Photo:istock
Photo:istock

Valuation concerns dampen activity in seed stage VC deals

Seed-stage deals may be turning a corner. Investors expect that 2019 could reverse the four-year downward trend

Mumbai: While late-stage venture capital deals saw a record 2018 driven by a slew of big-ticket fundraising and exits, seed-stage deals witnessed a slowdown in recent times owing to valuation concerns, according to venture capital investors.

According to data from private capital tracker Venture Intelligence, 2015 onwards, seed transactions have fallen both in value and volume, recording 150 deals worth $124 million in 2018. At its peak in 2015, 211 deals worth $161 million were recorded.

“The founder delays the funding as the valuation offered may not meet their aspiration. This led to lower funding. In these cases, founders bootstrap and build value hoping to raise a bigger round later at a better valuation," said Anil Joshi, managing partner, Unicorn India Ventures, an early-stage investor.

Sectors such as lending, content and education have seen strong funding in growth stages. But the relative success of these sectors has meant that early-stage start-ups are seeking higher valuation on the back of the momentum that the sector is witnessing.

After the heady funding frenzy of 2015-16, investors also became more cautious on early-stage bets, which did not yield the expected returns.

“People who invested 4-5 years ago, are still waiting for the money to come back before they invest again," said Vikram Gupta, founder and managing director, IvyCap Ventures, an early-stage investor.

“Exits for seed investors happen either through further rounds or a merger. There have been fewer transactions in both these categories, and lack of exits has been a key issue."

According to Anirudh Damani, managing partner of seed-stage investor Artha Venture Fund, investors have become more conscious of the risks that come with investing in the early-stage space.

“Investors poured money without fully understanding the risks or requirements, but since the listed market was delivering fantastic returns in 2016, deploying some of the profits into venture made sense. However, by the second half of 2018 the write-offs started, the markets went into a tailspin and once the spray and pray model’s downsides were fully revealed, it led to a flight to safety."

Investors and entrepreneurs also seem to have got more real and, today, there is a sense of reality, as opposed to the funding boom of 2015-16, when founders got a term sheet after one meeting, said Srikrishna Ramamoorthy, partner, Unitus Ventures, a seed stage investor. He added that the quality of founders has also improved, making expectations higher and making it more difficult for some founders to get funding, which would have been easier a few years ago.

The recent move by income tax department to levy angel tax, wherein startups were asked to pay tax on inflated valuations over and above their ‘fair market value’, is also keeping investors at bay. “Most startups start small and raise money at a premium linked to future performance. But it takes time to get big. Due to angel tax, the cost of funding increases and it doesn’t make sense for founders to raise money," said Joshi of Unicorn India Ventures.

However, seed-stage deals may be turning a corner and investors expect that 2019 could reverse the four-year downward trend. “The deal flow has increased again, especially in the last three months. I expect to see an increased number of good quality seed-stage deals this year," said Prerna Bhutani, partner, India Quotient, an early-stage fund.

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