A Happy New Year for startups? Not really

2022 has been a rather tough year for startups—pinched by the rising cost of capital on the back of a spike in interest rates amid global central banks’ attempt to tame unruly inflation, investors tightened purse strings, refusing to cut cheques for companies that failed to demonstrate healthy growth. Most startups that typically thrive in a culture of over-indexing on growth with limited focus on profitability struggled to raise capital and cut staff strength to check costs. The new year is going to be no different; with the period of easy liquidity now behind us, the first half of the year at least is going to be challenging for the mid to late stage startups, say experts. “There is a real and a sharp focus on companies that are or on the path to becoming valuable and sustainable. Companies which are focused on top line and bottom line or on path to profitability are increasingly evincing interest from investors. These companies work hard on unit economics, gross margins, contribution margins, ROIs on spends..those are becoming important. At IAN, we are trying to build valuation companies, not just valuation-driven models. Companies will raise money for growth rather than just plugging their cash burns continuously. That’s the big change that 2023 will see,” says Padmaja Ruparel, co-founder at IAN (Indian Angel Network).

For the mid to late stage startups, in particular, whose ability to attract capital will from now on increasingly depend on the performance and viability of their businesses. There is another six to nine months of dullness that is expected, say analysts. “In the last couple of years, the availability of cheap capital made a lot of companies pursue what loosely can be called unsustainable growth and the market rewarded that. The change in interest rates and macro environment has led to a rebalancing. Growth is important to pursue but when done in consonance with creating a long-term profitable outcome. At the very least, a clear path and trajectory to profitability is important to see. In the absence of that, companies are seeing a clear and visible impact on their ability to raise capital at mid-late stage,” says Rahul Taneja, partner at Lightspeed.

A report released by market research firm Tracxn that studied the 2022 funding trajectory for startups showed that funding for the sector dipped to $24.7 billion in the January-November period of 2022, registering a year-on-year (y-o-y) decline of about 35%. However, it is not that all companies are struggling to raise funds. A handful of firms have been able to get investor support even in the midst of a macroeconomic crisis. For instance, fintech firm Money View recently pocketed $75 million from a clutch of investors led by Apis Partners although a source said that the original deal negotiation was for a $150 million investment. Another fintech player KreditBee scored $80 million from investors while digital payments major PhonePe is reportedly seeking to raise as much as $1 billion at a valuation of over $12 billion. “KreditBee has mentioned that it is a $80 million round but is be much bigger. In 2-3 months, probably another $80 million will come in,” another source said on condition of anonymity. And there are credible reasons as to why these firms have been able to garner capital. “Many of these firms are generating enough cash flows. If you take PhonePe, it is one of the biggest startups in India, they are looking at an IPO and PEs (private equity investors) want a play in it,” says an analyst.  

Companies with positive unit economics will continue to raise capital. The broader funding landscape, though,  remains tepid, seconds Amit Nawka, partner at PwC. Deal talks are back on the table but there is not much advancement when it comes to conversion of the talks into signing of term sheets. “Growth stage deals are most difficult where conversations are pretty slow for deals in the range of $20-$100 million. It will take at least six months for normalcy in deal activity to set in,” says Nawka.

On a day when D2C unicorn Mamaearth has filed IPO papers, generating much needed buzz for the startup space, investors don’t see all doom and gloom for startups. In fact, experts feel that new age IPOs will be back with vigour after being challenged by market instability. “Companies are planning IPOs, they are targeting Q4 of 2023. The general consensus is that IPOs will be back,” says Nawka. Also, the market downturn has created room for sustainable companies to grow. Given the impact of early 2022, with large cheques drying up, the valuations have lowered. And that makes an excellent opportunity for investors to pick up companies at more sensible valuations than they were last year. So, the fluff in the system has died down, or at least reduced,” says Ruparel.

Kiko Live, an early stage startup that is building a live video shopping platform acknowledges that the funding winter has materially changed the company’s perspective. “Driving hyper-growth at any cost has changed to becoming profitable as soon as possible,” says co-founder & CEO Alok Chawla. “We are currently in the middle of a fund-raising round. However, there is a definite cool-down in terms of the valuations businesses can expect vis-a-vis the benchmark that was set in early 2022, where valuations used to multiply every month without any material change in the business growth or metrics,” says Chawla.

Time will unfold what the new year holds for startups. The funding winter is certainly not here for good but in the end it will take prudence to win the game. “Our consistent advice to companies is to build business prudently. It is uncertain how and when they may be able to raise the next rounds of financing, so they should extend their runway as much as possible,” says Taneja.