Prominent investors focused on India, which have typically backed portfolios in growth and late-stage rounds, have moved downstream towards funding early stage (including seed to Series A) companies amid increasing uncertainties caused by global macroeconomic headwinds.
Venture funds have also lowered expectations in communications with their investors, or limited partners, bringing timelines for fund deployment and returns aligned with the current business environment.
The fund deployment cycle is expected to move from an average of two years as seen during the peak in 2020-2021 to three-four years now, with the lifecycle of the funds also increasing, several VC fund executives told ET.
Additionally, while bets across the emerging sectors of artificial intelligence, climate-tech and deep-tech seem good on paper, VCs have struggled to form a long-term thesis and are going cautious on these sectors, especially in the Indian context.
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In the first six months of 2023, equity funding by Indian and global investors in startups totalled $3.85 billion across 546 deals, or a just over one-fifth compared with the $18.4 billion they had invested in the same period last year, according to data sourced from research firm Venture Intelligence. It was also lower than the $4.1 billion of investment in the first half of 2020, when the Covid-19 pandemic had gripped economies worldwide, leading to a halt in funding activity.
In the January-June period of this year, India saw no new unicorns, or companies valued at $1 billion or above, as the funding winter deepened. Sixteen startups had attained the unicorn status a year earlier.
According to at least six investors and bankers ET spoke to, the slowdown in funding comes as investors struggle to find large opportunities in untapped areas to invest in early stages.
“Markets have a tendency to overreact in both directions. In 2021 and 2022, too much money went in, and in 2023, the pendulum has swung in the other direction,” said Alok Goel, partner, Stellaris Venture Partners. “We find investing in AI today to be both a massive opportunity and a challenge as well. Opportunity for obvious reasons. Challenge because it is very hard to build a long-term thesis given the pace of change in underlying technology as well as landscape.”
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Funds go downstream
Even as larger funds continue to search for bets at early stages, data show a dramatic slump in funding in early-stage companies. This is contradictory to the popular narrative that the ecosystem has been weaving about deals being robust at early stages.
Data from research firm Tracxn show that overall funding across the early stages, from seed to Series B, stood at $1.61 billion, down from almost $6.8 billion for the same period last year.
“Some of the investments in new segments in India like climate and AI are often driven by deployment pressure because there aren’t too many large white spaces or opportunities left in larger segments like fintech which have been over invested in the past few years. The challenge with new segments is that we will see early pre-seed and seed rounds, but the number of Series A and B may be smaller as long-term conviction has to be built in new segments, which is not the case presently,” said Vaibhav Domkundwar of Better Capital, a pre-seed fund that has invested in these new segments.
While larger funds go downstream, in the current scenario, several of them are banking on proven hypotheses and business models than creating a new thesis for a new segment which takes time, Domkundwar said.
“The issue is that when funds go downstream, and assess deals with the same bar of proven business models (as they look at growth), it increases the bar for everyone at early stages. This is leading to most investors staying away from underwriting unproven companies and (upcoming) segments,” he added.
With their assets under management increasing with larger fund closures, venture backers are also losing their ability to play at seed stages, which was a focus for several in 2020 and 2021, as they retreat to calling on Series A and onward bets, said Arjun Malhotra, general partner of Good Capital, which just launched a $50 million AI fund.
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Expectations tempered
The slowdown has led to several VCs toning down expectations to limited partners, four venture operators told ET.
“Deployment cycles are likely to move to three years rather than two. At the growth stages, the funding momentum has worsened because previous valuations were at top of the market, and companies which have raised in peak cycles have liquidity. If these companies go into the market, they might see a 50%-60% erosion in valuation, leaving no incentive for entrepreneurs to raise. At early stages, the liquidity has dried up because there is less quantum of companies,” said Malhotra.
According to a recent macro keynote from global investor and fintech backer Coatue, aggregate value of unicorns globally is down from $5 trillion previously (raised at peak valuations in their last round) to $2.5 trillion.
Currently, Coatue estimates the potential funding needs of startups and technology majors globally at $250 billion per year.
“While there is a slump, the market is warming up with newer mandates coming up for acquisitions and new deals. Global VCs are evaluating deals and may make a comeback towards the second half of this year or the first quarter of next year,” said Amit Nawka, partner (deals and India startups), PwC India.
As liquidity seems tough, and investment firms close large funds, global limited partners are pushing investment managers to provide exits on previous funds, leading to a rise of secondary share sales where existing investors sell their shares to the new investors.
“The latter part of the year might see a couple of secondary deals, mostly on a heavy discount. The narrative is to give exit to older early-stage VCs, and bring in more stronger and larger investors on the captable. A very small portion of the overall deal (10-20%) being raised by a startup is primary funding now, which is being raised at the previous valuation. So, companies get some liquidity and there are no markdowns,” said a banker who was working on these deals.
The second half of 2023 is expected to see deals at a blended valuation of primary and secondary (at a discount) to help give some exits to existing limited partners, the banker said.