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Capital crunch in Startup Land?

The economic impact inflicted by the COVID-19 pandemic cannot be understated. The International Monetary fund projects a 4.5% contraction of the Indian economy. The Asian development bank has a similar outlook, forecasting a 4% contraction in GDP. In an earlier post, we had discussed a downgrade of India’s sovereign credit rating, exacerbating our economic troubles.


Though numbers are perhaps the most important component of any economic story, the on-ground reality you would observe in any major city is far more depressing. Millions of migrant workers have left for their homes, with some planning on not coming back. Thousands of small businesses have shut down, and their owners left without any options. In this edition, we analyze the impact of the pandemic on capital availability for startups, arguably the most important innovation engines of our economy.


With funding drying up, and demand coming to a standstill, the pandemic is an existential crisis for the Indian startup ecosystem. Survival, always a challenge for early-stage companies, seems a remote possibility.


According to a NASSCOM survey, 70% of startups have less than three months of cash runway. The survey found that around 40% of startups have either temporarily shut down their operations, or are on the verge of shutting down. Unsurprisingly, B2C startups have been the worst hit, with 60% facing the possibility of a closure.


Even venture-backed startups have been forced to adopt radical cost-cutting measures, including and not restricted to layoffs. Multiple internet businesses including Oyo, Blackbuck, Treebo, Acko, Fab Hotels, Meesho, Shuttl, Capillary, Niki.ai, Swiggy and Faceportal have on average cut workforce by 30%.


The capital situation is unlikely to improve anytime soon. Despite public claims that they are

exploring news deals, investors across the board are simply not making new investments.

According to a joint FICCI-Indian Angel Network survey, 59% of investors stated they would prefer working with startups in their current portfolio, instead of working on new deals. The response from investors to pitches hasn’t been encouraging either, as only 8% of startups have been able to sign agreements and receive funds during the lockdown.


Moreover, logistical challenges due to social distancing norms make new deals even more difficult. VCs are unable to meet startup founders in person, and thus deals are simply not happening. Most investors are conserving cash for their portfolio companies, to ensure they stay afloat. