The epic momentum of 2021 saw $40 Bn worth of funding invested in Indian startups. With $19 Bn funding pouring by the second quarter this year, founders and analysts believed that 2022 was going to be another record-breaking year.
That is, until the funding winter arrived.
The signs of a brutal winter were lurking in the shadows amidst a global economic slowdown & stock market crashes. The latest funding numbers have only reinforced the onslaught of a funding winter that has gripped the Indian startup ecosystem.
Before deconstructing what this means for founders, let’s understand the causes of India’s current funding winter.
Understanding Startup Funding Winter
Funding winter refers to a period of market correction in capital inflow which lowers the probability of startups getting higher valuations in the short to mid term. Simply put, founders find it difficult to raise funding and achieve sky-high valuations.
A fund crunch spells bad news for startups that focus on customer acquisition instead of profitability with no clear business model thereby leading to mass terminations, cost-cuttings and in worst cases, shutting shop.
The question is: How did we land here?
Landscape of Funding Winter
In a bid to stimulate the economy post-pandemic, global central banks nurtured a low-interest-rate environment. This led to a massive capital influx in the VC & PE industry ultimately leading to a funding boom & ‘hyper’ valuations for Indian startups.
VCs shared the readily available capital pie with founders who prioritised quick expansion over profitability. In order to achieve near-impossible targets, startups mass-hired employees at inflated packages. Such conditions inevitably brewed a bitter concoction of cash burn and caused a low-key talent war.
Cut to the bleak midwinter of 2022,
Owing to the market conditions, capital inflow has diminished from the top resulting in lesser funds for startups. This has led to a fund crunch in the market. VCs are now reluctant in cutting bigger checks and priority is being given to sustainable businesses with good fundamentals.
Factors Contributing to Indian Funding Winter
- Geopolitical tensions- The Russia-Ukraine war led to a power tussle between the East & West. US-imposed sanctions on Russia made matters worse as developing nations faced massive supply chain disruptions & commodity scarcity.
- Global Inflation- Market conditions forced central banks including the Federal Reserve, to raise interest rates. Rupees’ steep depreciation made a dent in India’s foreign reserves as well.
- Dismal performance of IPOs- IPOs of startup giants such as Paytm, Nykaa etc have been less than optimistic as their value plummeted in the public market. Stock market behaviour is increasingly defining VC sentiment as IPOs are the only viable exit option in absence of a robust M&A market.
Impact of Funding Winter on Startups
Current market conditions have altered the shape of the startup economy in multiple ways. Going forward, startups will have to realign priorities and pivot based on these major trends:
- Smaller paychecks & multiple funding rounds– Founders looking to raise capital are noticing delays and renegotiations resulting in multiple rounds of funding with smaller valuations.
- IPO frenzy to slow down– Around 15 startups intended to go public in FY 2022-23. Industry giants like Oyo & Byju’s are now deferring their IPO plans, others are expected to follow suit.
- More M&A and consolidation activity– Funding winter has created a unique opportunity for mature startups to expand their product offerings by acquiring companies that haven’t been able to raise funding.
- Cost-cutting & right-sizing– As funding dries up, most companies will struggle with balancing growth & revenue. The focus will be on high efficiency & productivity with leaner teams.
Wondering how to build a lean, rockstar team? Read: 5 tips to build a lean startup
- Renewed focus on profitability– Businesses will be tested on the viability of their business model. Most investors are likely to ask tougher questions to justify valuations.
Expert Advice on Funding Winter: Cautious Optimism is Key
Contrary to the negative sentiments in the market, most experts are convinced that the funding winter is, in fact, a good thing. Experts have squarely advised founders to focus on unit economics & product-market-fit in order to survive this funding winter & come out stronger.
According to most investors, a cyclical correction of 10-12% was to be expected. Many believe that there’s a lot of capital (dry powder) waiting to be deployed in Indian startups, especially because China has slowed down. Kejriwal of Kedaara Capital explained, “We have a plethora of new capital coming into India- Large LPs had 80 per cent of their portfolio in China earlier. Their asset allocation has changed from 80-20 to 50-50. They have moved to a China+1 strategy and India is benefiting from that.”
Road Ahead for Raising Startup Funding
The mandate is clear: Get the business basics right.
Even though the next 12-18 months will be difficult for Indian startups to raise funding, it is not all doom & gloom.
VC firms have enough dry powder to fund startups that obsess over their customer-market fit & clear path to profitability. Those who have been funded and are in need of a fresh round will have to face greater scrutiny on sustainability. The ones that are at the growth stage may have to settle for a lower valuation.
In order to tide through the gloomy funding winter, startups will have to focus on extending their runway. The simplest way to do that is by reducing the burn rate & generating revenue. For the first time, start-ups must ensure their acquisition cost is lower than the revenue generated by an onboarded customer.
Investors and founders will recall Sequoia’s iconic “RIP Good Times” presentation ahead of the 2008 great recession. While the situation is a far cry from that, founders must approach this winter with renewed clarity on their problem statement.
This winter is all about the survival of the quickest and startups that can reflect & pivot in time will thrive when the spring eventually returns to the startup ecosystem. Click To Tweet
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1. What is startup funding winter?
Funding winter is a market correction phase where the cash flow decreases and it becomes difficult for businesses to raise money. As a result, startups with higher burn rate & acquisition cost find it difficult to survive.
2. How long will the startup funding winter last?
According to the latest PwC report, startup funding winter can last from anywhere between 12-18 months. During this time, startups must focus on building profitable businesses and extending their ‘funding runway’.
3. What is the startup funding trend in 2022?
Indian startups are currently facing a fund crunch post a record-breaking year. Most investors are hesitant in writing high value checks & renegotiating valuations with due diligence becoming the new norm. Early-stage startups are being given priority based on their business models.
4. How to raise funds for startups during funding winter 2022?
Traditionally VC & PE firms were the most popular routes for startup founders to raise capital. In the absence of easy capital due to funding winter, founders are increasingly looking at other underexplored routes such as crowd-funding, venture debt & government schemes for startups.