Financial markets, public or private, go through their cycles, the peaks and the troughs. The recent Russia-Ukraine war, energy supply, depreciating GBP/EUR, rising inflation etc to name a few issues have resulted in a risk of recession and a rising interest rate environment. The cost of capital has thus increased, and investors are wary to deploy capital as they were doing earlier. All in all, we have reached a situation not too great for startups, early or late stage. Looking at the last couple of quarters gives a clearer picture. There has been a downward trend in the funding amount as well as the number of startups getting funded.
Having said this, markets will always have their cycles, whether it was 2008-10 or even 2016 when funding levels dropped. While today we are in a downward cycle, the questions that come to our mind are, when do we see this winter? What do startups do till then?
One important aspect to consider is there have been record amounts of money raised by funds globally and in India too. In the US this year in H1 2022, Venture Capital (VC) firms have raised an amount equal to what they raised in all of 2021. In India, in just H1 2022 VC funds raised $14.1 bn (this is more than 3X of the 2021 number for perspective). What this means is there is a lot “dry powder”, ie funds waiting to be deployed.
Venture capital money is “patient money”, it will wait for the right opportunities to deploy.
Putting all this together, depending on the sector and the stage of the startup, we will see it playing out differently. Late-stage startups are typically seeing internal rounds, given that IPO is a much sought-after route for existing investors. Given the track record of recent IPOs and subsequent share prices, there wouldn’t be a rush to get an exit via IPOs by late-stage startups. This sub-segment could be the most affected. Sustainably riding out this “winter” period would be of paramount importance.
“While VC money is patient money, what is likely to happen is that there will be the deployment of capital since they will be under pressure to generate returns for their investors”
Hence, one would see layoffs, re-alignment of business plans, projects and a rapid alignment towards getting EBIDTA positive/profitability of the business. All in all, a recipe to cut down the burn rate and extend the runway.
Startups in the early stage, seed/Series A, would also see changes. While there is a lot of “dry powder” certain sectors would find it easier to get funding than others. The reason for this could be two-fold, the positive/negative outlook on the sector, and the other being that in some sectors that received high volumes of funding in the last 2 years, many VC firms have already taken their bets and not made fresh ones.
Startups in the Series A/B/C segment could see bridge funding or flat rounds since sustenance would be key. Startups have already started cutting down marketing budgets and rationalizing workforce to ensure that they ride out this lull period. While VC money is patient money, what is likely to happen is that there will be the deployment of capital since they will be under pressure to generate returns for their investors. Having said that the metrics for evaluation may change, from growth at any cost, the evaluation metric will change to growth with good profitability/business metrics.
VC Funds would search for good deals (startups), and take their own time in making good decisions and getting good quality companies in their portfolio. They would also, reserve funds for the existing portfolio companies to ensure they sail through too in this period. Also, consolidation and M&A activity would continue to pick up.
Sectors where a large volume of similar startups exist would see some falling off due to the inability to raise funds or getting acquired by larger players.
Having said this, it’s also known that unicorns or even high-quality start-ups are made in tough times. VCs have been in this business for decades and know this. While VCs would do stricter checks and metrics of evaluation would be more stringent, good quality start-ups will continue to get funded. It’s important for startups to re-align to this and ride out the tough period. For those who make it out, we are sure they would be high-quality with good business metrics.
(The author is the founder and CEO at PurpleTutor)