When Private Equity (PE) and Venture Capital (VC) investments in India logged a record high in 2021, it was hailed as a golden era for startups as ample investors competed to grab a piece of the pie. However, as evolving macroeconomic factors and much-justified re-evaluations take excess heat out of the system, VC investments might be headed to a conservative, yet reasonable future, paving the way in for strategic investors once again.
A peek into the rear-view mirror
Over the last five years, venture capital deal volumes have grown at a rapid pace, logging a staggering 95% uptick in 2021. In addition, the average deal size more than doubled to ~25mn in 2021, and with the growing number of unicorns being minted in India every year (44 in 2021 alone), the country saw strong interest from established names and new entrants alike. Increased technology adoption during the pandemic, funnelled $3.7bn to B2B and B2C ecommerce startups in the first four months of 2021 alone. 2021 also saw $14bn worth of exit deals, where secondary transactions drove 3/5ths of the exit value. At the same time, this did stir the fear of missing out in the VC space, which injected ample supply of dry powder into the ecosystem, amplified by the rise of fintech and edtech unicorns like Byju’s and RazorPay to glory.
VC investments in 2022: a much needed correction?
The VC investment frenzy of 2021 was propelled partly by low interest rates across the globe, and excessive enthusiasm in the technology sector, which recorded multi-fold gains over 2020-21. Moreover, startup valuations have always been driven by relative pricing dynamics. Apart from contributing to the bubble, these overvaluations also led to immoderate payroll expansions, which led to the technology sector’s infamous attrition problem. For the strategic investor, these factors tilted the build vs. buy conundrum in favour of the former while PE/VC funds overshadowed them in a race to make profitable exits.
While investors have continued to pump more cash into VC funds in 2022, $18bn have been invested in the first half of 2022. The number of $100mn+ deals have contracted, and investors are less enthusiastic to bet on late-stage startups, especially as macro-trends such as rising interest rates in the US, oncoming slowdown, and devaluation of publicly listed technology companies and startups alike has led to a trickle-effect across the ecosystem. In fact, overvaluation was a global issue until recently, when US-based unicorns like Klarna, Canva, and Gopuff lost up to 50% in value when re-evaluated in 2022. Dry powder is estimated at $50bn as of August 2022 indicates VC funds are exercising increased caution in placing bets now.
The inevitable reset: what’s next for strategic investors?
In a market where exits have become more difficult and VC funds show no signs of hurry in deploying the funds, the ecosystem is likely to head towards a rationalisation. There is a renewed focus on profitability, and cash preservation has taken precedence over the prevailing FOMO that characterised 2021. In fact, the hype was so prominent, that it persuaded market leaders of the replacement of strategic investors entirely by PE/VC Funds. Moreover, the Great Resignation, which is at its peak in India (where 66% are expected to quit their jobs in 3-6 months) is now evolving into a phase of Great Renegotiation, where cash-strapped startups are considering new ways to retain talent pools.
Now that low interest rates and a bullish tech sector of 2021 is undergoing course correction amidst rising interest rates across the globe, overvalued startups will be subjected to more realistic valuations. In addition, slower exits and the piling of dry powder despite the cautious deployments will lead financial investors to consider more promising avenues through seed rounds. In the process, they are likely to cinder capping their losses in deals with significant downsides, which will present exciting opportunities for strategic investors. The return of reason and talent stability to the markets will therefore pave the way for strategic investors, which were until hence, unable to justify the extraordinary premiums across deal opportunities in 2021.
Leading analysts continue to issue optimistic forecasts for 2022, and most expect a deployment of $30-31bn by the end of the year – while this number will mark an 18% decline from 2021, it must be read as the return of the market to reasonable expectations, and rational dealmaking rather than a deal winter, so to say. Instead of an unflinching focus on growth valuation, a return to unit economics and rationalisation of payrolls will pave the way for strategic deals and improve their quality in the long-term, while emerging sectors like Web 3.0 will continue to attract interest from VC funds. Finally with the return of exit momentum to moderation, strategic investors may spot lucrative deal opportunities from financial investors that are looking to cap their downsides and redeploy the capital in more promising avenues.