Looming VC Downrounds Signal An Upcoming Reset For Indian Startups

With the lockdown might have ended in many parts of India and restrictions eased in other cities, the fallout of the Covid-19 pandemic will have a prolonged impact on India’s economy. While the Centre for Monitoring Indian Economy estimates a whopping 100-120 Mn job losses due to the nationwide lockdown, International Labour Organisation in its ‘ILO Monitor: COVID-19 and the world of work’ has further estimated that with almost 90% of people working in the country’s informal economy, about 400 Mn workers are at risk of falling deeper into poverty.

As most continue to work from home and some gingerly make their way back to the office, almost every microeconomic and macroeconomic aspect of human life seems to be cosmically entangled with the Covid-19 pandemic.

In India, however, the Covid-19 pandemic’s noticeable spread happened only by March-end. The Q1 figures of Indian startup ecosystem do not really show the pandemic impact. According to DataLabs by Inc42, in Q1 2020, Indian startups witnessed 208 deals and raised $4.1 Bn compared to 171 deals and $3.2 Bn in Q1, 2019. However, if we look at the monthly data, the slowdown in terms of funding becomes crystal clear.

In April, this year, which observed a lockdown throughout the month, only $474.4 Mn was raised against $1.06 Bn in March’20 $1.1 Bn in February’20.

Even if we look at the YoY funding amounts, April 2018 and April 2019 had seen $.1.09 Bn and $514 Mn respectively which are again high, compared to April 2020.

Facing a historic fund drought, Covid-19 simply made startup lives a lot tougher. Valley-based rental platform Lime is in talks with Uber to raise $170 Mn in a fresh venture round funding at $510 Mn post-money valuation, a 79% drop from its previous valuation.

India’s largest food delivery platform Swiggy’s funding raised during its recent round is almost 84% and 26% less than what it raised in its last two rounds closed in December 2018 (Series H) and June 2018 (Series G) respectively. In the latest round, Swiggy so far raised $113 Mn (February 2020) and $43 Mn (April 2020) in the ongoing Series I funding, significantly less than not only its last Series H ($1 Bn), but also less than Series G ($210 Mn).

Similarly, lending aggregation platform BankBazaar which had raised $30 Mn as part of Series D funding, back in October 2017 has further raised $2.2 Mn and $3.8 Mn in March and April this year, as part of the on-going Series D funding. The total funding in Series D round is thus still 40% less than Series C funding which it had raised back in 2015.

Swiggy, Bankbazaar and Lime are just a few examples where the funding appears to have been adversely affected by the pandemic — the lockdown has indeed brought in dozens of such examples where either funding has been cancelled or startups have gone through a down round with a lower valuation. The entire landscape of the Indian startup ecosystem is changing fast with some of the biggest players going from dawn to dust and new startups mushrooming to encash the new opportunities emerging in the market. As we reported earlier, unicorns such as Swiggy, Udaan, OYO and many others have either laid off or furloughed thousands of their employees or contract workers. In growth-stage startups, the situation is worsening.

And the future seems to be more ominous than optimistic.

Speaking to Inc42, Siddarth Pai, founding partner of 3One4 Capital said, “Of the 40K startups, over 25% i.e. 10K startups will have to shut down if the government does not come up with a bail package at the earliest. As exits are delayed, the VCs money will be less and tougher to get.”

Most Startups To Witness Falling Valuations

For startups, the biggest concern is indeed funding and the down rounds that usually come with times where survival is the bigger priority than valuation. Not only has valuation gone down for many startups but they have also witnessed a sharp decline in their valuation-dependent market indicators too. Of course, the valuation on paper may have a different story to tell.

While it’s true that over 24 startups so far have successfully raised funding in April and May, some of the startups did disclose the fact that their funding witnessed down rounds. In most of the cases, barring few, investors refused to issue the agreed cheque, paring down the funding round as well as valuation.

Besides Swiggy and Zomato, other unicorns such as Ola and Dream11 that were in talks to raise around $400 Mn – $500 Mn have seen talks fizzle out or delayed. If indeed the talks are around survival companies may have to settle down at a far less cheque size it appears.

With Covid-19, what initially appeared to be temporary seems to be causing permanent damage for many startups, as once a startup gets down-valued, it will not only adversely affect the share subscription equations of founders in future but such startups will also find difficult to attract corporate investors / VCs without compromising on equity or valuation further. It’s particularly difficult when the market itself is in an upheaval and revenue growth, which often offsets any down rounds, is not guaranteed.

