Funding Winter Propelling Founders To Diversify Capital Stack with Alternative Financing: Startup Pulse 2023

Delhi-based Recur Club has unveiled the first edition of Startup Pulse, an annual report to provide insights about the Indian start-up and funding scenario to founders and business owners across India. The company has claimed that the report is based on data assimilated by Recur Club from multiple sources including an online survey of approximately 200 founders conducted in 2022. Along with these founders, the company spoke to the founders from MeitY (Ministry of Electronics and Information Technology) Startup Hub and other VC-funded start-ups.  It also took insights from the survey of 40 investors in India by InfoEdge Ventures as a part of its "Winning in tough times" report in October 2022. 

Macroeconomic Changes in 2022

According to the report, the global start-up ecosystem saw a significant course correction in 2022, receiving around $24 billion in equity capital, down from a record $42 billion in 2021. With growing concerns about rising inflation and the cost of capital, slowing down of the global economy, spectacular fall in valuations of public tech companies, and uncertainties caused by geopolitical tensions, investors turned cautious and investment activity largely muted in 2022.

Massive layoffs and declining funding as a result of a collapse in the global stock market and the ensuing liquidity crisis also heralded the arrival of the "funding winter” in India. But despite a downturn in growth-stage financing, the year witnessed a sharp rise in angel investments, especially in the retail sector, with a stronger emphasis on value-based investments than rapid growth.

Challenges Faced by the Indian Start-up Ecosystem

Startup Pulse 2023 suggests that 57 per cent of the founders were constrained by limited access to relevant investors; also 51 per cent of these founders faced challenges of lack of urgency among investors and indefinite wait periods. This impacted the growth of digital enterprises across sectors such as D2C (direct-to-consumer), B2B (business-to-business) tech platforms, and tech services, with median revenue growth decreasing from 103 per cent in 2021 to 48 per cent in 2022. Property tech (comprising co-working/co-living business) and SaaS businesses were, however, notable exceptions, and managed to largely maintain their growth velocity and stability in these testing times. Startups across all stages were impacted by a dip in their growth rate, with SMBs (Small and Medium Businesses) with ARRs under Rs 10 crore taking the biggest hits. 

Adapting to the Changing Times

Raising equity capital was a major challenge in 2022 as VCs became increasingly selective and prioritized sustainable growth over fast deployment and high rates of growth. According to data from Startup Pulse 2023, only 17 per cent of founders were able to raise the additional capital that they required in 2022.

Founders adapted to this by concentrating on slower but more effective expansion to maintain improved unit economics. To mitigate the effects of the economic downturn of 2022, more than 60 per cent of the founders turned to increase their overall efficiencies. 37 per cent founders cut their CAC,  general and administrative costs. There was also an increase in median ARR (annual recurring revenue) per employee (from Rs 17.1 lacs to Rs 18.6 lacs). As the founders’ emphasis moved to enhance margins and cash flows, median growth decreased from 103 per cent to 48 per cent

Businesses Still Confident to Build in India

The report has claimed that despite the global slowdown, India maintained itself as one of the biggest global economies with the quickest growth rate on a large scale. IMF's most recent projections predict India's GDP to grow at 6.9%, outpacing the developed economies. India’s economy is seeing increasing formalization, with the number of businesses paying GST increasing dramatically from 8 million in 2017 to 14 million in 2022. This echoes the growing demand in the Indian market and attest that the Indian economy is well-equipped to handle external challenges. 

The country has a rich and vibrant start-up ecosystem with 58,000 tech start-ups, out of which 108 are unicorn businesses. This start-up ecosystem represents a total investment of $136 billion backed by almost 9,600 investors. The Indian government has also consistently made sustained efforts to support the startup ecosystem.

As per the report, Indian founders have endorsed their confidence in the growing Indian economy, with a staggering 81 per cent of founders confident that they can accelerate their business growth in 2023, with SaaS, co-working, and tech services firms being the most optimistic. The downsizing of 18,000 employees by 52 Indian startups in 2022 has resulted in a reduction of expenses and a surplus of tech talent, leaving a positive impact for the founders. Bullish about their prospects, 76% of founders are not looking to decrease their CAC or G&A spending in 2023. However, given their concerns with the fundraising, many are opening up to new sources of capital to fuel their growth. 

Impending Rise of Alternative Financing in India

Though 44 per cent of founders ranked equity financing as their preferred source of raising capital, 60 per cent recognized that it would not be easier to raise equity capital in 2023. The further dampening of the equity market provided an unprecedented opportunity for debt and alternative financing to take root in India last year.  

The report has also highlighted that the funding winter has propelled Indian entrepreneurs to diversify their capital stack and emphatically respond to alternative financing options which provide quick and adaptable financing without any equity dilution. Founders are also recognising the value of optimising their capital stack with the optimum amount of debt to reduce their cost of capital.

The report has stated that the Indian venture capital ecosystem witnessed a surge in the growth of Debt and Alternative Financing methods, verified by Recur Club's survey, which estimates that 14 per cent of entrepreneurs will choose alternative financing sources as their most preferred source of raising capital in 2023. In the coming years, the Indian VC ecosystem will experience considerable expansion and breaking of several stereotypes, especially for asset-light companies. Debt and alternative finance will be essential to fostering this growth and new funding paradigm.