The billions turned into the millions as the funding environment for startups fell from the peak of 2021 to a more subdued situation in 2022. Total venture capital funding in July this year captures the decline as it was located at $652.7 million vs. $2.7 billion in June.
The year 2021 has seen an influx of capital into Indian startups, with $38 billion flowing into the ecosystem, and the emergence of more 40 unicorns. It was also a time when venture capitalists were struggling with FOMO (fear of missing out).
Recounting those days, a venture capitalist, speaking on condition of anonymity, said: “There have been deals that were done in three days when due diligence for a seed investment takes at least three to four weeks.”
Now there has been a complete turnaround, with a sharp drop in funding in July. This trend should continue at least for the rest of the year. In this scenario, startups become cautious by limiting expenses and cutting costs with job cuts. They also struggle to raise fresh capital.
Venky Harinarayan, Partner, Rocketship.vc says, “Now capital is scarce, the bar for investors is higher. We are in transition now and it is hard to say where this will settle.
In this context, investors’ priorities and their approach to financing startups have changed. Your story spoke to a cross section of venture capitalists to understand key current and future trends.
July 2022 saw a sharp drop in venture capital inflows
Closing deals takes time
During the 2021 funding boom period, seed deals were closing within days as FOMO was in play. Now, a sense of normalcy has set in, with early-stage deals, especially in the category of angels, taking about a month. Growth-stage deals, which involve larger sums of money, take months to close. Essentially, the focus is on thorough startup due diligence.
Adith Podhar, Founder of Gemba Capital, says: “There is no more FOMO among investors, which was noticeable in 2021, and they are in no rush to close the cycle. Moreover, there is no pressure on them to conclude a certain number of transactions.
Focus on seed funding
The funding winter hasn’t dampened the flow of capital to early-stage startups, as investors continue to bet on innovative companies, rather than pass up opportunities. It is expected that once the tide turns, investors will have a better chance of success.
Ankur Mittal, co-founder of Inflection Point Ventures, an angel investment platform, says, “Rapid expansion and scaling of first-generation startups has happened in 2021, and investors and the broader ecosystem were generally positive. 2022 has seen some high quality deals, although fewer, showing a strong post-COVID-19 recovery. High-quality startups have further aroused investor interest.
Growth-stage startups, especially those in the Series A category and above, will have a harder time raising funds as it would involve larger sums of money.
The funding boom of 2021 was all about focusing on a startup’s growth metrics, but now the focus is on sustainability. Questions are asked about how to burn cash, the path to profitability, and building a long-term sustainable business. Previously, it was about growing at all costs, which naturally led to spending large sums on acquiring customers in order to gain market share.
Also, given the easy access to capital in 2021, startups haven’t really focused on conserving cash. Today it is about extending the track in terms of the amount of money in the bank account, so that it can last at least two quarters.
V Balakrishnan, co-founder of Exfinity Venture Partners, said: “B2C startups could see a reassessment of their valuations and there could be more emphasis on their business model. B2B startups seem to be relatively stable given their low cash burn.
Startups may now have to raise capital at a reduced valuation or flat round. This will lead to a revaluation in the valuation of startups, especially growth-stage startups. It is also a backlash from the correction taking place on the public markets. Valuations in some segments, which were typically calculated at 40 times startup revenue, may not be achievable at this time.
The pessimistic economic environment of 2022 has upended the type of interaction founders have with their investors. In 2021, founders had something of an advantage over FOMO-driven investors. Now, founders need the support of their existing investors to better navigate the current environment. This could mean urgent additional capital to overcome the crisis.
Amit Kumar, Partner, ah! Venture Partners, an early-stage angel investment platform, says, “Startups are now considering bridge funding to expand their runway and would consider large capital raises once demand returns.”
Quality of founders
The quality of a startup and the founder now makes all the difference for the investment community. It used to be that many me-too startups received funding, but that may not be the case anymore with the scarcity of capital. Only those with the right references are funded now. With increasing emphasis on the due diligence process, the bar has certainly become higher for founders to secure funding in the current environment.
Total venture capital funding in July this year was $652.7 million, down from $2.7 billion in June.
Question marks on exits
The current environment makes it difficult for startups and investors to get an exit. The rich valuations of 2021 are unlikely to be the benchmark now. This means that founders will have to bide their time before embarking on their next funding round, as any step in this direction will involve raising capital at a reduced valuation, which would not be suitable for existing investors and founders. This could lead to mismatched valuations and failed M&A deals.
Balakrishnan of Exfinity Venture Partners believes that there could be a correction in the net asset value of VCs in terms of seed investments next year.
Investment in new areas
Opinions are mixed on how the investments will play out, especially with the negative developments in areas such as cryptocurrency and NFTs. Some investors believe investment in these areas will decline while others believe it will continue.
Ankur of Inflection Point Ventures says, “A number of technologies have generated interest in 2022, including NFT and blockchain. Despite all their uncertainties, entrepreneurs are exploring them and investors are increasingly interested in them.
Despite the so-called funding winter, the medium to long-term story of the Indian startup ecosystem remains very strong. The current situation is unlikely to last long, and things are expected to start reversing early next year, if not sooner, although the 2021 boom may not be seen. .
Adith of Gemba Capital said: “Dealing activity is picking up on the side of investors, after their first step back. There is enough dry powder available in terms of capital.
(The story has been updated to correct a typo.)