By Priyadarshi Nanu Pany
Just a few months ago, start-ups were the apple of investors’ eyes. Raising funds was easy and closing deals just as fast. India, the third largest start-up ecosystem after the United States and China, has hit a unicorn almost every week. But a tsunami of global headwinds rattled the shores that supported cash-intensive start-ups. The days of blockbuster fundraising are over. The once plentiful cash in the hands of big venture capitalists is now draining fast. Enter the era of runaway inflation and skyrocketing interest rates in the United States – they are having a negative impact on start-up financing. Add to that the Russian-Ukrainian conflict and the prices of ballistic energy, and you realize that the crisis has reached its crescendo. Sentiment in the startup community, however, is muted as the bull run has turned into a bear gait.
In a changing landscape, bags of money have become circumspect. Sequoia Capital, which has invested in 30 unicorns in India, including Byju’s, has advised its beneficiary companies to tighten their belts as investors reduce their investments in public and private markets and instead place funds in bonds. Market intelligence firm CB Insights reported that venture capital funding for India-based start-ups fell to $3.6 billion in the second quarter of 2022 from $8 billion in the first quarter and over $10 billion a year ago.
In 2022, five of the top five venture capital deals by start-ups were led by sovereign wealth funds and pension funds, such as the Ontario Teachers’ Pension Plan, the Pension Plan Investment Authority and the Qatar Investment Authority. Private equity (PE) and venture capital (VC) firms are now in the back seat. SoftBank Group and Tiger Global, both of which have been aggressive investors in Indian start-ups, said they would slow investment this year.
The scenario has settled into a vicious cycle – cost cutting, falling business metrics, low investor interest and talent drain. Predictably, startups are taking knee-jerk action: shutting down nonessential verticals, laying off employees, cutting vanity marketing spend, and freezing hiring. According to layoff tracker Inc42, more than 11,000 employees were laid off in the first six months of this year. Industry watchers expect more cutbacks as mature and growth-stage start-ups will struggle to raise funds.
Indian start-ups have sunk into a shortage of funds. Industry estimates say they need $10-15 billion over the next six months, but only $2-4 billion is available. VCs have grown wary and vigilant after losing millions of dollars in tech stocks that suffered market carnage.
The days of due diligence are over. Investors will be looking for strong business fundamentals before writing checks for startups. The propensity for financing will be stronger for early-stage start-ups with lower valuations. Growth-stage startups need to tighten their frugal belts. Their founders must now prioritize stronger unit economics, lower cash burn and streamlined customer acquisition costs. Talent acquisition for them will be tricky as these start-ups will struggle to distribute high-end BMW bikes and ESoPs or reimburse their employees for exotic vacations. Startups can survive the funding winter by learning to survive on leaner budgets. Cutting fat and burning cash must be at the top of their agenda. Until this cycle of shortage of funds is reversed, start-ups will have to expand their track. The start-up can be a safe bet in a context of lack of external financing. And, to withstand heightened investor scrutiny, start-ups need to get back to business fundamentals: establishing transparent and resilient business models, strengthening corporate governance, charting a clear path to profitability, and foregoing obscure business practices.
Funding is key to fueling the growth of start-ups. As markets around the world are facing a shortage of liquidity, debt financing has become crucial to meet working capital needs. A gratifying trend is that start-ups are tapping into risky debt – an alternative source of capital. India Venture Debt Report 2022 reports that seed funding through venture capital debt has nearly doubled in the past year. This trend is expected to continue to lessen the reliance of Indian start-ups on PEs and VCs. Another encouraging factor for start-ups is the “Fund of Funds” initiative under the “Start-up India Programme”. It acts as a multi-manager investment fund and helps startups by reducing the risk of investing in bonds, stocks, and other types of securities. The initial corpus of Rs 10,000 crore can be increased by the government given the proliferation of start-ups and existing fundraising challenges.
India is home to 103 unicorns with a total valuation of $335.80 billion (Source: Invest India as of June 29, 2022). This is a compelling growth story of entrepreneurial innovation and job creation. This funding winter can be a cyclical phenomenon. Nevertheless, it has lessons of caution and introspection for start-ups. Start-ups should not give up the edge and advantage gained over the years. The challenge is not just to survive this winter, but to stay nimble and navigate the seasons to come.
(The author is the founder and CEO of CSM Technologies. Opinions expressed are personal)