India has a remarkably different consumer landscape vis-à-vis developed markets such as the US in that the former is more volume-driven, price sensitive and economical, while the latter is more value-driven with people having a higher willingness to pay for a service. This, coupled with strong headwinds on account of global geopolitical events, interest rate hikes, supply chain obstacles, inflated input costs, and the dismal performance of tech stocks globally; have put a pause on the “erratic” investing in over-valued companies that became a global phenomenon over the last two years
The last two years were an anomaly – it exemplified abnormal growth for digital businesses. This phenomenon had a flywheel effect on the investing space, where start-ups/new-age businesses secured sky-high valuations, often at the cost of unit economics, product-market-fit, and other fundamentals of the business. Furthermore >70% of the ecosystem raised excess pre-emptive capital because it was available cheaply. Today, the ground has shifted, and the entire ecosystem is now being cautious about aggressive growth at the cost of profitability. However, one theme that has played out during and posts the pandemic is a consistent shift towards digitization for many Indian consumers.
Most global central banks saw the need to implement easing monetary policies to ensure liquidity to control the impact of the pandemic on growth. Now, to control inflation, banks had to reverse their policies and increase interest rates which subsequently led to start-ups rationalizing their valuation asks even with zero debt exposure and have used equity capital to finance their operations. Compressed multiples in global public markets have also had a trickle-down effect on private markets, leading to adjustment on absurd valuation asks and increasing focus on unit economics. Additionally, depreciation of the Indian rupee, which is at record low levels vis-a-vis the US dollar, could also impact both, start-ups that are trying to raise funding in dollar terms and the ones that have already borrowed in dollars. During such times, venture funding at a later stage (post series-B) and those nearing IPO will be limited, and investors will be cautious, taking small ticket and long-ended early-stage bets. The pace of deal-making is also likely to become more measured, with an emphasis on high-quality companies.
Public market trends indeed indicate certain headwinds for venture capital investment, affecting the investment outlook for this year. However, given the asset class’s strong footing in 2021, a robust ecosystem, and available dry powder (~$5 Bn+), the long-term outlook for India remains positive. There is an abundance of capital, waiting to be deployed in Indian start-ups, especially because of the slow-down in China. Large institutional limited partners (LPs) which had >80% of their portfolios invested in China have now moved to a China+1 strategy and India continues to be a huge beneficiary of the same.
In 2021, India-based venture capital funds distributed net positive cash-flows to their LPs. This was following several years of managers calling up more capital than they distributed (except for 2019), suggesting a momentum of successful exits. More managers raised larger vehicles, with about 15% of the funds raising over $250mn, vis-à-vis 6-7% in 2020. This reiterates high investor confidence and a buoyant fundraising environment.
At Silverneedle Ventures (SNV), we recognize these challenges and have thereby created a robust investment strategy to ring fence specific market risks with clear focus on Enterprise SaaS, B2B, deep tech, emerging technologies & consumer internet/D2C where cash burn is low, and visibility of recurring revenues is high. Our focus on early stage has created a much broader pool for co-investing possibilities, spreading the risk over a larger base. We have earmarked about 35% of the fund to double down on our select high conviction bets. We believe these are the best times for founders to dig deeper & build strong businesses; companies that show resilience and emerge stronger from this funding winter, will command higher valuations in subsequent rounds. Early-stage start-ups with sound business models can leverage their position to raise capital and SNV focuses on companies that are more mindful of their spending, have sufficient runway of at least 18 months and a clear visible path to profitability. On the strategic side, consolidation trends are likely to play out as established companies may use this environment to their advantage for buy-outs of start-ups.