As a result, many of the startups have avoided the fundraise as part of their regular Series funding and instead have either gone for venture debt or have decided to issue preference shares to keep debt-to-equity ratio checked. For instance, Zomato and VOGO have recently raised some funding through preferred stock routes.

Speaking to Inc42, Santosh N, managing partner, D and P Advisory LLP and external advisor for Duff & Phelps, said, “Over 80-90% of the Indian startups will witness a minimum of 20-40% fall in their valuation.” 

Elaborating on this, he said the stock market which has gone down over 30% since January sets the benchmark. Using the same barometer, one can actually start off by adjusting the positives and negatives to zero down to the exact change in valuation and accordingly the latest pricing by VCs.

If we look at the figures last week, eight of the 10 most-valued Indian companies lost INR 2.50 Tn in market valuation. Among the biggest losers were TCS and HDFC bank.

The rise and fall depend on a slew of factors including the burn rate, runway, and pitch quality (market dynamics) which will help recalibrate the startup pricing. However, these negotiations will start only after paring down the value. Suppose, three months back, the valuation of a startup was 100, then, in the post-Covid era, the starting point would be assumed at around 70. This goes down or up, depending on the factors above, said Santosh.

Talking from the VC perspective, Sequoia India Capital MD GV Ravishankar recently said that down rounds are an inescapable reality. Things don’t change until you need capital. But, overall, given the expectations of growth and sentiments, the valuation drop will moderate. It will depend on how the company’s own performance and how much it is going to be affected by the pandemic and recession.

“The impact will be mostly for Series B and above. Cheque sizes would also reduce due to the higher risk and uncertainty in the market at this point of time.”

Varun Gera, founder and CEO of HealthAssure, which recently raised funding from its existing investors, said valuation and down round figures can’t be generalised. “Healthtech alone is too wide. In some of the cases, the impact has been positive while in some other cases, it’s negative too.”

The valuation has not gone down for many of the healthtech startups due to the seemingly higher market interest. Investors are now considering backing their existing portfolio companies which they might have overlooked earlier, which could have resulted in down rounds for many startups, added Gera.

Has there been any change in term sheet conditions with Covid-19 in the picture? Not for Gera, but in a tweet, angel investor Gokul Rajaram noted a top venture investor as saying,

“We are cutting all valuations by 50%. And a flat round is the new 3X up.”

Rajaram said that this is what most startups have to look forward to over the next few quarters. Further, other entrepreneurs have tweeted that the VCs and investors are walking away from signed term sheets or renegotiating in bad faith. They have also tried to collate the information on such investors and ensure no other entrepreneur faces these issues in the future.

What Drives Investors To Down Round  

Investors are recalibrating their funding mathematics based on the stress testing of their portfolio. According to Pankaj Raina, MD, Research & Investments, Zephyr Peacock, besides the sector-specific market dynamics, this stress test will determine the revised capital allocation for existing portfolio companies at PE/VC funds.

Thus, Raina said, investors are more likely to stay away from investing in a company which is facing the maximum risk and may not be able to survive the crisis. In such cases, even if the investors had earlier agreed to participate in follow up rounds, there are chances of them not investing under this new circumstance.

Every portfolio will most likely have four types of startups:

1. Startups whose situation is so bad that it cannot be revived
2. Startups that are in a bad place, but some capital will allow them to ride through this crisis. Investors would definitely consider extending their help in order to make them survive
3. Startups that have adequate cash and will manage for the next 12-odd months or more
4. Opportunity startups which are finding a more suitable environment to thrive on. These startups will top on the list when it comes to new funding deals

Furthermore, the revised capital allocation strategy and portfolio prioritisation also depends on the fund lifecycle which plays an equally important role to determine capital allocation strategy. The fund lifecycle will help determine how badly the portfolio has been impacted. Fund disbursal is very much likely to align with the lifecycle status report which will determine whether the dry powder for a particular startup can be extended or not. If yes, what are the odds of survival.

Brand New Deals Go Dry

As most major VCs are currently busy reassessing their portfolio startups which is fast-changing with the recession and lockdown extension, the number of new deals is estimated to be quite low for the next couple of months. Major funds are currently working with their portfolio companies to optimise costs and extend the runway. Any new commitments that existing funds plan to make would be used to preserve valuation and address new demands emerging in the market that the portfolio can capitalise on.

