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Too early to give up Indian start-up story

Point Blank

The mood in the start-up space changed from arrogant confidence to palpable nervousness. There are increasing reports of funding shortages, mass layoffs of employees, closures of unsustainable verticals, reductions in customer acquisition spending, and a general shift towards reduced consumption of Treasury.

However, the writing has been on the wall for some time now, with the value and number of deals falling sharply since the last quarter of 2021. But that had been dismissed as a temporary blow with companies optimistic that the funding environment will soon improve.

The cat was put among the pigeons by Masayoshi Son, CEO of SoftBank Group, when he made a candid admission during the company’s March quarter earnings call that the company was going to fold on a ‘defense stance’ – monetize current investments and become extremely cautious with new investments. These thoughts were prompted by a whopping $26.2 billion loss to its Vision fund from investments in high-growth tech companies.

The distress in the portfolios of global private equity/venture capital investors is leading to lower investment and increased scrutiny of start-ups. So, is the party in the start-up ecosystem over? While there is no doubt that Indian and global start-ups are entering a difficult period where funds will be more scarce compared to the last two years, it is perhaps not fair to assume that this will end the boom. investments in start-ups.

Private equity and venture capital funds will continue to find lucrative investment opportunities among Indian start-ups. But Indian entrepreneurs need to make some shifts to retain their credibility.

What went wrong?

There had been frenetic activity in private equity and venture capital investments in India. Excess global liquidity due to central bank stimuli has facilitated fundraising for these funds, some of which have found their way to high-growth regions like India. The value of transactions at $77 billion and the number of transactions at 1,266 were the highest on record in 2021. As digital adoption increased during the pandemic in areas such as education, shopping, payments and within enterprises, technology companies catering to these needs have seen an increase in PE/VC interest.

But the tide started to turn from November 2021, with the number of transactions as well as the value of transactions decreasing from there (see chart). The US Federal Reserve and the Bank of England initiating the reduction in liquidity injection and the outlook for higher interest rates made investors cautious. High global inflation also played a role in restricting flows.

The first quarter of 2022 was tough for all asset classes with the Omicron wave, Russian-Ukrainian war, Chinese lockdown and high inflation driving stocks, cryptocurrencies, SPACS, commodities raw and other assets. The Nasdaq composite, which is a gauge of tech stock prices, is down 29% since the start of this calendar year. Bitcoin is down 38% this year and stock markets have turned tepid. Private equity and venture capital funds saw their profits shrink in the crash and some, such as SoftBank’s Vision fund and hedge fund Tiger Global, suffered heavy losses.

Funds with heavy exposure to China had already taken a hit in 2021 due to the collapse of edtech stocks on the Shanghai and Shenzhen exchanges as the Chinese government cracked down on such stocks.

Given these challenging conditions, it’s no surprise that global investors are taking a defensive stance.

The Indian saga

Global private equity and venture capital investors have not had it easy in India as well. While the booming stock market last year encouraged outflows, market conditions this year have become quite challenging. Outflows reached record highs with a value of $11.9 billion in May 2021 and $7.4 billion in August 2021. But in April 2022, an outflow worth only $1.2 billion dollars was recorded.

The stock market performance of some of the start-ups that had attracted immense investor interest was quite disappointing, further disrupting matters. Zomato, for example, which had been oversubscribed 38 times with investors investing over ₹3 lakh crore in the issue, saw its share price fall by 20% from its IPO price . The financial performance of the company has also been dismal with losses of ₹360 crore in the March 2022 quarter.

Other start-ups listed since last year such as One97 Communication, PB fintech and CarTrade Tech have also led to an erosion of investors’ wealth. While private equity and venture capitalists may have made profits on the listing, other investors who took up the offering would feel cheated, making future exits difficult.

All is not lost yet

Although the current outlook looks bleak for startups as investors tighten purse strings and take a closer look at their operations and valuations, there are plenty of reasons why conditions could ease in the future.

First, a closer look at PE/VC deal data reveals that the value of deals in the first quarter of 2022 at $15.7 billion is well above the values ​​in the first quarters of 2021, 2020 and 2019. The value of the transaction as well as The number of transactions in April 2022 is slightly higher than in the previous month. While investments are down from last year’s peak, this cannot be called a total shutdown.

What is more encouraging is that fundraising by India-specific funds continues. According to the EY-IVCA report, a total of $1.5 billion was raised in 16 funds in April 2022, compared to $569 million raised by eight funds in April 2021. Elevation Capital raised its eighth fund dedicated to India at $670 million, which is its largest ever corpus. Advent International recently announced that it will invest $5 billion in India and other Asian countries over the next few years.

With digital adoption being the dominant theme, investors cannot afford to avoid India, which is a big market. According to Inc42, the number of internet subscribers nearly doubled from 446 million in 2017 to 834 million in September 2021. Internet penetration increased to 61% with 931 million smartphone users. Companies that address this market have much better growth prospects and investors are aware of this.

But start-up promoters in India need to improve their action if they are to continue to receive private equity and venture capital funds. Competition is intense in the Indian start-up space and only the best will be able to survive and grow. Of the 40,000 active start-ups, only 4,700, or less than 10%, have received funds from private equity and venture capital investors and only 17 of them have been listed so far.

But in order to attract funding, they must be careful not to resort to shortcuts such as inflating revenue or user base or making high projections. Governance must improve in companies and unnecessary internal conflicts between founders must be avoided. The focus should be on product innovation rather than providing complementary products and services which have very low barriers to entry.

The Center can also increase the corpus earmarked for funding start-ups at a time when global venture/venture capital investors are likely to scale back their investments.

Published on

May 25, 2022