How Venture Capital is enhancing focus on sustainable business models

The macroeconomic environment prevalent today globally is increasingly emphasizing the need for capital preservation within organizations. Global macroeconomic headwinds such as high inflation, interest rate hikes and the ongoing Russia-Ukraine war has dented investor confidence. The scenario has trickled down to India, with big-ticket funding drying up and investors remaining cautious about writing large cheques towards late-stage start-ups/unicorns.

According to a recent CB Insights report, VC funding in India hit a 21-month low in Q2 FY23. In the comparable period of last year, funding reduced from $9.8 Bn to $2.8 bn. The number of deals in the equivalent period reduced from 525 to 387.

Even though the transaction activity levels may seem to have slowed down and many sophisticated market participants talking about a long funding winter (some developed countries are convinced about an upcoming recession), however, there is money waiting on the sidelines. Investors are sitting on a significant dry powder of around billions of dollars, which has to be deployed in the near future. In addition to the existing Funds’ dry powder, there have been several new funds launched in the past couple of years that raised $6 Bn in fresh capital which is yet to be invested. However, this capital is going to be not as easily accessible – there is a lot of diligence which will accompany this capital, many a times to compensate for the relatively more generous underwriting done in the past.

The current environment for Entrepreneurs raising new capital has become discerning as capital providers are cautiously deploying fund in a world that suddenly looks very different from what it was at the beginning of the calendar year. In the last couple of years, the start-up ecosystem witnessed a highly benign funding environment where companies commanded valuations and were flushed with offers for funding. There were a record number of start-ups during this period that turned unicorns. Many of these unicorns are finding the going rough in the changed circumstances. IPO bound companies like OYO and Pharmeasy have put plans to go public on hold because of the prevailing market conditions and are now focusing on improving unit economics and turning profitable. Soft Bank, a large and prominent late-stage tech investor has also marked down their investment value in OYO by more than ~20%. Public markets have also illustrated this trend by providing a much warmer reception to more sustainable unicorns such as Nykaa compared to loss making ones like Paytm, Zomato and Policy Bazaar.

In the current environment, Investors are now once again going back to basics. The markets in general and companies like Titan, Pidilite, Dabur, Asian Paints in particular- which are cash flow generating businesses and can scale without the need of external capital to fund cash-burn are near all-time highs. The sheen of a “new world companies which should not be subject to quarterly earning calls” is disappearing quite fast. Investors are digging deeper and scrutinizing the unit economics of businesses and looking at previously overlooked (or not so deeply studied) parameters to distinguish between high quality and not so high quality. Investors are not shying away from asking tough questions to unicorns. Byju’s, which is India’s most valued start-up at ~$23 billion, is a classic example- where the company has been facing increased scrutiny from its auditors and investors amidst rising losses.

So, while funding may have dried up for late-stage tech startups/ unicorns, given the hazy environment existing today; there is dry powder which is ready to be deployed in high-quality businesses. Sustainable businesses which are providing technology or tech-enabled services which increases efficiency of output, creating consumer brands, making a shift from unorganized to organized services, or operating in the healthcare industry with a focus on providing quality patient care are likely to do well in the times to come.

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