For startups, the silver lining to funding cloud

The winter that startups were dreading in mid-2020 hit them in the April-June quarter. VC funding dropped by about 40% as the Russia-Ukraine war continued, central banks tightened money supply and public markets lost appetite for tech stocks. Indian unicorns that went public in 2021 with fanfare saw their stock prices plunge. The number of mergers and acquisitions—another exit route for VCs—fell to 54 during the quarter, against above 100 in each of the two previous quarters, according to Venture Intelligence.

Startups are responding by tightening their belts. They are paring joining bonuses and offers of stock options for new employees, and reducing pay hikes and notice periods for existing ones. Unacademy, an edtech startup, hit the headlines after it stopped business-class travel for top management and free lunch for all employees. But between March and June this year, it also pruned its workforce by 1,150 employees, or 16.5% of its total. According to data compiled by Inc42, Indian startups fired over 11,360 employees in 2022, led by edtech companies, which accounted for 35% of all layoffs in the startup space.

Wide-ranging impact

Such concentration is common in the VC-funded startup segment. In the June quarter, 79% of all VC funding went to just five sectors: fintech, software as a service (SaaS), media and entertainment, logistics and autotech, and direct to consumer (D2C). However, there was a drop in funding in nine of the 12 segments, the exceptions being fintech, media and entertainment, and B2C e-commerce.

The biggest drop—of about $1.7 billion, or 50%—was in the SaaS sector. It reflects the fortunes of Freshworks, the poster boy of the Indian SaaS industry and whose share price has tumbled 73% over its listing price. Fintech, the second biggest recipient of VC funding in Q2, saw inflows inch up by about 2%. However, the sector is also facing more intense regulatory scrutiny. In June, the Reserve Bank of India said prepaid instruments such as wallets cannot use credit lines issued by non-bank lenders. This will impact the buy now pay later (BNPL) segment, as expected.

Smaller ticket size

The change in sentiment towards startups is in sharp contrast to prospects of Indian startups in 2021. The sector was drawing greater attention from international VCs, partly driven by the Chinese crackdown on its own startups. The series of IPOs in India opened another exit route. Softbank invested over $2 billion in India last year alone. Temasek invested in 20 companies, its highest ever in the country.

Of the 48 startups that turned into unicorns last year, 22 had received investments from Tiger Global. Last year, Tiger deployed $2.3 billion across 62 deals. In a recent report, Silicon Valley Bank noted that “crossover investors are reevaluating their private market strategy, for instance, Tiger is investing in more early-stage deals”. show growth, albeit on a small base. The average deal size dropped to $23 million, from over $30 million in each of the four previous quarters.

silver lining

The length of this funding winter will depend on multiple macroeconomic factors, including the Ukraine war, inflationary pressures in Western economies, monetary policy, and the recovery of the US’ tech sector, which has also seen layoffs. However, investments are unlikely to dry out.

In its State of the Market report, Silicon Valley Bank estimates that VC funding for 2022 in India will close at $31 billion—lower than in 2021, but higher than in any of the preceding years. Similarly, it adds, the size of India-focused VC and PE funds has already crossed $14.1 billion, over three times more than all of 2021. Even in fintech, while the BNPL segment has been hit by regulatory measures, other segments such as insuretech are optimistic. What has changed is that startups have also turned their attention to efficiency and cost. It could help them in the long run.

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