The way founders approach VCs and vice-versa has changed due to the slowdown in venture funding, or “funding winter,” in 2022. Deal flow has significantly decreased, and VCs are very selective about their investments. Although investments are still down 69 per cent year-on-year, start-up funding in India experienced its first uptick of the year in October after nine months of declining activity. According to data provided by Tracxn, Indian start-ups raised $1.08 billion in October 2022, an increase of 39 per cent from September 2022.
Given that the macroeconomic environment is still uncertain with regard to the trajectory of inflation and interest rates globally as we, the situation is still unclear about a significant rebound in the near future. Because PE and VC valuations follow public markets, which are still largely unstable and plunging, cash flow is likely to remain low. In such a scenario, how can entrepreneurs make the best investment decisions?
2023 for entrepreneurs: Finding the dynamic investment areas
In spite of a decline in funding deals, early-stage funding saw growth in 2022 as deal sizes increased. According to Tracxn’s analysis, early-stage venture capital investments in India increased by more than 28 per cent in Q1 2022, from $1.17 billion to $1.50 billion.
While deals are still being conducted, the broad allocations prevalent just a few months ago have significantly slowed down. That’s why investors are no longer focusing on early-stage funding; instead, they’re looking at late-stage startups as a viable investment option with a clear path to profitability.
A focus on late-stage companies
The venture capital industry, for long, has regarded early-stage startups as the most-preferred destination for yielding the highest returns. But that isn’t always the case. In the modern era influenced by technological advancements, investors are now looking to invest in late-stage firms with a predictable business model, such as tech-based startups. Being inherently much more de-risked than early-stage companies, late-stage investments are often credited for outperforming early-stage investments in the longer run.
A Business Today report claims India overtook China in late-stage funding in 2021. The country’s share of late-stage funding globally also increased to approximately 10.5 per cent in 2022 from what was recorded at 5.7 per cent in 2019. These statistics are valid indicators of the acceleration in late-stage investments in the country, which are less risky than investing in early-stage startups, primarily because the firms being funded are established in the marketplace, and their investments can be converted more quickly into cash.
Considering tech-based startups
Investors have been betting more and more on start-ups with a “horizontal,” or cross-industry, focus in recent years. Technology played a significant role in the boom in venture capital investments over the previous years. According to a Bain & Company analysis, from 2010 to 2020, most of the venture funding from independent and corporate venture capitalists went to tech start-ups. This indicates that investors and business owners have passed the naïve stage and are now following a more methodical innovation path to get more distinct payback opportunities.
After the pandemic, there has been an increase in the use of cutting-edge technologies in startups. As the need for the ability to seamlessly distribute workloads across various computing environments grows, many businesses have increased their spending on SaaS tools, AI, ML, cloud, IoT, and other areas of their operations. Entrepreneurs can consider investing in tech-based startups because a disruptive invention usually encourages a new round of growth opportunities.
Crafting a targeted portfolio
Despite the global economic uncertainties, now is a good time for venture capitalists to build long-term value. For entrepreneurs with access to long-term capital, the current environment is excellent for building portfolios. In contrast, late-stage venture capitalists will need to comprehend the new valuation norm and realign portfolios to account for markdowns in existing portfolios before determining their appetite to invest.
Although VC leaders might want to make investments that significantly outperform the industry norm, this strategy must be followed cautiously. They must update their investment thesis in light of what they have learned and then invest in the businesses that best suit their strategy in 2023.
All things considered
This is a challenging time for venture capitalists and the businesses they fund, especially after 2022, when some industries will have suffered significantly. However, while some industries are contracting, others are steadily expanding. The need is to find the right investment in the niche that is anticipated to grow in 2023.
VCs are likely to witness significant market desperation as startups begin to run out of capital if positive economic signs take longer than six to 12 months to occur. If that desperation closely accompanies an economic turnaround, there might be a sweet spot there for VCs, but whether or not that materialises is still in disarray.
Kishore Ganji is the founder at Astir Ventures.
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