Financial markets, public or private, go through their cycles, ups and downs. The recent Russian-Ukrainian war, energy supply, depreciation of GBP/EUR, rising inflation, etc., to name a few, have led to recession risk and higher rates of interest. The cost of capital has therefore increased and investors are reluctant to deploy capital as they did before. All in all, we have reached a not too great situation for startups, early or late stage. Looking at the last two quarters gives a clearer picture. There has been a downward trend in the amount of funding as well as the number of startups funded.
That said, markets will always have their cycles, whether it’s 2008-2010 or even 2016 when funding levels plummeted. While today we are in a bearish cycle, the questions that come to mind are, when do we see this winter? What are startups doing so far?
An important aspect to consider is that there have been record amounts of money raised by funds around the world and in India as well. In the United States this year, in the first half of 2022, venture capital (VC) firms raised an amount equal to what they raised in 2021 (number for perspective). This means that there is a lot of “dry powder”, ie funds waiting to be deployed.
Venture capital money is “patient money”, it will wait for the right opportunities to deploy.
Putting it all together, depending on the sector and the stage of the startup, we will see this play out differently. Late-stage startups typically see internal rounds, given that going public is a highly sought-after path for existing investors. Given the track record of recent IPOs and subsequent stock prices, getting an exit via IPOs by late-stage startups would not be urgent. This sub-segment could be the most affected. Getting through this “winter” period sustainably would be of paramount importance.
“Although venture capital money is patient money, what is likely to happen is that there will be a deployment of capital as they will be under pressure to generate returns for their investors”
Consequently, one would see layoffs, realignment of business plans, projects and rapid alignment towards achieving positive EBIDTA/profitability of the business. In short, a recipe for reducing the burn rate and lengthening the track.
Early-stage seed/Series A startups would also see changes. Although there is a lot of “dry powder”, some sectors would have an easier time obtaining financing than others. The reason could be twofold, the positive/negative outlook on the sector, and the other being that in some sectors that have received high volumes of funding over the past 2 years, many venture capitalists have already taken their paris and have not made any expenses.
Startups in the Series A/B/C segment could benefit from bridging funding or fixed rounds, as sustenance would be key. Startups have already started cutting marketing budgets and streamlining headcount to ensure they get through this lull. Although venture capital money is patient money, what is likely to happen is that there will be a deployment of capital as they will be under pressure to generate returns for their investors. That said, valuation metrics can change from growth at all costs, the valuation metric will shift to growth with good profitability/activity metrics.
Venture capital funds would look for good deals (startups) and take their time to make good decisions and bring good quality companies into their portfolio. They would also set aside funds for existing portfolio companies to ensure they get through this period as well. In addition, consolidation and mergers and acquisitions activity should continue to pick up.
Sectors where there are a large number of similar startups would see some fall due to the inability to raise funds or get bought out by larger players.
That said, unicorns or even high-quality start-ups are also known to be made in tough times. VCs have been in this business for decades and know it. While VCs would do tighter checks and assessment measures would be stricter, good quality start-ups will continue to be funded. It’s important for startups to realign with this and get through the rough patch. For those who do well, we are sure that they would be of high quality with good trading indicators.
(The author is the founder and CEO of PurpleTutor)