Why the funding winter for Indian startups could stretch longer

Come January and India will play host to the World Startup Convention, a jamboree of startups and investors from around the world, who will converge upon a plush country club resort in Noida, to celebrate, well, startups.

Last year, in a bid to promote India as a startup destination, Prime Minister Narendra Modi had even coined January 16 as India’s National Startup Day, amid much fanfare.

So, the hype and hardsell notwithstanding, how well is Modi’s vision of making India a startup nation, say like tiny Israel, going?

If recent funding activity is any indication, things are not going as planned, and Indian startups are seeing a cash squeeze after a blockbuster 2021 when startups and unicorns raised a massive $32 billion across 1,406 deals.

To be sure, 2022 began on a strong note with January recording fundraising of almost $4 billion. But startup funding slowed thereafter and fell for four months in a row before bouncing back in June. However, the fundraising pace has slowed again since then.

June saw $2.7 billion in funds raised across 128 deals, according to startup news website YourStory. This fell to 116 deals that contributed to startups raising $652.7 million in July, registering a month-on-month decline of 76%.

July and August were not so good for the Indian startup ecosystem from a funding perspective. In August, Indian startups raised $1.08 billion across 135 deals. This was a 66% increase in fundraising from July, but 68% lower than $3.38 billion raised over 141 deals in August last year. During September, Indian startups raised about $905 million across 137 funding deals.

And this squeeze is beginning to hurt. Even if one discounts cutbacks by cryptocurrency startups like WazirX that have had to sack nearly 40% of their staff owing to a regulatory jolt delivered to such businesses in February’s union budget, other startups too are now beginning to cut back on spends.

In April, a Business Today report noted how several marquee Indian startups like Meesho and Trell had seen major spending cutbacks. And this means laying off employees. According to the Inc42 layoff tracker, over 11,000 employees were fired in the first six months of this year.

On top of that, as the report noted, were cases of alleged fraud by founders of startups like BharatPe (Ashneer Grover) and Zillingo (Ankiti Bose), to name a few.

But why is this squeeze happening?

Cash crunch

For one, there is a liquidity crunch all over the world and India is no exception. Not only has the money dried up and made global investors like Softbank and Sequoia cautious, back to back rate hikes by all the major central banks from the US Federal Reserve to the Bank of England to the Reserve Bank of India (RBI) have only exacerbated the problem.

While central banks are having to take lending rates to unprecedented levels in order to fight inflation, most recently listed blockbuster tech and fintech stocks are trading below their IPO price. One case in point- Paytm.

And to make matters worse, the ongoing war in Ukraine, tensions between China and Taiwan and elevated energy prices, have only exacerbated the problem.

“The reason for such a ‘funding winter’ is to be traced to global macroeconomic developments, especially changing interest rate regimes between 2020 and 2022. As the pandemic struck, several central banks and especially the US Federal Reserve, with a view to control the worst effects of the pandemic, followed easy monetary policies to ensure the flow of credit in the economy. These policies involved the use of both conventional and unconventional monetary-policy instruments,” Tulsi Jayakumar, a professor of economics and executive director, Centre for Family Business & Entrepreneurship, Bhavan’s SPJIMR recently noted in a piece in Mint newspaper.

Jayakumar goes on to say that as interest rates rise and with Present Value calculated by the formula [Present Value=Future Cash Flows/ (1+ interest Rate)^number of time periods], these hikes would lower the valuations of startups, even if they had no debt exposure and have used equity capital to finance their operations.

On top of that, the depreciation in the Indian rupee, which has been trading at historically low levels vis-a-vis the US dollar, will also impact both startups that are trying to raise funding in dollar terms and those which have already borrowed in dollars.

“In the case of the former, depreciation of the rupee affects their funding and also their valuations in the process. For those which have already taken dollar loans, their debts would become more expensive on account of rupee depreciation,” Jayakumar notes further.

The startup (non)story?

But does it mean India’s startup story is on the verge of becoming, well, a non-story?

Not really. As an analysis by Mint newspaper noted, as of 7 September, India had 107 unicorns making it the third biggest startup ecosystem in the world. These unicorns- startups valued at $1 billion or more- had an aggregate valuation in excess of $340.79 billion. Add to that the long list of “soonicorns”- companies that could soon turn unicorns- and the list would look even more impressive.

Analysts feel that the Indian startup ecosystem should adapt to the fund crunch.

For one, Indian startups, whose valuations have gone south and for which fundraising at lower valuations is not too attractive will need to find sources other than equity funding.

Second, they will need to find ways of conserving more cash to give themselves a longer runway.

Others like Able Joseph, founder and chief executive officer at Able told the Business Standard newspaper that startups should first spend on manpower than on marketing. Marketing expenses should produce results, cannot spend indiscriminately, he says adding that there has been overhiring for absolutely no reason. Don’t see the need for software startups to hire hundreds from top-tier colleges, the newspaper report cited him as saying.

Echoing this view, Rashmi Daga, founder and chief executive officer at FreshMenu was quoted by the same report as saying that companies should stick to their core business. They should work towards fulfilling business milestones. Firms will reduce vanity marketing spends, she said.

So, in January 2023, when Prime Minister Modi addresses entrepreneurs, the Indian startup ecosystem will still be alive and growing, but perhaps will be treading a lot more cautiously than before.