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Funding in 2023: The Year of ‘Cautious Optimism’

India-focused funds are well-capitalised. As per recent reports, India-focused funds are sitting over USD 12.9 billion corpus of unallocated funds. These investors are looking at the right businesses with vision and a clear path to profitability

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If 2021 was the year of unbridled optimism, 2022 turned out to be the year of cautious pragmatism for start-up eco-system in India, particularly on the funding side. It didn’t require an oracle to foresee that the funding frenzy of 2021, marked by FOMO-driven investments and companies focusing on hyper-growth at any cost was not sustainable and would lead to pain and suffering for many; which it did in 2022. 

The year has been characterised by dreaded buzzwords; layoffs, hiring freeze, flat rounds, and down rounds. As the year comes to an end, every founder and investor is asking the same question. Is 2023 going to be an extension of the year past? As a person who has worn both the hats, of the founder and the investor, I think the picture might not be as gloomy as it seems and there are reasons to be cautiously optimistic.

First of all, the fundamentals of Indian economy remain strong. Despite the global headwinds, India continues to register robust economic growth fuelled by pragmatic and sensible approach to economic and foreign policy issues. The digital rails which paved the path for India’s start-up boom continue to evolve and mature, leading to better access to digital tools and bringing in more efficiency for both the consumers and the founders. This does not necessarily mean India is, or will be, immune to global macro risks such as inflation, interest rate hikes or geo-political factors. It means India is in a relatively better position to handle the shocks and adapt well to changing environment.

Secondly, India focused funds are well-capitalized. As per recent reports, India focused funds are sitting over $12.9 billion corpus of unallocated funds. These investors are looking at the right businesses with vision and clear path to profitability. A very good example of robust businesses and sectors not only surviving but thriving in the funding winter is SaaS. While for virtually every other sector, 2022 was disappointing to say the least, SaaS businesses raised significantly more funding in 2022 than they did in 2021.

As far as valuations are concerned, there may not be significant rebound. In fact, investors will make a hard bargain and will look at deals with realistic valuations. Again, SaaS businesses provide a glimpse into the future on valuation reset and adjustment as well. In 2022, there was significant reset in valuations. While the multiple last year ranged quite a bit, the companies need to be ready for the multiples to be following long term average and also need to demonstrate revenues sooner than what was acceptable last year. If a sector which has performed relatively better despite the prevailing conditions is witnessing significant adjustment in valuations, it is safe to predict that the era of sky-high valuation is gone, at least for the next few years.

One of the key features of the funding frenzy of 2021 was investors betting on ambition rather than experience. This was a major factor in driving the hyper-growth focus that resulted in crash and burn of sectors like ed-tech. Now, experience will get a premium. The founders demonstrating fiscal prudence, clear thinking, a robust vision for sustainable growth and experience in building marketable products will be prioritized. In the last 2 years, operational excellence had taken little bit of a back seat and brand building and market share in terms of revenues or new customer acquisition had taken a lot more front seat and as a result, the operational excellence had become slightly less important. This is going to change. Operational excellence will become far more important for investors.

A positive trend from the investors’ side we saw developing this year was a longer diligence cycle. The investors will take more time to ask the founders about product-market fit, unit economics, path to profitability and dig deeper into the actual execution capability rather than solely focusing on vision and ambition of the founders.

Finally, as with every cycle, this funding boom and winter is also an opportunity. As has been witnessed in previous cycles, the valuation reset might be more permanent than transitionary for existing industries utilizing Internet as a distribution platform. Once the fund availability improves, as with every cycle, there will be a lot more focus on new industries. One emerging sector that could see a funding frenzy is deep-tech, a combination of hardware plus software, Internet of Things (IoT). Year 2023 could be a defining year for such businesses.

For investors and founders, it is essential to learn the lessons from 2022 and rather than assuming the worst is ahead, go back to building the basics. Despite the doomsday prophecies, the diligent investor and prudent founder will always find the winning formula.