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Investment in Indian startups in the first six months of 2023 is the lowest in four years. Here's why
According to the investors, the early-stage investments are still happening, but the late-stage investments have slowed down. Things are expected to get better in 2024
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Two years ago was a great time for Indian startups. But funding came to a standstill in the second half of 2022. With each passing month, the funding crisis in India appears to be getting starker. Despite the significant dry powder reserved for Indian startups, the ecosystem reported the lowest six-month funding trends in the last four years during H1CY23 (January–June) at $3.8 billion across 298 deals. According to the PwC India findings, this is a decline of nearly 36 percent as compared to H2 CY22 ($5.9 billion).
During the last few quarters, investors have supported startups that are showing good growth but have decided to stay away from inducting new investors due to adverse market conditions. However, there has been an increase in due diligence being carried out by investors before making investments, both in terms of detailing and coverage (from typical finance and legal to now covering technology, HR, and business processes). These are driven by the recent financial misreporting issues that have come to light and market conditions when investors are able to perform thorough due diligence to differentiate between startups and make more informed investment decisions, as the study highlighted.
A funding winter is just a season in a startup’s journey. There is a slowdown in startup funding despite significant untapped capital reserves held by venture capitalists (VCs), according to Amit Nawka, partner, deals, and India startups leader, PwC India. "Active VC firms in India have secured new funds in the past year, and we can expect the pace of investments to pick up in the next few months."
Software as a Service (SaaS), direct to consumer (D2C), and fintech are currently the top sectors in terms of attracting investments. In H1 CY23, funding for growth and late-stage deals contributed to 84 percent (in terms of deal value) and 43 percent (in terms of deal count) of the total funding activity. Additionally, 80 merger and acquisition (M&A) deals involving startups were executed in this period. Of these, 80 percent were domestic transactions, and the rest were cross-border transactions.
Forbes India connected with some investors to understand the reason behind the funding drought and how long it is expected to last.
The slowdown in funding is not because there is a funding crisis, but purely because the funding ecosystem has slowed down compared to 2021, which was a blue-bird year. The slowdown has happened because a lot of companies that have raised money are seeing huge governance issues, explains Padmaja Ruparel, co-founder, Indian Angel Network. These are large companies and late-stage startups that are clearly not building the bottom line. They kept building their businesses on cash raised as equity or even debt, for that matter. "We at IAN have been very diligent about this. We've always invested in only two business models: Those that build the top line as well as the bottom line. Companies have to be on a path to profitability, be sustainable, and create profits at some point, and very soon. So when they raise money from us as early-stage companies, they may be at a loss, but they completely have to be on a path to profitability. And for such businesses, their parameters are very clear: Eye on the cash flow, contribution margins, unit economics, and gross margins."
Also Read: From the sunshine of early-stage funding to damp unicorn runs, numbers unfurl the story of funding winter
Also Read: From the sunshine of early-stage funding to damp unicorn runs, numbers unfurl the story of funding winter
A lot of the drop has been spurred by the decline in late-growth startups. For instance, Tiger Global has reduced its investment. Even SoftBank, which used to invest large funds in growth-stage startups, has reduced its investment in India, explains Sajith Pai, a venture capitalist at Blume Ventures.
According to the report from Moneycontrol, for the first time since 2014, SoftBank has not made any investments in India in the first six months of this year. Even Tiger Global has recorded its lowest deal count in the past five years, resulting in one of the worst funding periods for the world's third-largest startup ecosystem.
"Because of this, the entire growth market is frozen. And that is fundamentally leading to this drop. The impact on early-stage startups has not been significant. Of course, it's come down from the buzzy, bubbly days. At Blume, we're not doing deals at the same speed as we were earlier. But no one has stopped doing deals, and for good companies, the valuations are pretty much the same," adds Pai.
The slowdown in funding is mainly due to inflation in the economy, which has impacted enterprise value. Due to a drop in valuation, the enterprises are unable to raise a significant up-round in spite of a lot of dry powder available, explains Anil Joshi, founder and managing partner at Unicorn India Ventures. “Considering the current economic situation, most global investors have marked down their portfolio values, impacting overall sentiment, and with down rounds getting reported, many startups have worked on unit economies to sustain their current run rate. Everyone is waiting for the upliftment of the economy so that the investments can be at better numbers than what are being offered currently. I expect this trend to continue for some time. Also, considering the governance issue, the due diligence cycles have increased. However, it has more to do with post-investment than pre-investment. And hence, investors need to work on a post-investment scenario rather than a pre-investment scenario,” he says.
Deals are happening, but they're in the slow lane. This is more applicable to late-stage or growth stage investments, compared to early-stage investments that are still happening. "We expect things to be better in 2024. From a fund perspective, we are quite bullish on the India story and expect to do 20–25 investments from the new fund," concludes Joshi.