On the flip side, follow-on rounds may grow as VCs who may have decided to exit or not participate in future rounds for a portfolio startup, may have to participate in order to keep them afloat. Exits and fundraising through LPs is a long-shot. Companies which had set a deadline for IPOs can no longer work with the same target with GMVs suddenly gone drastically down.

For instance, SoftBank-backed PolicyBazaar and Ola which were mulling to go for IPO within next 9-19 months are now reportedly considering to defer the timeline. Among the Valley-based startups, online community marketplace Airbnb and food delivery Postmates have already announced plans to postpone their IPOs.

“The existing investor who is convinced of the startups’ gameplan may have to support those investments. Otherwise, if it doesn’t support those investments, maybe the $20 Mn that it had made earlier might completely go away if the startup goes bankrupt. So, just to protect the cash that he has already invested, the investor may have to invest more money,” said Zephyr’s Raina

Game Of Thrones For Startups 

“Whether it is a ride-hailing company, hospitality, logistics or an infrastructure company, there would be a serious impact on their balance sheet and cash flows.” – Santosh N.

The lockdown has adversely impacted a large number of startups particularly in the areas of hospitality, travel & tourism, supply chain, ecommerce and so on. Barring hyperlocal services and digital entertainment, there is hardly any demand on platforms like Makemytrip, OYO, Bookmyshow, Flipkart, Amazon, Zoomcar, Rapido, Ola, Uber etc.

While Uber, Ola, Amazon India and Flipkart can afford to remain idle until things get better, other startups may not have this luxury. For instance, OYO which had last year witnessed a 6.4x fold increase in its losses amounting to INR 2,330.6 Cr is left with no choice but to curb its assets and reduce manpower, despite the company claiming to have $1 Bn cash on its balance sheet. According to reports, the company’s revenue has dropped 50%-60% against the initial estimates of 10%-15%. The company has already laid off over 5000 employees, globally.

Similar is the case with many other unicorns, who were on an expansion spree overlooking their burning rate and revenue model. For travel booking platforms, meeting cash flow was the immediate concern as all the customers suddenly had to cancel their orders, an unprecedented move for which no one was ready.

“Companies which will not be able to generate enough revenue in the social distancing era, will ultimately die in this process, while companies which emerge stronger will be recognised as the new Flipkarts of the Post-Covid-19 era,” said Santosh N.

Out of 30 unicorns which have so far raised $30 Bn+ cumulatively, around 20 have not been able to generate profits over the years. As a result, many of them are now badly struggling in fundraising. While Swiggy and Zomato had to settle for less, Ola and Dream11 have to delay their funding rounds. Ola had been reportedly in discussion with Microsoft to raise $200 Mn since last year, however, the current situation has put the talks on hold. Similarly, Dream11, India’s only gaming unicorn was in talks with Tiger Global to raise $500 Mn ahead of the upcoming IPL, however, as the IPL has now been cancelled, the funding too seems to be delayed for the time being.

It is also worth noting that most of these unicorns have been on a high cash burn rate which is now being cut to size. However, will they be able to attain profitability and preserve cash for the next 12-18 months? That remains a billion-dollar question for the unicorns.

Then there are unicorns such as BigBasket, Grofers, BYJU’s and PolicyBazaar which have either benefitted or have managed to navigate the lockdown to a large extent. So which are the startups that will emerge stronger in the post-Covid-19 scenario?

The startups which are able to align themselves with the changing consumer behaviour and changing government policies will most likely dethrone some of the existing unicorns, said Santosh.

Can Investors Bounce Back?

In India, where Covid-19 became a matter of national urgency only after March 22, it’s a bit too early to quantify the outcome, say experts, whereas in China, where Covid-19 originated and recognised as early as December 2019, the impact on startups has been huge.

According to data compiled by PitchBook, starting from January last week to 1st week of March, venture capital activities in China — the number of deals and the capital raised by startups — have witnessed a downward trend, with the amount of investment in Chinese tech startups falling more than 60% compared with the same period last year.

However, the latest report says the VC industry is recovering fast, “Chinese firms recorded 66 venture capital deals for the week ended March 28, the most of any week in 2020 and just below figures from the same time last year.”

While Chinese investors are slowly gaining back the confidence to invest, India has only tightened the noose when it comes to Chinese capital inflow with the new FDI norms. Among the most prominent late stage investors, SoftBank is expecting a towering loss of $24 Bn in its investments.

For the Indian startups, be it, the early-stage or late-stage, challenges of funding and valuations are only beginning by many estimates. The funding winter has definitely come in the scorching summer months.

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