A twist and a silver lining

It is a well-known fact that like all industries, the VC industry also goes through cycles. The VC industry has a clear advantage in receiving high credit for its connection to technological disruption. The promise of a new fundamentally more digital world and the desire to participate in value creation has led to a higher capital allocation to venture capital. This expectation was fueled by the 12-year bull market cycle and the massive digital adoption that occurred during Covid. The global deployment of venture capital has grown from $220 billion in 2017 to $650 billion. Over the past 5 years, approximately $1.8 billion has been invested in early-stage and late-stage startups. Venture capital investment in India has also seen a dramatic increase, from $4.7 billion in 2017 to $38 billion in 2021.

Investment decisions made on a zoom call, seed rounds with no real rights for any investors, stretched SAFE rounds, pressure to close in a week, $5 million seeds, lack of SEO, VC emerging from the woodwork and funds VCs raised and deployed in 18 months – all of this has become the norm rather than the exception.

After many warning shots, in the second quarter of 2022, the party finally seems to be over. Until June 2022, venture capital funding acutely reflected the underlying decline in liquidity. Late-stage investors have suspended deployments, causing tension in Series C and beyond.

The level of seed funding activity was lower. Most VCs went on vacation in June and July. The market witnessed renegotiations of many deals by late-stage investors, with final valuations closing 30-50% lower than the initial offer. The founders have responded maturely to the changing environment by taking decisive action to reduce unnecessary burns. The most nimble have started raising capital to add to the pot without restricting the quality of investors.

The rounds are open at the same valuation as the last rounds that might have closed a year ago.

Startups whose business models require high consumption and delayed monetization, such as those in B2C marketplaces, are most exposed to funding risk. Low-power businesses such as SaaS startups saw less impact. Indian founders are notorious for resisting the fundraising option of lowering demand against the last-round price. Efficient private markets allow a flow of capital to businesses that operate under current conditions. Founders should keep an open mind to let the market price rounds even if it is lower than the price of the last round.

Streamlining exercises toward cash conservation undertaken by cash-rich companies have blighted many acquisition deals. The lack of acquisition activity due to valuation mismatches is expected to contribute to the mortality of cash-strapped start-ups. Many small startups are chained with the promise of a deal, but then left to drift as priorities change. This causes more pain than necessary.

For startups that hit Unicorn valuations last year but haven’t yet backed it with metrics in effect, growth in valuation is an option. But with new earnings expectations that are certainly more subdued than last year, a unicorn valuation may be a liability to raising new capital.

So where’s the silver lining?

First and foremost, India’s growth story is profound. In 2001, US venture capital struggled to find disruption big enough to sustain some funds even betting big on cleantech as a sector. India is relatively wealthy with high potential sectors such as Fintech, Agri, Healthtech, Consumer Internet and SaaS. This is the second cycle that the Indian founders are going through and the lessons are largely integrated.

Global capital allocators must choose which markets to deploy and India has emerged as a top choice given its size, quality of entrepreneurship and more recent signs of a public market that is enabling the return foreign capital at their origin.

Third, Captables is in good shape simply because recent rounds have been at high valuations. So there’s plenty of room to dilute while managing the founder’s property.

And finally, there is a lot of dry powder. India VC can be at a thriving level even at $10 billion invested capital per year. 2021 was $38 billion and there’s a lot of foam there that’s sure to be missing. We estimate over $20 billion in global committed capital raised for India that has yet to be deployed. We expect this capital to flow back to Indian start-ups by the second half of 2023.

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