Startup valuations reset a reflection of the investment landscape’s dynamism

The startup ecosystem is indeed grappling with palpable challenges. The pace and volume of startup funding have noticeably contracted.

Prominent investors are revising their private equity stock valuations in unlisted companies, a necessary fiduciary and regulatory procedure akin to marking to market public listed stocks. This does not herald doom; instead, it's a reflection of the investment landscape's dynamism.

Debunking The Valuation Myth

The media fervour surrounding these valuation revisions is largely unmerited for a multitude of reasons. These valuations are, at their core, theoretical. No transactions are happening at these lowered valuations — no buying or selling — thereby making them mere numbers on paper. The valuation an investor assigns is inherently subjective. Two investors in the same company, who invested at the same price two years ago, may now record wildly different valuations in their books. They might maintain the original valuation or mark it down based on their individual perspectives. These revisions do not directly impact the company's operations. Companies have already garnered funding at higher valuations. While future funding could potentially arrive at a lower valuation due to the current climate, it remains a separate narrative.

For investors, these mark-downs are paper losses, not actual ones, and are representative of the current market environment, including public markets, much like their public market portfolio would reflect lower mark-to-market.

Navigating The Funding Freeze

While the valuation revisions are merely accounting adjustments, thestartup ecosystem is indeed grappling with palpable challenges. The pace and volume of startup funding have noticeably contracted. Investors are treading cautiously, taking more time to close deals, offering lower valuations, and causing higher dilutions. The sector longs for a return to the euphoric days of quick Zoom call deals and swift fund transfers. Companies that previously secured funding are in a favourable position. They can restructure, pivot, cut costs, work on profitability-centred models, and extend their financial runway, reducing their need to seek additional funding for the next 18 to 24 months.

Companies maintaining a low burn rate, positive unit economics, and not relying on aggressive promotions to grow are also well-placed. They have the option to raise bridge funding from existing investors, even if it's at a reduced valuation. High-growth companies aggressively expanding their market share and aiming to raise capital in 2023 based on growth metrics are the most impacted. Their playbook of using risk capital for growth and raising the next round at a higher valuation has been thrown off balance. These companies need to drastically reduce their burn rate by cutting unprofitable verticals, downsizing, and narrowing their geographical coverage. Demonstrating improved unit economics, a well-thought-out expansion plan, and a path to profitability is crucial.

Navigating Down Rounds

The fear surrounding lower valuations or down rounds is often overblown. Yes, valuations have been reset, but this is often balanced by the weighted average anti-dilution method, which compensates investors who invested at higher valuations. Major public market stocks have faced significant drops from their 52-week highs - Pinterest fell by 78.1 percent, Netflix by 74.9 percent, Zoom by 84.4 percent, and Peloton by 91.1 percent. So why should startups be judged differently?

An Action Plan For Founders

Founders are inherently resilient entrepreneurs, capable of weathering any storm. Here are some strategic considerations:

–     Acknowledge the situation. Optimism is crucial, but so is a firm grip on reality. As a leader, it is your duty to take swift, decisive action.

–     Resist the temptation to maintain past appearances or boom-time valuations through shortcuts. We've seen examples where large companies raise funds at previous valuations using complex, structured terms — this is a perilous path driven by ego. Embrace simpler, cleaner terms, reset the valuation, apply the weighted average anti-dilution method, and issue additional shares. Focus on building the business rather than financial manoeuvring.

–     Maintain faith. As with all cycles, this too shall pass. In the interim, concentrate on the health of your company, ignore the media noise, and stay clear of critics who take pleasure in the struggles of others.

–     Recognise the exceptional courage it takes to be an entrepreneur. It's the road less travelled, chosen over the safety of employment. It's these challenging times that test and reveal the true mettle of an entrepreneur.

As we traverse these tumultuous times, it's essential to remember that turbulence often precedes tranquillity. The world is rooting for you, as you steer your startup through this storm, towards the promise of brighter days ahead.

K Ganesh is a serial entrepreneur, and promoter of BigBasket, Portea Medical, HomeLane and BlueStone. Views are personal, and do not represent the stand of this publication.