Financial markets, public or private, go through their cycles, peaks and valleys. The recent war between Russia and Ukraine, energy supply, GBP/EUR depreciation, rising inflation, etc., to name a few issues, have resulted in a risk of recession and an environment of rising interest rates. interest. Therefore, the cost of capital has increased and investors are wary of deploying capital as they were doing before. All in all, we have come to a not very good situation for startups, early stage or late stage. Looking at the last couple of quarters gives a clearer picture. There has been a downward trend in the amount of funding, as well as the number of new businesses being funded.
That being said, markets will always have their cycles, be it 2008-10 or even 2016 when funding levels fell. Although we are in a downward cycle today, the questions that come to mind are, when will we see this winter? What do startups do until then?
An important aspect to consider is that there have been record amounts of money raised by funds globally and also in India. In the US this year, in the first half of 2022, VC firms raised an amount equal to what they raised in all of 2021. In India, in the first half of 2022 alone, the funds VCs raised $14.1 billion (this is more than 3X the 2021 number for the outlook). What this means is that there is a lot of “dry powder”, ie funds waiting to be deployed.
VC money is “patient money,” it will wait for the right opportunities to unfold.
Putting all this together, depending on the sector and the stage of the startup, we will see that it develops differently. Late-stage startups often see internal rounds, given that the initial public offering is a highly sought-after route for existing investors. Given the track record of recent IPOs and subsequent stock prices, there would be no rush to get an exit via IPOs by late-stage startups. This subsegment could be the most affected. Sustainably coping with this “winter” period would be of paramount importance.
“While VC money is patient money, what will likely happen is that there will be a deployment of capital as they will be under pressure to generate returns for their investors.”
Therefore, you would see layoffs, realignment of business plans, projects and a quick alignment to obtain a positive EBIDTA/profitability of the business. All in all, a recipe for reducing the consumption rate and extending the track.
Early-stage startups, seed/Series A, would also see changes. While there is a lot of “dry powder”, certain sectors would find it easier to obtain financing than others. The reason for this could be twofold, the positive/negative perspective of the sector and the other is that in some sectors that received large volumes of financing in the last 2 years, many VC firms have already gambled and done nothing. the frescoes
Emerging companies in the Series A/B/C segment could see bridge funding or flat rounds as sustainability would be key. Startups have already begun cutting marketing budgets and streamlining the workforce to ensure they get through this lull. While VC money is patient money, what will likely happen is that there will be a deployment of capital as they come under pressure to generate returns for their investors. Having said that the evaluation metrics can change, from growth at any cost, the evaluation metric will change to growth with good profitability/business metrics.
VC funds would look for good deals (startups) and would take their time to make good decisions and get good quality companies into their portfolio. They would also set aside funds for existing portfolio companies to ensure they sail through this period as well. In addition, consolidation and M&A activity would continue to pick up.
Sectors where there is a high volume of similar startups would see some fall due to an inability to raise funds or be acquired by larger players.
That being said, unicorns or even high quality startups have also been known to be made in tough times. Venture capitalists have been in this business for decades and they know it. While VCs would tighten controls and evaluation metrics would tighten, good quality startups will continue to receive funding. It is important that startups realign with this and get through the difficult period. For those that do, we are sure they will be of high quality with good business metrics.
(The author is the founder and CEO of PurpleTutor)