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Photo: iStock
Photo: iStock

Start-ups rely on bridge rounds to tide over fund crunch

VCs want entry valuations to settle further before deploying fresh capital in start-ups

When the founders of angel-funded healthcare start-up Medd set out to raise institutional capital from venture capital (VC) funds in June, the tide had turned.

The start-up ecosystem was showing signs of trouble, with large start-ups such as Housing, TinyOwl and others laying off employees and struggling to raise capital, as venture funds became stingy.

In October, Medd raised $150,000 in a bridge round from a group of angel investors, while continuing to negotiate with VCs for a larger round.

“We were already negotiating a bigger round at that point, but negotiations were taking time," said Arpit Kothari, a co-founder at Medd, which helps locate and compare pathological labs. Medd wanted to create a buffer, in case negotiations dragged longer, while also having enough money in the bank to grow the business in the meanwhile.

Medd is one of many start-ups that have tapped bridge finance, offered by existing or new investors to ensure that the company doesn’t run out of cash until it raises the next round of funds. At the angel stage, bridge rounds are normally 1-3 crore.

Raising Series A funds of $1-10 million from VC funds has become increasingly tougher for many angel-funded start-ups.

“A large chunk of angel money these days is actually going towards bridge rounds," said Lovkesh Kapoor, founder at boutique investment bank WisdomHill Capital, which advises high net-worth individuals and family offices as part of its start-up investments practice.

The reason is that it’s not just large funding deals, venture funds have become cagey about smaller capital infusions as well.

“The bigger venture capital (VC) funds, even though they have cash, are saving it for the good bets in their portfolio. Most money from VCs will flow to these start-ups to back them in their next rounds," said Kapoor.

Although overall Series A deal activity in 2015 has doubled to almost $600 million over last year, according to data from VCCEdge, most of this funding rush came in the first half of the year. The first six months saw 72 Series A deals worth $383 million being closed. Since July, Series A deals worth only $216 million have been reported across 57 deals.

Even as VC deals have slowed, the money put in by angel investors has continued to rise.

While the first six months saw $128 million worth of angel investments (across 271 deals), the July-December period witnessed $169.5 million worth of investments (across 336 deals), shows data from VCCEdge. Angel and seed investments in 2015 have increased 60% to $284 million, compared to last year.

VCs are flush with cash, but they want entry valuations to settle further before deploying fresh capital in early-stage funding deals. In later-stage deals, like Series B and C rounds too, there is a shortage of capital, said people familiar with the market.

“There has been a lull in the market in the last two to three months and fewer VCs are cutting cheques. If a company’s revenue is X, VCs are asking them to come back when they have sales of 2X or 3X," said Mohit Gulati, an angel investor who is currently raising a new early-stage venture capital fund called Altius Ventures.

“To grow to that 2X or 3X size, these start-ups need money, and new investors are not giving that money; so start-ups have to go back to their angel investors to raise bridge rounds," said Gulati, calling it a “chicken-and-egg" situation.

The founder of a tech start-up, which recently raised a bridge round, agreed. “An option was to grow a little slow or flat on gross merchandize value. However, if we don’t show a growth of at least 5-10% month on month, then most VCs might not show an interest when we go back to them to raise funds," he said, adding it is better to raise a small bridge round to ensure decent growth and have enough cash to last out the current phase.

The past couple of years have seen a huge jump in the number of people who are making angel investments and the amounts being invested. Having made huge bets on start-ups, angel investors now find themselves in a tricky situation of having to put in more money to help their companies survive in an challenging environment.

“Earlier, if a Series A wouldn’t happen, angels would tell the company to somehow survive on its own. But in recent times, a lot of money has entered angel-funding rounds and round sizes have gone up to 5-6 crore at the angel stage. That money is now trying to back their companies with a bridge round, thinking that with such rounds, their firms will be able to survive this slowdown," said Anand Lunia, founder and partner at early-stage VC fund India Quotient.

The rush of money being invested in start-ups also resulted in firms becoming less frugal about expenses, in the belief that they will be able to raise funds when required. This has meant high cash burn at a number of firms and hence the need for more frequent funding.

“Companies started to think that they will be able to raise a Series A within next six months and this led to several start-ups burning money quickly. That behaviour is now hurting several companies," said Lunia.

While the new environment could mean some pain for start-ups, many investors are seeing it as a welcome correction.

“There is a little reality check going on, which is healthy for the ecosystem. There was a general feeling in recent times that anybody can do a start-up and that money will just come in. So, a little bit of consolidation in the industry is a welcome development and it is just a natural cycle, which is seen in almost every industry," said Rajiv Dadlani, an angel investor and a member of Mumbai Angels and Indian Angel Network.

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