Funding Winter

A) Meaning:

-Funding winter refers to a period of market correction in capital inflow which lowers the probability of startups getting higher valuations in short to mid term. Simply put, founders find it difficult to raise funding & achieve sky-high valuations.?

-A fund crunch spells bad news for startups that focus on customer acquisition instead of profitability with no clear business model thereby leading to mass terminations, cost-cuttings & in worst cases, shutting shop.?

B) Causes:

-In a bid to stimulate economy post-pandemic, global central banks nurtured low-interest-rate environment. This led to massive capital influx in VC & PE industry ultimately leading to funding boom & ‘hyper’ valuations for Indian startups.?

-VCs shared readily available capital pie with founders who prioritised quick expansion over profitability. In order to achieve near-impossible targets, startups mass-hired employees at inflated packages. Such conditions inevitably brewed a bitter mixture of cash burn & caused a low-key talent war.

Cut to 2022,

-Because of then prevailing macroeconomic & geopolitical conditions that drove inflation, commodity prices & interest rates, we saw market slowdown & economic volatility that led to a dip in funding .

-Many VC firms closed new funds & continued to invest in the existing ones.?

-In response to the scenario, VC sentiment turned conservative & they are now negotiating valuations, asking tough questions about profitability &, in some cases, preferring follow-on rounds to taking new bets.

-Dismal performance of IPOs was also one of the factors contributing to the nervousness amongst investors.?IPOs of startup giants such as Paytm, Nykaa etc have been less than optimistic as their value plummeted in public market.

C) Impact:?

-Smaller paychecks & multiple funding rounds: Founders looking to raise capital are noticing delays & renegotiations resulting in multiple rounds of funding with smaller valuations.?

-IPO frenzy to slow down: Around 15 startups intended to go public in FY 2022-23. Industry giants like Oyo & Byju’s are now deferring their IPO plans, others are expected to follow suit.?In addition, smaller companies such as Lido Learning, Udayy & Vauld have shutdown operations as they have struggled to raise funds in ongoing downturn.?

-More M&A and consolidation activity: Funding winter has created a unique opportunity for mature startups to expand their product offerings by acquiring companies that haven’t been able to raise funding.??Around 54 M&A transactions were executed recently. The largest deals were in foodtech space, including Zomato’s acquisition of Blinkit & Swiggy’s acquisition of Dineout. We expect consolidation & buyouts to increase, given the broader correction in the funding market.

-Positive Impact:?

-Smaller startups are seeing growth in their businesses as?larger startups which were spending large amounts on marketing aspects are currently constrained by the funding winter.

-Early stage investing is relatively less impacted especially for those startups with deep technology.

-On the other hand, funding winter is also helping the larger startups to re-organise themselves and relook their business models. Marketing spends are becoming smarter and personalised; there is renewed focus on cost of acquisition (CAC) of customers . Large teams are being reviewed frequently for more efficiency and efficacy. This is helping start-ups to strive for the execution stage from the idea stage.

D) Strategies to cope with funding constrained environment:?

-Balanced focus on growth & profitability;

-Emphasize on market fitness of the product than being an early player in a sector;

-Target cash optimisation in business processes(efficient working capital mgmt., sticking to tried & tested marketing strategies, etc)

- Well funded companies are also resorting to lay offs, cutting down employee incentive, delaying appraisals, deferring campus recruitment, etc.

E) How long will this last & will it end the Start-up rush in India?

-It is predicted that funding winter might yet last for 12-24 months until economic volatility reduces.

-The funding slowdown has normalised high valuations & fund sizes raised by start-ups in 2021. Investors see this as a sign of sanity returning to the market & predict that stronger, sustainable businesses will emerge from these times.

-Even though next few months will be difficult for Indian startups to raise funding, it is not all doom & gloom.?

-VC firms have enough dry powder(cash kept in reserve to be deployed) to fund startups that obsess over their customer-market fit & clear path to profitability. Those who have been funded & are in need of a fresh round will have to face greater scrutiny on sustainability. The ones that are at the growth stage may have to settle for a lower valuation.?

-Kejriwal of Kedaara Capital explained, “We have a plethora of new capital coming into India- Large LPs had 80% of their portfolio in China earlier. Their asset allocation has changed from 80-20 to 50-50. They have moved to a China+1 strategy & India is benefiting from that.”?