More than $30 billion worth of funding, a record number of 45 unicorns and a clutch of sizeable IPOs — 2021 has been nothing less than a dream run for Indian start-ups. The funding frenzy on the start-up street came on the back of a ‘digital overdrive’. Nudged by the pandemic that confined millions to their homes, consumers’ appetite for digital services shot up, boosting start-up subscriptions, which eventually translated into investors infusing billions of dollars into new-age companies at high valuations.

2022 seemed to be going well too. Funding in the first two months surpassed the year-ago period. Start-ups raised around $7.75 billion during January-February this year, compared with $2.63 billion in the same period last year, according to data sourced from market research firm Venture Intelligence. Also, the unicorn count for the year has already touched over 10.

But “all good things must come to an end.” The word on the street is that funding for start-ups would now be under pressure in the near-term, at least for the growth and late-stage ones. A culmination of local and global factors is creating a perfect brew for things to go awry. Tightening of interest rates by global central banks — The Federal Reserve recently hiked rates by a quarter of a percentage point, the first since 2018, while hinting at six more hikes this year — and strained geopolitical relations are reasons enough for investors to switch to a risk-averse posture or stay on the sidelines. At home, choppy public markets and the consequent hammering of tech stocks have hurt sentiment across the board, raising questions around the high valuations of start-ups. Consider this: Paytm’s stock price has plummeted 71% since its D-Street debut in November last year. “The global economic outlook is uncertain at this point. War, inflation, high fuel prices, and the supply chain crisis are creating a bit of a storm, which is reflecting in stock prices across the globe. This affects start-ups as investments in this asset class are driven by sentiment to a much greater degree than in other cash-generating assets,” says Ritesh Banglani, partner, Stellaris Venture Partners.

Feeling The Pinch

Late stage- and growth-stage start-ups are expected to bear much of the brunt. To be sure, exposure of late-stage start-ups to global investors is higher. In fact, according to analysts, most investors at that stage do not even have India-dedicated funds. “We were seeing a lot of non-traditional VC money coming into the market like hedge funds, corporate venture capital... all such companies will now be on the sidelines waiting and watching how the market plays out,” says Sanjay Mehta, founder and partner at 100X.VC. “If I were to take a bet on the future, I see winter coming for start-ups in the series B or C bracket and onwards,” he adds. A series defines different stages of start-up financing; they are usually categorised alphabetically — pre-series A would imply early stage financing while series C is largely growth-stage financing. Besides, the broader investor narrative has shifted from deal making to portfolio management. “VCs are now talking about the path to profitability and urging portfolio companies to look at the same,” says Mehta.

Focus On Profitability

And it is not difficult to see why. It has to do with more than just the subdued macro environment. The last one and a half years were marked by a deals blitzkrieg. Consider Byju’s which has been on a fundraising spree, adding over $2 billion alone to its kitty since the onset of the pandemic and taking its valuation to $22 billion from just about $8 billion in January 2020. Investors now want to see how much of the investments have actually translated into growth. “Some of these businesses will have to show their performance before they raise more rounds of capital. Negotiations (between investors and founders) will become tougher, metrics will be seen more stringently,” says Madhur Singhal, managing partner and CEO at Praxis Global Alliance. Most importantly, the flow of capital will become selective and only strong ideas will get investor backing. As a matter of fact, the business models of start-ups have often come under the scanner. Take for instance Blinkit (formerly Grofers). The e-grocer’s pivot to a 10-minute delivery model seems to have hit a road bump, and Zomato had to extend it a loan of up to $150 million to stay afloat. The start-up has reportedly laid off employees, shut dark stores and delayed vendor payments. An industry expert says Blinkit lost money on every order post its shift to a quick commerce model. “Business models of many start-ups are flawed. Some do not even have a real business,” says an analyst who did not wish to be named.

The bigger concern is the ability of highly funded businesses to continue funding cash burn. “They will need to cut burn substantially if they are unable to raise money or raise smaller rounds. This may result in job losses or smaller salary raises,” says Stellaris’ Banglani.

There is another perspective at play within the start-up ecosystem and that needs to be factored in while assessing the fund flow. As the physical world increasingly opens up amid an improving Covid situation, it may eat into the share of digital. “Digital is here to stay but what could change is the growth rate. As people start going to the malls, online sales will decline and growth rates will be impacted. The FOMO has gone away,” says Atit Danak, principal & head, CoNXT practice at Zinnov. Also, the competitive landscape has undergone a sea change with the entry of deep-pocketed players like The Tata Group and Reliance. It is a very different market environment now. It is not about bringing customers online but more about market share gain, says Singhal. “Investors now have a better bargaining power and they will use it to rationalise the valuations,” says Danak.

The IPO Conundrum

It will be difficult times ahead for start-ups aspiring to provide investors exits via IPOs. Zomato’s over ₹9,000-crore IPO launched in July last year, which received a stellar response from D-Street, was almost like a playbook for many fledgling firms, encouraging more start-ups to cement their IPO ambitions.

Even as start-ups, including Byju’s and Swiggy, are chalking out their IPO blueprint, the current instability of the markets has raised concerns over their feasibility. Already, firms such as Mobikwik, Delhivery and PharmEasy, which had secured Sebi nod for their IPOs, are revisiting their timelines. Some like Oyo are looking to trim their issue size.

“There would be huge challenges now to get a start-up IPO done in India. Market sentiment has changed and companies are unlikely to find favour with retail investors,” says Mehta. Consequently, late-stage VCs which typically write large-sized cheques for start-ups and who corner the bulk of the returns from an exit may not have the appetite to infuse sizeable capital. “For any VC firm, the most palatable way to find an exit would be via IPOs of their portfolio companies. It would not be prudent for late-stage investors to bet large sums of money at high valuations if they are unable to find an exit via IPO,” say analysts.

Looking ahead, the PE/VC market in India will enter a different zone with rising interest rates and inflationary pressures, and potentially hawkish monetary policies, according to a recent EY-IVCA report. “This is likely to impact valuation multiples that have been on a record high over the past year and may see some downward revision in the over-heated segments,” it added.

Analysts, however, expect seed and early stage funding to continue at the same pace on the back of a widening pool of investors spanning family offices and angel investors. “When betting on an early stage start-up, investors only look at its potential. Early stage is still in demand,” says Rema Subramanian, co-founder and managing partner at Ankur Capital.

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