Cautious Investors Reserving Cash To Support Late-Stage Start-Ups

Winter is coming–that was Ned Stark's ominous warning to his clan in the first episode of the 'Game of Thrones' series. Late-stage start-up founders could do well to heed this warning too. 

In its July 2022 cover story, Outlook Business states that in April and May 2022, Indian start-ups raised $2.92 billion against $4.07 billion in the same period last year. The number of deals has seen a month-on-month decline since January 2022—from 124 deals in the beginning of the year to 87 in May. In comparison, the total number of funding deals stood at 1,128 in 2021. 

A recent Economic Times report corroborates this. Citing data from research firm Venture Intelligence, it claimed that Venture Capital (VC) funding into Indian start-ups dipped 37% in the second quarter of this year to $6.9 billion, while overall investments into start-ups in the first quarter were $11 billion. For the year's first half, the overall investments stood at $17.9 billion, a 36% increase from the same period last year.

Several start-ups are gasping for breath as VCs turn the funding tap off. However, this was not an unexpected move, as per experts quoted in Outlook Business' July 2022 cover story.

According to Kunal Chowdhry, CEO of Apollo Singapore Investments, a Singapore-based investment firm, the funding winter for start-ups is purely a result of overly accommodative central bank policies during the first Covid-19 wave in 2020, which resulted in trillions of dollars of liquidity being pushed into the system. "This eventually led to an increase in real asset prices. With inflation now running out of control, the 'easy money tap has been firmly turned off ... and interest rates are rising rapidly. More importantly, the overall market sentiment has soured," he says.

Going Gets Tougher For Late-Stage Start-Ups

According to the Venture Intelligence report, funding for early-stage start-ups dipped marginally from $856 million in the January-March quarter to $839 million in the April-June period. 

However, investors are reexamining their valuations and approach to late-stage rounds, especially after the poor IPO performance of some recent start-ups, including unicorns like Nykaa and Paytm.  

The Venture Intelligence data showed 19 funding rounds of $100 million or more in the second quarter of this year. This cumulatively amounted to $3.6 billion, compared to 29 similar deals worth $6.7 billion this year's January-March period, Economic Times reported.

Talking to Outlook Business, Sri Purisai, Founder and General Partner, Rico Capital, a Silicon Valley-based VC firm explains, "The overall worldwide macro-economic shift and its effect on public markets has impacted valuation of later-stage portfolio companies and made exits hard to come by for investors, leaving them with a fund flow problem. This is typically true for all investments made in Series B onwards. Investors are now being cautious and, in some cases, may not lead rounds but could explore it with other investors to de-risk investment." 

Aware that they have the luxury of time on their side, cautious late-stage investors are in no hurry to rush into any fiscal deals. Instead, they are spending ample time renegotiating valuations and reserving cash or keeping a large part of "dry powder" to support late-stage start-ups. "VCs are first doing an internal portfolio review to see which of their portfolio companies need their support in the next 12 months because even they do not want to go for a down round," says Amit Nawka, partner, deals and start-ups leader, PwC India.

In the Outlook Business Cover Story, financial experts suggest that VCs will continue to be active, but with caution, despite the downturn, as focus shifts from valuation to profitability. "The business model will have to be significantly better than the peers in the sector, focus on unit economic with low cash burn, [be executed by] founders with 10 to 12 years of work experience and [be backed by] the technology stack," says Aparajit Bhandarkar, Partner, Varanium Capital.