VCs Exercise Caution and Increase Diligence Amid Slowdown in Startup Deals
- ByStartupStory | April 10, 2023
The venture capital inflow to India’s startup industry witnessed a drop of almost 20% in Q1 of 2023, leading risk capital investors to adopt more rigorous scrutiny of business models and extended deal-closing timelines. This decline has caused a delay in closing both early and late-stage deals, as per inputs from investors, founders, and funding experts.
In Q1 of 2023, aggregate venture funding in India witnessed a significant decline, dropping to $2.19 billion from $11.34 billion invested during the same quarter in the previous year, as per data from Venture Intelligence. Even in Q4 of 2022, the total funding received by startups was about $3.17 billion. Anand Lunia, the founding partner of IndiaQuotient, which has invested in firms such as Koo and ShareChat, stated that the current scenario of prolonged due diligence and negotiation is similar to what transpired in 2018 or 2019. This level of scrutiny and deliberation is not new, but it had been absent when international funds were poured into India. The decision-making process is presently slower, resulting in the current sluggishness in the funding landscape.
Furthermore, investors are selecting the top contenders in each category for funding. A significant portion of the funding allocated in the Jan-Mar 2023 quarter is credited to the $500 million raised by Lenskart, Asia’s biggest eyewear retailer. Walmart-owned PhonePe also secured $650 million in three rounds as part of its $1 billion fundraise drive. Meanwhile, investors are taking more time to conduct thorough due diligence for other deals. The discrepancy in valuation expectations between founders and potential investors is also impacting deal closures. These protracted timelines resemble those seen in the pre-pandemic years of 2018-2019. The massive funding boom that Indian startups witnessed in 2021 was fueled by a substantial increase in demand for digital services and a surge in global money supply.
Anand Lunia highlighted the macroeconomic transformations triggered by the pandemic, stating that companies cannot devote six months to one deal if they are raising one fund every six months. Previously, incoming investors would accept existing diligence work, but that is no longer the case. Due diligence was previously conducted quickly by lawyers and third-party firms, but the practice has declined. Internal teams that conduct due diligence are also more cautious now and are spending more time to avoid making mistakes. According to Lunia, this could be due to the fear of being caught off guard.
During the previous years of the funding boom, investors were eager to close deals quickly to avoid missing out on valuable assets. This year, however, VC firms have slowed down their pace, and some funds are requesting additional data, causing negotiations to take longer. According to Madhur Singhal, managing partner of the financial investors group at Praxis Global Alliance, a consulting and advisory firm that assists venture investors with commercial due diligence and M&A, the situation has changed this year. Last year, numerous funds competed to acquire good assets, but that is no longer the case. Investors are now conducting pre-due diligence and asking for exclusivity.
According to investors, startups will remain focused on enhancing core metrics until the funding slowdown subsides. The bottom of the situation is yet to be seen, and it may not occur until the US Fed’s rate cycle changes, which is unpredictable. Anand Prasanna, the managing partner of Iron Pillar, a venture fund that has invested in FreshToHome, Uniphore, Servify, and Curefoods, shared this view. To prepare for the next fundraising, startups will also aim to create what may be required. Early-stage companies’ top priority now is to reduce their cash burn rate and survive until 2023, according to IndiaQuotient’s Lunia.
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