Unicorns are passé, cockroaches are the new favourites of venture capitalists

• Cockroaches are startups that can survive a long period of funding winter, like the pests that can live through a nuclear war.
• Most startups pass through the cockroach phase at least once, gaining experience and knowledge as well as strategizing their business, say experts.
• For those startups that cannot survive without external funds, the future is bleak leading to mergers, acquisitions and in worse cases even shutdowns, experts say.

The Indian startup ecosystem has been maturing but it is also getting the chills with the onset of the funding winter. In these circumstances, venture capitalists (VCs) have turned their focus from the unicorns – companies valued at $1 billion, to cockroaches – companies that can survive the test of times. The name is a reference to the fact that cockroaches are known to survive even a nuclear war.

Anirudh A Damani, CEO of Artha Group defines a cockroach as a startup that does not require external support to survive. “It can run forever on the cash it generates from selling its products or services at a profit – something a loss-making startup cannot afford to do since its biggest customer is the venture capital investor,” he says.

Struggling for funds is not an unknown challenge for most startups starting from the pre-seed level. However, this time around a long funding winter has set in and is expected to last anywhere between 6-18 months as per many experts. And the funding started drying up six months back – dropping to $2.7 billion in the quarter ending September 2022 from a peak of $15.9 billion in the year-ago quarter, according to a Venture Pulse report.

A good startup can persist through these changing dynamics, experts say. “Startups following the cockroach approach persist despite changing market conditions, environments, and investment scenarios. Most of the startups pass through the cockroach phase at least once, gaining experience and knowledge as well as strategizing their business despite changing market conditions,” said Mitesh Shah, partner at Physis Capital.

To ensure that a startup turns into a cockroach, businesses will have to make tough changes in their models – founders will need to pivot focus from valuations to cash flows.

“Those unicorns sitting on cash always survive but those at the end of their runway struggle. However, the good thing is because of these times, companies have begun to focus on the businesses in terms of unit economics and the path to profitability rather than merely looking at fundraise and vanity valuations,” said Bhaskar Majumdar, managing partner, Unicorn India Ventures.

Sustainable unit economics is key


For the VC ecosystem, which has seen hits and misses in good measure, the funding winter will be an acid test. “In these winter periods, the businesses solving a fundamental human problem thrive at the expense of the companies that are buying revenues in the guise of deep discounting leading to unsustainable unit economics,” says Damani.

For those startups that cannot survive without external funds, the future is bleak leading to mergers, acquisitions and in worse cases even shutdowns.

“In the current environment, where the funding parameters have become tougher and valuations are under pressure, startups (their founders and investors) are looking at alternative survival strategies. Some startups which are heavily dependent on funding for survival and growth tend often to do distress sale or shut ship,” said Majumdar.

Sectors like edtech, which have raised a lot of funds during the pandemic, are also in trouble because of overestimates of TAM or the total addressable market. Those consumer-facing sectors which show the ‘need’ to spend money to acquire customers also might reduce a startup’s ability to turn into a cockroach.

“As their marketing spend is key for customer onboarding and a significant contributor to burn, unless they are able to pivot into models that can sustain existing business operations without discretionary marketing spend, it is highly likely such businesses are in most trouble,” said Ankur Bansal, co-founder and director of BlackSoil.

Late-stage startups in most trouble


Cockroaches who intend to survive will also have to cut down their valuation expectations, experts say. This is especially true with late-stage startups, which will require more funds, and also need to demonstrate a path to generate cash.

According to Shah, late-stage startups will face the most amount of trouble obtaining additional investment, as valuations reset and there’s renewed emphasis on profitability. There also needs to be moderation in valuation expectations, in line with the changing market dynamics.

“Good companies will definitely get access to capital but they have to be more accepting of the valuation multiples. Some correction in multiples is needed for efficient markets, every once in a while. But yes, many companies have and should be open to strategic outcomes from larger peers or established corporates,” said Apoorva Sharma, partner at Stride Ventures.

How to turn into a cockroach?


Sharma believes that Indian startup founders will channel their strong survival instincts. “They are pruning costs to ensure they have longer runways. Some companies have actually demonstrated improved unit economics,” she told Business Insider India.

As per Shah, many of those who might fail the test are the ones with a Utopian vision of scaling up beyond their capacity. Cockroaches must have sound fundamentals like product demand, a short product development cycle, and controlled capital expenditures.

“A key component of a successful cockroach startup is focusing on a specific niche or target market, at least early in its journey. A targeted, long-term business concept and a captive market are necessary for becoming a successful cockroach startup. A value-based proposition is crucial if an organisation wants to reach its target clients. A company needs a distinctive selling proposition in the business to get investors to reach for their pockets,” Shah says.

Bansal believes that a strong focus on fundamentals and cash flows is of the essence– cockroaches are those startups that can shy away from the concept of growth at all cost and focus on capital efficiencies. Most VCs also say that it’s the founders who will have to go through the mindset change along with the startup.

Majumdar lists the traits of a good cockroach that can thrive when funding is slow –“Survival instinct of the founders, ability to morph the business to a clear profitable path, inherently low key and not in the business of building profile for the sake of it.”

SEE ALSO


Tata’s mega aviation merger is poised for flight, but the skies are not clear yet

India’s GDP growth forecast continues to see cuts