How The 2022 Funding Winter Has Fuelled The Surge In Indian Startup M&As

Picture yourself in a brutally cold winter with not many resources to keep yourself warm or sheltered. In such adversity, humans huddling together can be the difference between survival and death. And so it is for some startups in the ongoing funding winter.

We won’t waste too much time convincing anyone that things are bad for the startup ecosystem in the short term from the point of view of capital inflow and business prospects. The data for Q3 2022 makes for dismal reading already as we have seen, with just $3 Bn raised between July and September.

Headwinds such as rising inflation, the consequent drop in consumer spending, slowdown in pace of private investments, sell-offs in the public markets and global fiscal pressures have squeezed plenty of startups already.

If the 12,500+ layoffs are one indication, then the spate of shutdowns in the edtech sector in particular is another clue. But arguably the biggest indicator is the record number of M&As for the first three quarters.

With 203 recorded mergers and acquisitions, this year is on pace to crush last year’s record of 210 M&As. Besides this, the total number of recorded M&As from 2014 onwards breached the 1,100 mark in Q3 2022. So what explains this surge?

Funding Crunch Trickles Down

The funding winter began early in the year for giants such as Unacademy, BYJU’S, Meesho and other late stage startups. These startups typically lead M&As, but are struggling to raise funds. And it’s only in the second and third quarter that this slowdown is trickling down to growth stage and early stage companies, particularly those that are yet to raise funds.

In fact, a majority 130 of the 203 M&As in 2022 till September 24, 2022 have been for bootstrapped startups. It’s safe to assume that several of them might have been in the market for funds. The number of acquired bootstrapped startups in 2022 has already exceeded the total tally of 127 in 2021.

In contrast, late-stage and growth-stage startups accounted for 31 deals, while seed stage startups were acquired in 32 M&A transactions. Essentially, the acquired funded startups only accounted for less than half of the total acquired bootstrapped startups.

This indicates that the pressure of investor exits has not been the primary driver of M&As in 2022.

As per a survey of the 30 most active venture capital and venture debt firms in India, the M&A wave is being driven by late-stage startups looking to consolidate their market share or expand into new verticals. A majority 58% of respondents believed this to be the primary reason, while only 23% believed that it was the pressure of investor exits that forced companies into M&As.

House Of Brands Lead M&As In 2022

Last year’s M&A boom was led by BYJU’S but D2C house of brands also accounted for a significant chunk. Seven of the 10 most acquisitive companies in 2021 were house of brands and together they accounted for 47 acquisitions.

In 2022, house of brands are more firmly driving the M&A boom, even as edtech giants have taken somewhat of a backseat. This year, 47 M&As have come from the ecommerce sector, followed by 35 from the enterprise tech sector and 18 in consumer services.

Indeed, ecommerce ‘platforms’ such as GlobalBees, Curefoods, Mensa Brands have led the M&A wave with 20 M&As this year. Firstcry-backed GlobalBees has led the way with eight acquisitions, followed by Curefoods and Mensa, both of whom acquired six startups.

As competition in the D2C and retail brands segment intensifies with the emergence of many more brands, such acquisitions are expected to drive the consolidation wave in ecommerce. It’s not just startups making the big moves, but also corporate-backed retail platform plays.

For instance, Aditya Birla Fashion-backed TMRW is looking to acquire/incubate 30 fashion and lifestyle brands over the next year. Similarly, Mumbai-based listed beauty platform Nykaa is also looking to bolster the number of brands under its umbrella.

After acquiring three companies last year, Nykaa is accelerating the house of brands plan. Indeed, much of its business growth in the current year (FY23) has come on the back of new launches such as Nykaa Fashion’s Twig & Twine home decor brand, men’s innerwear brand Gloot, and accessories brands Azai and Kica.

The exceptions to the dominance of house of brands in the M&As landscape are upGrad and Shiprocket, both of which have acquired five startups in 2022.

Mumbai-based higher education startup upGrad is something of an anomaly in the edtech segment, given that BYJU’S and Unacademy have been relatively quiet on the acquisitions front in 2022.

