The funding winter has been acknowledged and startups have been working on measures to stretch their capital runway. The changes have been visible and immediate in growth stage companies, with multiple rounds of employee lay-offs and stretched follow-on funding.
According to a recent report by Tracxn, early-stage deals hit a 12-month low in May 2022. Startups up to Series A round mopped up $227 million across 90 rounds, compared to the unusual buoyancy of July 2021, when early-stage deals reached $654 million.
“The deal activity is tempering already and we anticipate a slowdown compared to the previous year,” says Madhur Singhal, Managing Partner and CEO at Praxis Global Alliance.
He adds that the slowdown will impact startups across ecommerce, marketplaces, edtech companies, and consumer services more than the others. Also, the mortality from seed to Series A will increase as raising Series A rounds is going to get progressively difficult.
“The bigger impact will be on tempered valuations rather than business mortality. The entrepreneurs and investors will settle at an equilibrium that is at a lower valuation multiple than what we saw last year,” adds Madhur Singhal of Praxis.
The cautionary approach will bring early stage investing back to the baseline of 60 to 70 percent conversion rate, says Deepak Gupta, Co-founder and General Partner at early-stage venture capital firm, WEH Ventures.
The five-year-old seed stage fund, which typically bets on startups across fintech, content, and commerce with cheque size between Rs 1 crore to Rs 3 crore, will continue to pace its investments in nearly six deals annually.
WEH Ventures has backed companies like content-led commerce platform from which it recorded a partial exit, as well as Sequoia-backed Animall, D2C food brand , savings app , and others.
The Mumbai-based firm, which is currently deploying from its second fund of Rs 120 crore and is yet to announce its final close, will be conserving 60 percent of the cash for follow-on rounds, taking a conservative approach of the current cycle.
“Across our vintage portfolio of the two funds, 14 out of 15 have raised substantial institutional follow-on capital, which was not led by us. This was before the markets turned,” says Deepak. He further adds, “I do think that our conversion rate may go down slightly from 92 percent to 60-70 percent because this is what historical data suggests for pre-Seed and Seed stage companies.”
Speaking about what happens to portfolio companies which fail to raise a follow-on round, Deepak says that since these are very early-stage companies, especially in the pre-Seed stage, the company can either focus on moving to the slow-burn mode or wind up its business.
“We also invest in direct-to-consumer (D2C) brands, which can be picked up by larger players for consolidation play. It purely depends on the sector and how much progress has been made by the company,” says Deepak, adding that the Indian startup ecosystem is still on the learning curve when it comes to mergers and acquisitions.
Co-founder and General Partner at WEH Ventures, Rohit Krishna, says, there could be multiple reasons for an early-stage company to not work out, not necessarily attributed to market signaling.
“Since we come in very early, there may be multiple reasons why a company fits in this 30-40 percent bracket. If the product itself doesn’t find a footing in the market and after multiple iterations, if we don’t find a significant product market fit, the company might have to shut down. In some cases, the founders themselves understand this and we have had an instance of a founder returning our capital before closing down the company,” says Rohit.
He adds that if a business is doing well and the hurdle to raise another round is market dynamics, it can always move to a low-burn model and grow at a steady pace till the market turns.
“Depending on which bucket companies fall, we either help them bridge the gap with capital or if the product itself doesn’t work, be pragmatic about it,” says Rohit.
Second fund and playbook
Since inception, WEH Ventures has a portfolio of 18 companies, with Asset Under Management (AUM) at Rs 140 crore, the bulk coming from Fund II.
“We have committed investments across nine companies from our Fund II, which is over half the intended portfolio. We will have a portfolio of about 15-17 companies from our Fund II,” says Deepak, adding that this was the time for showing venture skills, allocating the capital well, and handholding portfolio companies.
With the new Rs 120 crore fund, the firm has made very little changes and wants to stay away from a spray and pray approach.
“Our access will also get a little better because of growth in our reputation and due to the softness in the space. Our methods may change slightly, but our volumes will not change,” says Deepak, adding that at the end of the day, 70 percent of the magic comes from the founder in early-stage deal making.