No more FOMO, as VCs approach startup funding with new metrics and priorities
The billions have turned into millions as the startup funding environment has come down from the high of 2021 to a more subdued situation in 2022. The total venture capital funding in July this year captures the decline, as it stood at $652.7 million compared to $2.7 billion in June.
The year 2021 witnessed a flood of capital into Indian startups, with $38 billion flowing into the ecosystem, and the emergence of more than 40 unicorns. It was also a period when venture capitalists were gripped with FOMO (fear of missing out).
Recounting those days, a venture capitalist, on condition of anonymity, said, "There were deals which were closed in three days when due diligence for a seed investment takes a minimum of three to four weeks."
Now there has been a complete turnaround in the situation, with a steep drop in funding in July. This trend is likely to continue at least for the rest of the year. In this scenario, startups are turning cautious with curbs on spending and trimming costs with job cuts. They are also finding it difficult to raise fresh capital.
Venky Harinarayan, Partner, Rocketship.vc says, “Now capital is scarce with investor bar being higher. We are in transition now and it is hard to say where it will settle.”
Given this environment, the priorities of investors and their approach to the funding of startups have changed. YourStory spoke to a cross-section of venture capitalists to understand the key trends now and going forward.
July 2022 saw a steep drop in venture capital inflow
Deal closures are taking time
During the funding boom time of 2021, startup deals used to close in a matter of days as there was the FOMO factor at play. Now a sense of normalcy has set in, with early-stage deals, especially in the angel category, taking a month or so. Growth-stage deals, which involve larger sums of money, are taking months to close. In essence, the emphasis is on thorough due diligence of startups.
Adith Podhar, Founder, Gemba Capital, says, "There is no FOMO among investors now, which was noticeable in 2021, and they are in no hurry to close the round. Also, there is no pressure on them to do a certain number of deals.”
Focus on early-stage funding
The funding winter has not dampened the flow of capital into early-stage startups as investors continue to place bets on innovative companies, rather than letting go of opportunities. The expectation is that, once the tide turns, the investors stand a better chance of success.
Ankur Mittal, Co-founder, Inflection Point Ventures, an angel investment platform, says, “A rapid expansion and scaling of first-generation startups occurred in 2021, and the investors and the entire ecosystem were generally positive. 2022 has been seeing a few high-quality deals, although lower in number, which shows a strong post-COVID-19 recovery. High-quality startups have further piqued investor interest.”
Growth-stage startups, especially those in the category of Series A and above, will find it more challenging to raise funding as it would involve larger sums of money.
The funding boom of 2021 was all about focusing on the growth metrics of a startup but now the focus has shifted to sustainability. Questions are being asked about cash burn, the road to profitability, and building a business that is sustainable in the long term. Earlier, it was all about growth at any cost, which naturally led to spending large amounts of money to acquire customers in order to gain market share.
Also, given the easy access to capital in 2021, startups were not really focused on conserving cash. Today, it is all about extending the runway in terms of how much money is in the bank account, so that it can last for at least a couple of quarters.
V Balakrishnan, Co-founder, Exfinity Venture Partners, says, “B2C startups could see a rerating of their valuations and there could be much more focus on their business model. B2B startups seem to be relatively stable given their lower cash burn.”
Startups may now have to raise capital at a lowered valuation or at a flat round. This will bring about a rerating of the valuation of startups, especially the growth-stage startups. This is also an after-effect of the correction that is taking place in the public markets. The valuations in some segments, which were generally calculated at 40 times the revenue of the startup, may not be feasible for the moment.
The pessimistic economic environment of 2022 has turned the tables on the kind of interaction founders have with their investors. In 2021, founders had a sort of upper hand with investors driven by FOMO. Now founders need the backing of their existing investors to navigate better through the current environment. This could mean additional urgent capital to tide over the crisis.
Amit Kumar, Partner, ah! Venture Partners, an early-stage angel investing platform, says, "Startups are now looking at a bridge round of funding to extend their runway and would look at large capital raises once the demand is back."
Quality of founders
The quality of a startup and the founder is now making all the difference for the investor community. Earlier, many me-too startups received funding, but this may not be the case anymore with capital becoming scarce. Only those with the right credentials are getting funded now. Given that there is increased focus on the due diligence process, the bar has certainly become higher for founders to get funding in the current environment.
The total venture capital funding in July this year stood at $652.7 million, compared to $2.7 billion in June.
Question marks on exits
The current environment makes it difficult for both the startups and the investors to get an exit. The rich valuations of 2021 are unlikely to be the benchmarks now. This means founders will have to bide their time before they go for their next round of funding, as any step in that direction will mean raising capital at a lowered valuation, which would not be acceptable to existing investors and founders. This could lead to a valuation mismatch and M&A deals falling through.
Balakrishnan of Exfinity Venture Partners believes there could be a correction in the net asset value of the VCs in terms of their startup investments next year.
Investment in new areas
Opinions are divided on how investments will play out, especially with the negative developments in areas such as cryptocurrency and NFTs. Some investors believe investments in these areas will come down while others think they will continue.
Ankur of Inflection Point Ventures says, "A number of technologies have gained interest in 2022, including NFT and blockchain. In spite of all their uncertainties, entrepreneurs are exploring these and investors are becoming increasingly interested in them.”
Despite the so-called funding winter, the medium- to long-term story of the Indian startup ecosystem still remains very strong. The current condition is unlikely to remain for long, and the expectation is that things should start turning around by early next year, if not before, although one might not see the boom of 2021.
Adith of Gemba Capital says, "The deal activity is picking from the side of the investors, after their initial step back. There is enough dry powder available in terms of capital.”
(The story was updated to correct a typo.)