BackLate-stage funds set to dry up as investors put profitability first
Investors such as SoftBank and Alibaba are returning to the drawing board to look for more ‘exit-able’ firmsThe collapse of WeWork’s IPO and the disappointing listings of Uber and Lyft are prompting late-stage investors to reconsider the metrics of investing in Indian startups
PremiumMumbai: Late-stage deals in Indian startups are expected to slow down, with investors turning cautious of funding companies with a high burn rate following the meltdown of WeWork.
The Indian startup ecosystem has been marked by a number of high-growth, near-decade-old businesses, which, despite being nowhere near profitability, continue to raise huge volumes of capital with no near-term exit route in sight for investors. Think Ola, Oyo, et al. But this may change soon.
The collapse of WeWork’s initial public offering and the disappointing listings of Uber and Lyft are prompting late-stage investors to reconsider the metrics of investing in Indian startups.
Deals of more than $100 million, generally considered late-stage, could see a slowdown next year as investors such as SoftBank and Alibaba return to the drawing board to look for more “exit-able" companies—firms that either generate profits soon after this large cheque, or whose cheque will be the last private round for these firms, said four people aware of the matter, requesting anonymity.
“The threshold for late-stage capital has clearly become higher in the last few months. Investors are finally asking: ‘By when will you become profitable? Will our capital be the last capital infusion you need?’," said one of the four people cited above, a partner at a multinational venture capital fund with more than a billion dollars deployed in India.
“Investors are now telling the companies they meet: ‘Show us a clear path to profitability. Our capital should last you at least two years, or until you are profitable’," this person added.
According to data from Venture Intelligence, the value of deals of over $100 million in startups that are 10 years old or less hit a three-year-low of $3.9 billion, compared to $5.2 and $5.8 billion in 2018 and 2017 respectively.
This is despite the number of such deals rising sharply from nine in 2017 to 21 this year, showing that more startups are raising relatively smaller rounds at mid-to-late levels and beyond.
And its not just external investors. Even board members of all unicorn startups (valued at $1 billion or more) and firms close to that valuation have realized that “the days of free money may be over. Sustainability may take precedence over blind growth," said the founder of a startup valued at $500 million, the second of the four people cited above.
To be sure, venture capital in India and globally goes through alternate cycles of focus on growth and profitability, depending on which way sentiment shifts.
What is new is that if late-stage capital were to reduce substantially, it would hit the companies already floating at multi-billion dollar valuations, while companies hoping to get there would see down rounds—raising capital at a lower valuation—a typical sign of trouble in the company.
With companies assuming that capital is available for the foreseeable future, even those more than five to six years old are losing money at a unit level.
The expected funding slowdown also comes as India’s broader economy reels under its slowest growth in six years, rising unemployment and rising debt and losses in a multitude of sectors.
The investor behind some of India’s most valuable startups—Japanese investment giant SoftBank’s Vision Fund — is facing its own reckoning. According to media reports, it is unclear whether it can raise another huge fund (which it needs to), and at least five of its investments across countries—from dog-walking startup Wag to fintech firm OneConnect—have seen valuations slashed by private investors.
With late-stage investors beginning to lower their risk appetite, startups themselves will have to change track—focus earlier on revenue and profits, and create real long-term value for stakeholders, all of which create pressure in the short term.
“If late-stage deals dry up, the issue will be as much for the growth-stage companies here—those valued between $50 million and $400 million—because a lot of them are building businesses assuming capital will always be available," said an early stage investor, the third person cited above, requesting anonymity
However, several investors and entrepreneurs that Mint spoke to said that this expected funding winter for big deals could actually be good for the ecosystem.
“The questions being asked suddenly over the last two months—about unit economics, profitability, IPO—these should have always been asked, in good and bad times," said another early-stage investor.
“This could help the current billion dollar companies become sustainable even as they have great products, while younger companies can endure much longer if built efficiently with limited capital," this person added.
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