The perceptible slowdown in private equity and venture capital investments into Indian companies since the beginning of this calendar year should serve as a reality check for entrepreneurs who seem to have taken foreign capital for granted. The deal value of PE/VC investors in the first two months of 2022 was over 50 per cent lower when compared to the peak in October 2021. Exit deals fell sharply with the correction in mid- and small-cap stocks. The long-term shifts in adoption of digital products in the country during the pandemic had led to a burst of innovation and heightened fund-raising activity. Global investors, flush with funds as a result of liquidity infusions by global central banks and ultra-low interest rates, fuelled this growth, pushing the Indian start-up economy to third place behind US and China in global venture fund ranking in 2021. PE and VC deal volumes as well as value reached record levels between July and October 2021, with some money also getting diverted from China due to the Chinese government’s clampdown on some digital start-ups. A booming stock market where many fintech and consumer tech start-ups could list at sky-high valuations, further increased attractiveness of the Indian market for PE and VC investors. But the tide seems to be changing now as the slowdown in deal volumes and value as well as exits in the first two months of this year show.

Several exogenous factors such as reduction in inflows into PE and VC funds due to the monetary tightening by the US Federal Reserve and other central banks, coupled with the sell-off in stock prices since the last quarter of 2021, are responsible for this slowdown. But Indian entrepreneurs also need to do some soul-searching. With many of these digital technology companies not delivering to their promises, investors have lost money in these companies. The steep valuation claimed by some of these companies while receiving funds from PE/VC investors or in the initial primary offers were out of sync with their business prospects. Unnecessary diversifications into multiple micro-markets in order to show business growth, lack of product innovation resulting in me-too product offerings and padding numbers to show higher customer acquisition numbers are other common issues with the start-ups soliciting funding. Further, episodes such as the recent one of alleged fraud in a high profile payments start-up raises questions regarding governance risk in some of these companies.

With the funding environment now turning challenging, Indian start-ups will have to concentrate on product innovation and delivering best-in-class products and services to customers, for that alone can deliver sustained growth and get them funding going ahead. Stock market regulator, SEBI, needs to ensure that investor trust in these start-ups is not lost since stock markets are an important channel for providing funding to these companies. The regulator should push through with its proposal to make start-ups disclose the basis of valuations used in pre-IPO funding rounds and during the IPO. In the absence of profitability track-record, it becomes very difficult for investors to value these companies. Regulators should also ensure that these companies comply with the governance requirements so that investor interests are protected.

comment COMMENT NOW