It is not as bleak as it looks in the world of start-ups. Top venture capital firms said the ongoing slowdown of new deals and funding in the Indian start-up ecosystem is not a reflection of the health of start-ups, but a trickle-down effect of several macro headwinds and geopolitical issues.

In the hindsight, many investors believe this is the opportune time to invest in early-stage start-ups with strong business models at attractive valuations for the long term.

Siddharth Mehta, Founder & CIO at Bay Capital, told BusinessLine, “During Covid the intent was to create a safety net by providing money to the consumers to help the economy bounce back quickly. But in an unintended consequence, a lot of this excessive liquidity went into financial assets and speculative activities. For instance, in the US and India, we have seen investments into high growth stocks, crypto trading and NFTs getting popular. Over the last 12-14 months, India also benefitted from this. We had the highest number of unicorns, businesses got funded. Everyone was getting funding quickly.”

Starting from January, there were supply chain disruptions with China and its restrictions, the Russia-Ukraine war and, most importantly, Fed’s stance on growing inflation and need to increase interest rates.

“Fed and the US have been very much behind the curve and have reacted slowly to inflation. As they extracted liquidity from the financial system, the first sectors to get hit are the speculative assets where all the hot money went. That’s why we saw crypto getting decimated and popular stocks in the US dropped 70-80 per cent. A lot of excesses is now getting corrected,” he added.

“All the tailwinds we had last year have changed to headwinds. We had a flood of liquidity and new money was getting printed. Almost 40 per cent of the US dollars in circulation was printed over the last 15-18 months. This, added with record low interest rates in some markets, Covid-driven surge in some sectors like Edtech, SaaS, gaming and bumper IPOs, have all started to become headwinds over the last 4-5 months starting with inflation,” Ashish Sharma, CEO & MD, InnoVen Capital told BusinessLine.

Sharma added: “Reaction to this will be more pronounced in growth and late-stage start-ups because their valuations are already very high. The investor base for mega rounds of $100 million-plus are very shallow and few. All of these investors are going slow now and there will be significant decrease in mega rounds.”

Scope for early stage start-ups

According to a recent mid-Q2 report by CB Insights, globally the number of deals are likely to drop by 22 per cent quarter-on-quarter, missing the estimate of 6,904 deals worth $115.4 billion. So far, only $57.7 billion has been deployed across 3,452 deals.

Last year, the private equity market was flush with liquidity with firms like Tiger Global raising $12.7 billion and SoftBank writing several big-ticket cheques. But now after reporting massive losses in the stock market and reported financials, both the investment firms are now set to slow down funding activities, while eyeing smaller ticket investments into early stage start-ups.

“Tiger Global had deployed $12 billion in a short span of 6-9 months. The fact that SoftBank and Tiger Global are not there the way they were deploying capital over the last 12-18 months is going to affect the ecosystem. That’s a good thing though given how they had distorted the market, making one believe anything and everything can get funded,” said Mehta.

“The silver lining is in the early stage where there is a lot of capital. And the time and horizon of exit compared to a late-stage start-up is much longer. So, you can underwrite some of these risks. Even if this scenario goes on for 24 months, it will still work out as the timeline for exit could be anywhere around 7-8 years and by that time things would improve. But if you enter late stage, your timeline for exit is around 24 months,” Ashutosh Sharma, Head of Investment for India, Prosus Ventures, told BusinessLine.

Short-term trend & consolidation

According to Mehta, the pace of deal activity will drop further in the second and third quarters, but overall, this is a short-term trend, and long-term investors can utilise this opportunity to pick solid and attractive businesses at lower valuations. The broader story of digital transformation has not changed and will continue attracting growth, he said.

“The good news is all large investment firms in India and globally had raised massive amount of funds. Though some of them have deployed, most of have them have still not started deploying that fund. My view is that the ecosystem is in a pause mode. Once some clarity emerges around the macro situation, a lot of them will start funding again,” said Ashutosh.

“The opportunity for early-stage funding still exists. There is a lot of capital that has come in the early stage and capital will shift towards it. Also, the valuation for early stage as well will correct. Lately, we have seen very large Series A and seed rounds. That will taper off and we will be able to see better start-ups. Growth and late stage will suffer though,” Anup Jain, Managing Partner, Orios Venture Partners, told BusinessLine.

Cash heavy businesses such as quick commerce, D2C brands and fintech and edtech products with very little differentiation and operating in cluttered spaces, will find it difficult to raise funding. Investors believe that either some of them will shut shops or are aligned to opt for acquisitions and mergers.

For more mature late-stage start-ups such as Swiggy and Meesho, which had raised funding recently, they will try to be leaner by downsizing verticals than raising fresh capital at lower valuations. Another impact of such a change has been seen with ongoing lay offs across start-ups, which is only expected to continue further.

“I believe flat is the new up right now. Even if they do a flat round, there will tighter terms with the investors. So, a lot of these big start-ups will not raise funds now or the next six months, even for flat rounds,” said InnoVen’s Sharma.

“If you are a company which burns a lot and you don’t have a decent runway, then my suggestion is that you go out and raise as soon as possible even if it is at a lower valuation. Don’t make valuation an ego question,” said Ashutosh.