However, upGrad and Shiprocket have had contrasting years when it comes to profitability in FY21.

Zomato-backed Shiprocket clocked $49.7 Mn in revenue from operations in FY21, with a profit of just over $1 Mn.

Besides the massive $200 Mn deal for an 80% stake in Pickrr, Shiprocket also acquired Glaucus Supply Chain, Wigzo, Rocketbox and Omuni fuelled by funding from Zomato last year. Soon after these acquisitions, the company entered the unicorn club with a $33.5 Mn bridge round.

Shiprocket’s acquisitions such as Wigzo and Omuni are a strategy for the logistics tech company to diversify into customer engagement and omnichannel retail tech.

In contrast, upGrad reported a loss of INR 211 Cr ($30 Mn) in FY21, but this year, it has acquired Rekrut India, Harappa Education, Exampur, International School of Engineering (INSOFE) and Centum. Like Shiprocket, upGrad also raised funds in the run-up to the acquisitions — $225 Mn at a valuation of $2.25 Bn in June being its latest round.

Given the problems across the edtech sector, upGrad is something of an exception when it comes to the mergers and acquisitions. upGrad entered new domains such as job placements and test prep for some entrance exams with these acquisitions

As for the high number of enterprise tech acquisitions, nine M&As involved international companies being acquired by Indian startups (including those registered outside India). In fact, SaaS startups that are primarily registered outside India led the M&A charts for enterprise tech.

What Will Q4 2022 Bring For Startup M&As?

As per analysts the demand for new technological capabilities by legacy companies as well as late-stage startups is expected to grow. More and more companies are likely to look to automate parts of their operations as part of steps towards cash conservation, and this is likely to result in acquisition of tech startups by larger players.

However, certain large ticket deals have failed in light of the current market conditions. The failure of the $4.7 Bn PayU-BillDesk deal is one example of how the funding winter will change fortunes for startups.

Besides this, scaled-up startups will look to acquire companies to bring feature and service parity with rivals. The acquisition of Dineout by Swiggy to compete with Zomato’s dining-out business and the acquisition of Blinkit by Zomato to compete with Swiggy’s Instamart are the two clearest examples how this might play out.

“Many unicorns will continue to become serial acquirers, causing a wave of consolidation among new-age businesses,” Shanthi Vijetha, partner at Grant Thornton Bharat, said in a recent report on the state of startup M&As in India.

An astonishing 90% of the investors who participated in Inc42’s latest Q3 2022 investor survey believe that the number of M&A deals in the Indian startup ecosystem is poised to grow in the next two quarters in FY23.

The Indian rupee’s (INR) steep decline against the US dollar (USD) could be the other major driver of M&As in the next few months. This could result in companies with dollar revenues (SaaS companies registered outside India for example) getting more leverage in any M&A deals.

Distress Sales On The Cards?

Distress sales have always been a feature of the tech industry, and not a bug. It’s a way out for startups because the failure rate is high. Many startups struggle to get the product-market fit even after many years and even after raising funds.

Pivots are so common because unit economics or operations prove nonviable in certain models, but when there can be no more pivots, founders can bank on IP and assets to get out of a sticky situation. Given that fundraising is proving to be particularly difficult, founders might indeed bite the bullet and enter into M&A deals to keep the slowdown from biting employees.

In March, Mumbai-based mobility startup Chalo acquired Bengaluru-based two-wheeler rental platform Vogo in a share-swap deal, after acquiring bus commute aggregator Shuttl in October 2021. Both these transactions came after the pandemic had disrupted operations and impacted revenue for the acquired companies.

Currently, investors and large companies are still in assessment mode as the spillover from the US Federal Reserve’s hawkish policy stance is expected to impact several sectors.

Forex market analysts believe the rupee is set to lose more strength in the near term against the US dollar. A depreciating rupee will slow down growth for startups in India that are already finding it expensive to scale up domestically. And this could complicate fundraising as well, forcing many of them to enter into M&As or distress sales with bigger rivals.