For startups, the silver lining of cloud funding

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When the pandemic started, startups were preparing for the worst. They thought markets would shrink and funding would dry up. The opposite happened. The pandemic has opened up new opportunities for growth as businesses and consumers embrace digital. As of March 2022, venture capital (VC) funds have invested more than $10 billion each in three consecutive quarters. The only thing missing was talent, as startups absorbed employees, inflating salaries and benefits.

The winter startups dreaded in mid-2020 hit them in the April-June quarter. Venture capital funding fell about 40% as the Russian-Ukrainian war continued, central banks tightened the money supply and public markets lost their appetite for tech stocks. Indian unicorns that went public in 2021 to much fanfare have seen their stock prices plummet. The number of mergers and acquisitions — another exit route for VCs — fell to 54 in the quarter, from more than 100 in each of the previous two quarters, according to Venture Intelligence.

Startups react by tightening their belts. They are reducing entry bonuses and stock option offers for new employees, and reducing pay increases and notice periods for existing employees. Unacademy, an edtech startup, made headlines after it halted business class travel for senior management and free lunch for all employees. But between March and June this year, it also cut its workforce by 1,150 employees, or 16.5% of its total. According to data compiled by Inc42, Indian startups laid off over 11,360 employees in 2022, led by edtech companies, which accounted for 35% of all layoffs in the startup space.

Large-scale impact

Such concentration is common in the VC-funded startup segment. In the June quarter, 79% of all VC funding went to just five sectors: fintech, software as a service (SaaS), media and entertainment, logistics and autotech, and direct-to-consumer (D2C) . However, there was a decline in funding in nine of the 12 segments, the exceptions being fintech, media and entertainment, and B2C e-commerce.

The biggest drop – of around $1.7 billion, or 50% – was in the SaaS sector. It reflects the fortunes of Freshworks, the poster child for India’s SaaS industry and whose share price has fallen 73% from its listing price. Fintech, the second largest recipient of venture capital funding in the second quarter, saw its inflows increase by about 2%. However, the sector is also facing more intense regulatory scrutiny. In June, the Reserve Bank of India said prepaid instruments such as wallets could not use credit lines issued by non-bank lenders. This will impact the Buy Now Pay Later (BNPL) segment as expected.

Smaller ticket

The change in sentiment towards startups contrasts sharply with the outlook for Indian startups in 2021. The sector was attracting more attention from international VCs, in part due to the Chinese crackdown on its own startups. The series of IPOs in India have opened another way out. Softbank invested over $2 billion in India last year alone. Temasek has invested in 20 companies, its highest ever in the country.

Of the 48 startups that turned into unicorns last year, 22 had received investment from Tiger Global. Last year, Tiger deployed $2.3 billion across 62 deals. In a recent report, Silicon Valley Bank noted that “crossover investors are re-evaluating their private market strategy, for example, Tiger is investing in earlier deals.” In the second quarter, early investments were the only ones among the four stages to show growth, albeit from a small base. The average deal size fell to $23 million from more than $30 million in each of the previous four quarters.

Silver lining

How long this funding winter lasts will depend on multiple macro factors, including the war in Ukraine, inflationary pressures in Western economies, monetary policy and the recovery of the US tech sector, which has also seen layoffs. However, investments are unlikely to dry up.

In its State of the Market report, Silicon Valley Bank estimates that venture capital funding for 2022 in India will close at $31 billion, less than in 2021, but more than all previous years. Likewise, he adds, the size of India-focused venture capital and private equity funds has already surpassed $14.1 billion, more than three times the size of all of 2021. Even in fintech, while the BNPL segment has been hit by regulatory measures, other segments such as insuretech are bullish. What has changed is that startups have also turned their attention to efficiency and cost. It might help them in the long run.

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