Late-stage deals are back but funding winter is far from over say VCs

• The funding winter is far from over and the recovery will be slow, say industry experts.
• But late stage deals have picked up in the last quarter due to valuation catchup.
• VCs too are facing pressure from LPs who have not received their Distributed to Paid-In Capital.
• Foreign LPs have turned wary while authorizing drawdowns for investments in India
  

Three startups — Zepto, Zyber 365 and Incred — turned unicorns in the last few months. They were the first such to officially hit the $1 billion valuation mark in 2023. While this indicates that late-stage deals are back in the market, there’s no thaw in the funding winter that’s set in mid-2022, say experts.

“The funding winter is far from over. We are not even halfway there,” Anas Rahman Junaid, chief researcher at Hurun India told Business Insider India.

Concurs Fazal Ahad, managing director at Merisis Advisors, “We expect the funding winter to start reducing and regular activity to start in a couple of quarters.”

In the quarter ending September, the startup ecosystem raised $1.9 billion, hitting a five-year low, as per KPMG’s Venture Pulse report. In spite of large deals, venture financing halved even on a quarter-on-quarter basis from $3.3 billion raised in July quarter.

Even at the height of funding winter, the early stage deals have been happening till Series B. Thanks to the valuation catch-up, funding has just now picked up in late-stage deals as well.

“There seems to have been more activity in the funding space but the metric for funding has evolved, which will mean valuations will remain under pressure especially at the late stage, though we feel the process will be slow and we may not see the 2020/21 phase for a long time,” said Manoj Agarwal, Co-founder & Managing Partner, SeaFund.

It’s a founders’ winter

Venture Capital firms had become tightfisted after the interest rate tightening cycle set in the summer of 2022. Since then, a lot of changes have set into the Indian startup ecosystem saw acquisitions, layoffs and more. But mostly, startups charted a path to profitability by tightening belts and rationalizing growth plans.

“The driver for companies during the funding days of 2021 was raising the next round. That was the driver for founders and most early VCs. Because of the slowdown, the focus shifted to profitability, where it should always have been,” said Bhaskar Majumdar, managing partner at Unicorn India Ventures.

Most VCs now are letting startups clean up shop before betting on them – extending the phase of funding winter.

“The duration of the current funding winter in the startup ecosystem is closely tied to the adaptability of founders. This phase will likely persist for those founders who resist aligning their valuations, expectations, and business models with the current market realities,” says Anirudh A Damani, managing partner at Artha Venture Fund.

India vs foreign LPs differ on drawdowns

While startups are struggling to match growth with profitability, VCs too are facing a tough road with higher-for-longer interest cycles, making capital tighter. They are under pressures of their own.

“VCs are also facing tailwinds from limited partners who haven’t got their Distributed to Paid-In Capital or DPIs. VCs are now starting to focus on DPIs,” says Majumdar. DPIs is a measure of the total capital that a fund has returned thus far to its investors.

Theoretically, there is a lot of dry powder amounting to as much as $40 billion sitting with VCs that are keen to invest in India. But these funds seem to be stuck in a strange limbo.

“The dry powder scenario in India's VC market presents a unique dichotomy. On the one hand, significant dry powder is available, but on the other, many foreign funds are experiencing reluctance from their LPs to authorize drawdowns for investments in India or VC asset classes, given the global uncertainties affecting this sector,” says Damani.

At the same time, Indian LPs have been aggressively backing funds as well as investments. Damani adds that Indian funds flush with domestic capital are facing intense drawdown pressures, and looking for investment opportunities to meet LP expectations.

“In 2023 itself, funds worth $5 billion have been launched to invest in Indian startups. Add to them the pool of capital available with the existing funds, and we have plenty of dry powder available for investing in India,” insists Agarwal.

The startup funding environment is currently under many forces and pressures. Yet, experts insist that good business models will always find investments — meaning that the fit will always survive.

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