Startups left high and dry as VCs press reset

Funding Reset

TILL 11 December 2022, the total large funding ($5 million and above) that had flown into startups from VCs this year was down 40% over the whole of 2021. Even compared to 11 December 2021, it was down 35%, reflecting concerns about the funding winter.

Still, total funding in 2022 so far is significantly more than in the years before 2021. This suggests 2021 was the exceptional year, and not 2022.

The year 2021 was exceptional due to low interest rates, high-profile exits and a general optimism driven by the tech adoption due to covid-19. That optimism tempered in 2022 in a backdrop made fraught by the Russia-Ukraine war and central banks clamping down on easy capital. This forced tech companies to focus on costs, which was reflected in layoffs. Deal closures became longer and the terms harder. The average deal size dropped 44% in 2022 over 2021.

July No More

LAST CALENDAR year, the second half was more active than the first. The second half accounted for 67% of the total deal value in 2021 (and 64% as of 11 December 2021).

However, in 2022, the July-December period so far has accounted for only 18%. The large deals data since 2010 shows that VCs tend to close most deals in July, and 2021 was no exception. By contrast, the first three months were the most active in 2022. A VC deal takes months to close, and most of these deals were initiated in 2021, during more optimistic times.

However, as the news of the Russia-Ukraine war sank in, and the fears of a slowdown intensified, thanks to tighter monetary policy by the US and other central banks, VCs became cautious. This reflected in the second half.

VC deal size in July 2022 dropped by over 88% compared to July 2021.

Spreading Wings

BENGALURU AND the National Capital Region (NCR) continue to dominate the funding landscape, accounting for about 60% of large deals struck in 2021. The greater availability of tech talent here led to the creation of startups, which attracted VC firms, and in turn attracted more talent. However, 2022 has tilted the field slightly. While Bengaluru and NCR saw the number of $5-million-plus deals fall marginally, Mumbai and other centres picked up. This is part of a long-term trend, which is driven by several factors. Valuations in smaller centres tend to be more reasonable, and therefore more attractive to VCs. Many believe India’s growth will be driven by tier-II centres. Lastly, the pandemic demonstrated the benefits of remote working, and therefore the possibilities in smaller centres.

Staying Power

THE MEDIAN age of startups that received $5-million-plus funding in 2022 was 11-and-a-half years, compared to 10 years in 2021.

It’s partly because companies that typically receive large funding tend to be in the middle or later stage, and the median age tends to go up over the years (unless it’s offset by newer startups getting big investments, as it happened in 2019). However, in the current context, the jump in the median age also reflects VCs becoming more discerning. Globally, VCs don’t have a shortage of funds to disburse—‘dry powder’ in industry lingo. According to an NVCA and PitchBook report, VCs are sitting on $290 billion of dry powder.

However, when risk levels rise, VCs tend to bet on companies with a longer track record, often from within their portfolios. While dry powder is high, they are now more careful on how to deploy it.

Caution Rules

THE CAUTION is also reflected in the money that VCs were willing to part with in the medium and later stages of funding (Series C and later). In 2021, the year of optimism, medium- and later-stage funding accounted for 86% of all stages of funding, including seed, pre-series, and series A and B. However, this year, this reset to 66%, which is even lower than in 2018 and 2019.

In fact, in most of the later rounds that VCs invested in companies, across ticket sizes, the average investment dropped between 24% and 79% compared to the previous year.

The two exceptions were series D and series F. In its recent report Tracxn Geo Annual Report: India Tech 2022, Tracxn said late-stage investments dragged overall funding in India. The worst impacted segments are fintech, retail and edtech, it said.

Will 2023 be better?

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