’s top 10 funds invested close to $43 billion in India in the last three years, the report showed. The largest deals from these investments were in IT/ITES and telecom, largely in Jio Platforms and Airtel. 

Major LPs (limited partners) are getting more active and co-investing with GPs (general partners) on large assets, according to the report. Last year saw 2x rise in activity from LPs compared to their average deal activity across 2018–2020, according to the report.

“The increase in LP participation in deals bodes well for PE in India as it unlocks access to larger deals with a shared risk for investors and allows a win-win for both GPs and LPs,” the authors said.

Further, the report showed that the quantum of buyouts also picked up, with a 5x growth in the last five years to reach $16 billion. In 2021, 46 percent of all PE deals were buyouts, compared to 33 percent in 2016, according to the report. 

The average buyout deal value has expanded 3x to reach nearly $900 million in 2021. Blackstone, Baring, Carlyle, Advent, GIC, and KKR are the most active in buyouts and have individually deployed more than $1 billion in taking majority control of firms in the last three years, the report showed. 

The expansion in buyouts coupled with larger valuations is leading to a higher emphasis on value creation through operational turnarounds, for which funds are setting up internal operations teams, authors of the IVCA-Bain & Company report said.

Exits peaked in 2021

Exits were at an all-time high in 2021, picking up rapidly from the past year’s lull across all routes of exit. In 2021, more than $36 billion exits happened in value, quadrupling the value over 2020’s approximately $9 billion. 

Even though the exit sentiment was muted in the second quarter of 2021 owing to India’s devastating second wave of COVID, second half of 2021 saw a flurry of activity, especially in IPOs and other public market sales. 

Exits of more than $100 million nearly tripled in volumes and grew by 69 percent in size, as all sectors witnessed an acceleration in exits and exit value, the report showed. Strategic sale continued to be the most dominant route of exit, with almost 50 percent of all exits over the last few years. 

Secondary sale and strategic sale are becoming the most preferred exit routes, expanding by 28 percent and 23 percent respectively each year, over the last three years, authors of the report said. 

The size of exits grew significantly faster than the exit volumes, indicating higher valuations, the authors added. 

According to the report, public markets also showed an appetite for large exits, with an average size of exit reaching $266 million, at a CAGR (compounded annual growth rate) of 95 percent since 2019. 

The average size of top 10 exits increased fourfold to nearly $2 billion, and 9 exits surpassed $1 billion in value. BFSI (banking, financial services and insurance) and consumer technology dominated as the top industries for exits. 

Exit returns increased by 1.2x to 5.6 in 2021 driven by high multiples on invested capital and large volume share of consumer technology, IT/ITES, and BFSI exits, like 2020.

Exit momentum is expected to continue this year, but the public market sentiment will see moderation even though a strong future IPO pipeline led by BFSI and consumer tech awaits, the authors said.

Moreover, fund portfolios looked much younger by the end of 2021 than at the beginning of the year, in a testament to the pace of both deal making and exit activity, the authors added.

ESG attains significance

Funds are increasingly viewing ESG (environment, social governance) criteria as a core consideration in investment decisions, according to the report. 

The global acceleration towards ESG adoption has reached Indian shores, as many India-focused funds are increasingly looking for ways to embed ESG norms into their firms and portfolios, the authors of the report said. 

Research by Bain showed that Indian funds expect ESG considerations over their PE AUM assets under consideration to grow to 90 percent over five years from now, up from only 39 percent five years ago, indicating a significant acceleration in ESG adoption across the sector, according to the report. 

ESG is becoming increasingly relevant as it is used for mitigating future risks to portfolios, and LPs are advocating it as important criteria in fund strategy and value-creation plans, the authors said. At 66 percent, India-focused funds view risk mitigation as a key driver for ESG adoption compared to peers in APAC (Asia Pacific), who view compliance as a more significant driver at 62 percent, the report showed. 

India’s push on compliance as a key driver is significantly lower at 34 percent, according to the report. At the same time, the value-creation potential of ESG is increasingly gaining attention across both India and the rest of APAC, the report said. ESG is getting recognised as an opportunity for value creation and should be viewed as a differentiated driver of value across the full investing value chain, the authors said.

As funds explore how to raise better, invest better, own better, and exit better, they have an opportunity to emerge as leaders capturing outsized value from their initiatives, the authors added.

According to the IVCA-Bain & Company report, firms have unlocked 3 percent to 5 percent points of EBITDA from ESG levers, and this value is expected to grow. 

Bain & Company said that it has examined emerging practices of ESG leadership by studying the examples of two leading funds, an LP and a GP, in defining their own approach to embedding ESG in their funds and portfolios. 

“To realise the full potential of ESG in value creation, these funds have articulated a core vision, set themselves up to ambitious targets, and integrated dedicated ESG teams. They embedded ESG across the investment lifecycle, supporting the funds’ and partner companies’ ESG goals,” it said.