India-focused private equity and venture capital firms find themselves in a peculiar situation as they sit on sizeable unallocated funds even as start-up funding hits a seven-year low. This implies that while the Indian VCs are holding a record amount of dry powder, they face a dearth of quality late-stage companies. 

According to data service firm Preqin, Indian VCs had $9.5 billion of unallocated funds as of March 2023, way higher than $7 billion in the year-ago period. As of December 2023, there were 185 India-focused VC funds with a targeted capital raise of $10.73 billion, according to Preqin. 

In 2023, VC firms announced 41 fund closures valued at $3 billion, while in 2022 the nearly 47 fund closures aggregated $6.79 billion, according to data from analyst firm Venture Intelligence. 

Dipping valuations

Investors believe that the funding cycle in the Indian start-up ecosystem will stabilise in the second half of 2024, though not at the levels observed in the previous two years. 

“The resurgence of the IPO [initial public offering] market and the projections of global interest rate reductions are expected to create a favourable investment climate. With the Indian start-up ecosystem holding $20 billion in dry powder, 2024 promises robust funding activity,” says Ankur Bansal, co-founder and director of venture capital firm BlackSoil. 

According to Pankaj Makkar, managing director of Bertelsmann India, a VC firm focused on early- and growth-stage start-ups, venture capital funding peaked in 2021 and 2022 globally. The sizeable funds raised, however, were meant to be deployed over a period of 3-4 years. 

When valuations began dipping in 2023, funding slowed and led to a pile-up of dry powder, says Vikram Chachra, founder of early-stage VC firm 8i Ventures. 

“As valuations have shrunk, there is more capital available to be deployed and that process of recalibration has been on,” he says. 

Investors’ outlook

There is now a greater emphasis on extensive and thorough scrutiny of deals. Investors are turning more selective, dedicating additional time to commercial and financial due diligence, alongside seeking a clear path to profitability and better unit economics from founders.

“Sentiments play a crucial role. The renewed emphasis was on evaluating the profitability of start-ups. It’s understood that start-ups, depending on their stage, require initial cash for customer acquisition, product development, and market testing. The critical aspect is to ensure that there are strong unit economics in place for future monetisation,” says Ankur Mittal, COO and co-founder of VC firm Inflection Point Ventures. 

Investors with substantial dry powder are looking to deploy them in pre-IPO rounds and late-stage companies set for IPOs in FY25. On the other hand, smaller VCs continue to scout for early-stage investments for their unused funds. 

The success of equity markets, particularly the surge in IPOs, has spurred many series B-plus funds to divert their attention to public markets. This, in turn, impacts series B and series C funding for start-ups, where bigger cheques are common. 

“For instance, as a series A investor, the uncertainty over series B investments can slow down the overall deal activity. This cyclical nature is inherent in every ecosystem,” says Mittal. 

However, several VCs also observe that raising funds has not been an easy task. “The appetite is almost nil among LPs [limited partners, who contribute funds to VCs] as they are looking for a demonstrated track record. I think first-time fund managers have had a tough 2023,” Chachra says. 

Sectors in focus 

Start-up investment in 2023 plunged 72 per cent to $7 billion, as compared to $25 billion in 2022, according to data from Venture Intelligence. However, the year ended on a more positive note with December witnessing an uptick in deal activity, including the $600 million that e-commerce giant Flipkart secured from Walmart as part of its $1-billion fundraising. 

With the dawn of a new year, the key sectors drawing attention include fintech, space technology, climate tech/clean tech, healthcare/healthtech, deep tech/SaaS, consumer internet, and logistics and supply chain. 

Notably, the widespread adoption of GenAI across diverse industries is poised to emerge as an overarching trend, driving a shift in focus to innovation and integration in the technological landscape.

“We can look at increased investment in deeptech start-ups, sustained growth in tier-2 and tier-3 cities, a pronounced emphasis on social impact start-ups, and a heightened focus on sustainability within the Indian start-up ecosystem,” says Ankit Kedia, founder and lead investor at early-stage VC firm Capital-A. 

Investors observe that early-stage funding will still attract greater attention as compared to growth- and late-stage investment.