The start of the new decade has so far not been auspicious for the economy. The coronavirus pandemic has caused a seachange in human behaviour as well as in business activity. The magnitude of the havoc created in over 178 countries is no less than a global war or an economic recession. Naturally, this will have deep ramifications on the startup ecosystem, tech economy and investment climate.
However, the negative impact of the pandemic is not readily apparent in the total capital inflow into Indian startups in Q1 2020, which concluded this week. In fact, the funding inflow has been better than every quarter in 2019.
The total capital raised by Indian startups in Q1 2020 stood at $4.1 Bn, which is 12% higher than the previous quarter.
The $807 Mn investment in OYO along with other outlier funding rounds have increased the overall value of funding this quarter. The real picture, however, is clear when you look at the data without the outlier funding rounds in all quarters from 2014 to Q1 2020.
Without the outlier rounds, the total funding amount in Q1 2020 was $3.31 Bn, 10% lower than the previous quarter.
It is a fact that the Covid-19 pandemic, along with the lockdown which followed in India and other countries has had a devastating impact on the startup ecosystem. There have been numerous reports on employee layoffs, cutting down of startup valuations, investors pulling out of funding rounds and a slowdown in the overall business performance of startups.
Two primary reasons behind the flux in the ecosystem are uncertainty and panic. With the sudden turn in events, the operations of Indian startups are poised to witness a series of fundamental changes, but the question remains how fruitful will this be for the overall health of the Indian startup economy.
Pandemic Fears Grip Startup Funding
The mega funding rounds in OYO ($807 Mn), ReNew Power ($450 Mn), FirstCry ($296 Mn) and others uplifted the overall value of capital inflow in Q1 2020 compared to the previous quarter. These outliers had a big role to play in the overall macro outlook of funding, but beyond this Q1 2020 has been only marginally better than the previous quarter on the deal count and the number of unique startups funded.
Compared to Q4 2019, both the deal count and the number of unique startups funded witnessed a minor uptick of 2% in Q1 2020, which is below the average quarterly percentage growth (6%) from 2014 to Q1 2020.
This clearly indicates that the venture capital activity has been underwhelming in this quarter when looking beyond just the funding amount.
Growth Stage Funding Takes A Hit
The growth stage (Series A and B) funding rounds, which are considered crucial for any startup looking to scale up its operations, plunged drastically in Q1 2020. The total funding amount of $550 Mn was 45% lower compared to the previous quarter ($998 Mn), whereas the total deal count of 47 funding rounds, was 36% lower than the 74 recorded in Q4 2019.
The primary reason behind the downfall in growth-stage funding is the fact that the acceptance of “growth at any cost” is fading among investors, with a bigger focus on sustainability and profit margins. In addition to this, the pandemic also brought some of the growth stage deal talks to a halt due to travel and meeting restrictions as well as the fear of uncertainty.
On the contrary, seed-stage and late-stage investment witnessed a surge in capital inflow and deal count in Q1 2020 compared to the previous quarter. Although the investments at the seed stage were relatively better than the previous quarter, DataLabs estimates that seed funding deals will decline in the next few months. Given the high risk associated with seed-stage deals and the increasing uncertainty stemming from the various coronavirus quarantines and safety measures, the capital inflow is likely to drop in the following quarter.
The Changing Tide Of VC Funding After Covid-19
The lockdown and quarantine situation has brought a reality check for startups as well as investors. The long-applauded culture of ‘blitzscaling’ which was defined by Reid Hoffman as “prioritising speed of scaling over efficiency, in the environment of uncertainty” is increasingly being questioned.
Conservation of cash is the new normal in the Indian startup ecosystem. This fundamental change will result in shifts in models and operations.
Sustainability Over Valuation
As the trend to conserve capital becomes prevalent, investors will bet on startups that have better unit economics and can achieve sustainable growth without burning external capital. Therefore capital-intensive businesses who had achieved high growth at the cost of profit margins will find it difficult to attract VC investments in the following quarters in 2020.
Even beyond the already poor state of seed funding in the Indian market in 2019, VCs will find seed-stage investments the riskiest in the current climate. The uncertainty of raising capital after the seed stage is very high, this means that even angel investors might not be as open to deals as exit opportunities shrink.
Enterprise Tech Set For Golden Age?
Despite the disruption brought in by the pandemic, businesses are continuing to make ends meet through remote working, team management and SaaS tools.
This opens up the market for enterprise tech products and services in India. So far enterprise tech startups have been heavily dependent on international clientele for revenue generation. One primary reason behind this was the lack of adoption by Indian businesses, which is changing with the lockdown and work-from-home reality. Businesses, particularly those in the SMB segment, were forced to use tools such as remote workplace management, video conferencing and meeting software.
With the habit being formed gradually, the demand for enterprise tools is expected to rise in the coming years.
Overall, the quarantines and the pandemic has had a devastating impact on sectors such as ecommerce, retail, travel, transport tech, hospitality and food & beverage. On the other hand, sectors such as media and entertainment, edtech, workplace management tools, video conferencing apps, healthcare apps and personal hygiene segments have witnessed an unprecedented boom.
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So even amid this economic turmoil, investors can capitalise by having a diversified portfolio.
Note: Q1 2020 data till 28 March