The macroeconomic conditions have made it difficult for Indian startups to secure funding, with private equity (PE) and VC investments declining by 63% year-on-year in January 2023. To navigate this funding crunch, startups have had to resort to cost-cutting measures, like shutting down business verticals, employee layoffs and much more. Further, as VCs adopted a more cautious approach, several cases of corporate governance issues have been found at venture-funded startups. To delve deeper into these topics, businessline’s Yatti Soni spoke to Arun Natrajan, the founder of Venture Intelligence, a private market intelligence company.

(Host: Yatti Soni, Producer: Jayapriyanka, Nivedita)

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Yatti: Today, we will be discussing the state of the Indian startup and venture capital (VC) ecosystem. The macroeconomic conditions have made it difficult for Indian startups to secure funding, with private equity (PE) and VC investments declining by 63% year-on-year in January 2023. To navigate this funding crunch, startups have had to resort to cost-cutting measures, like shutting down business verticals, employee layoffs, and much more. Further, as VCs adopted a more cautious approach, several cases of corporate governance issues have been found at venture-funded startups.

To delve deeper into these topics, we have with us, Arun Natrajan, the founder of Venture Intelligence, a private market intelligence company. Welcome, Arun, and thank you for joining us.

Yatti: Please give us an overview of the startup funding activity in the month of February as compared to last month and February 2022.

Arun: Absolutely. We have been talking about funding winter since 2022, but it has really hit home in 2023. Especially when you start comparing the month-on-month data to the previous year. About 42 startup funding deals happened in February of this year, worth around $536 million, which is 30 per cent down in both volume and value terms compared to the immediate previous month (January 2023). In comparison, when we go back to Feb 2022, startups saw 123 deals and the total value invested was a phenomenal $4 billion. February 2022 was absolutely the peak and it was just before everything fell apart. It was that time when we saw huge $300 million, $200 million funding rounds. So clearly funding winter is here and it looks like for a few more months at least, the comparisons will continue to look quite bleak.

Yatti: Talking about value, have the $100 million rounds also been reduced in February 2023?

Arun: Sure. The real drop-off is in the mega-deal segment. We saw just one $100 million plus investment for this month of February raised by FreshToHome, which was led by Amazon Smbhav Venture Fund and had participation from the Abu Dhabi Government’s investment arm. That’s the kind of falloff we are seeing today. We are still seeing quite large transactions happen in sectors like vertical e-commerce, enterprise software, and SaaS segments. It might not be a $100 million round but $50 million deals have happened in two cases. Also, we continue to see interest in like FinTech, for example, we saw Mintoak, which is in the b2b payments space raise $20 million. Again, it had very strategic investors such as PayPal, HDFC, and so on. Even edtech, it’s not fallen off completely, we saw a coding education company from Hyderabad, NxtWave raised $33 million from Greater Pacific Capital, which is more of a private equity player. So, it is not as if all big deals have dried up, but the mega $100 million deals are clearly trickling down to once a month. That is really very different from the days of 2021 and even the early part of 2022.

Yatti: Is there an impact on the early-stage rounds as well?

Arun: Relatively, the early stage has been the exception in funding winter. We see that relative vibrancy is continuing in the early stage but it is not without hiccups. There are going to be challenged in terms of valuations and VC expectations in terms of product market fit have also gone up. This tightening up is going to result in deal flow going down in the early stage, but it’s not going to be as much dip as we are seeing in the later stages.

Yatti: What is the impact of the funding crunch on the merger and acquisition space? Any sector-specific trends in M&As?

Arun: As funding tightens, some startups will either look for acquisitions or merging opportunities via equity swaps with other companies to bulk up. This is a typical phenomenon of a funding cycle downturn. We are already seeing some signs of that happening for multiple reasons including a funding crunch. For example, in Fintech, there have been quite a few regulatory clampdowns, especially in the lending space. Therefore, many stronger companies are acquiring companies that have some momentum but are stuck in new user onboarding because of the regulatory changes. So, fintech is one sector where we are seeing M&A activity and D2C e-commerce has also seen quite a few strategic acquisitions. Players like ITC and roll-up e-commerce companies are aggressively looking for good brands to acquire as it’s a good time for M&As, from a valuation perspective as well.

Yatti: Can you also share some specific numbers on M&A deal activity in February 2023?

Arun: In the last two months we have seen 10 deals, out of which 4 happened in just February. Fintech and e-commerce were the most funded sectors in the last two years and we are going to see some of the consolidation happening exactly in these high-growth sectors.

Yatti: I was going through some of your recent interviews, and you mentioned that layoffs and corporate governance issues in startups are bigger issues than funding winter. Would you like to expand on this thought?

Arun: Sure. The key thing about venture funding is that it’s a cyclical phenomenon, there is no kind of doubt that this is an industry that will go through its cycles and we have seen that in 2008, 2015-16, and so on. But this time around, the corporate governance issues that have come out of the woodwork in the last few months are big eyebrow-raisers. This is not something that we have seen often in the startup space. The governance question is like a cloud hanging over the startup ecosystem, and we will have to see how that resolves in the months ahead.

Yatti: Could such headlines also impact the deal activity, or impact how HNIs look at startups?

Arun: Recent corporate governance cases have actually put a question mark on some of the biggest venture capital funds in the country. So these events can definitely raise doubts in the minds of investors of those VC funds. We all know that it was difficult for investors to carry out due diligence during COVID. And, a lot of the diligence had to happen online, and there is only so much you can do in the virtual space. There was a lot of money coming to VCs along with the pressure to invest but they had no avenue to meet founders — mistakes were bound to happen. The investors are ready to admit that they probably overstep on the diligence or rather the lack of it during those years, but now it is definitely tightening up. The best of the VCs had to delay the closing of their funds. Going ahead, more diligence focus will be the natural order of the day.

Yatti: February started with the union budget and one of the most-discussed budget announcements was the angel tax provisions being extended to foreign investors. Given that most late-stage funding rounds in India are led by foreign investors, do you think such a step by the government can intensify the funding winter?

Arun: The announcement around angel tax being applied to foreign investors came almost out of the blue. If you look at it from the spirit of what it intended to do, was to bring foreign and domestic investors on an equal footing. So, this was applied a few budgets back for the domestic investors and largely impacted early-stage rounds, which is why it got the tag of Angel tax. Now, in the demand for equal treatment between domestic and foreign investors, and someone unintended consequences have cropped up. Today, lawyers and tax experts, are apparently inundated with lots of queries from their venture capital, and private equity customers as to how the angel tax provisions would apply to them. There is also an ongoing dialogue with the Government, till now the understanding is that the ink has not dried out on the announcement.

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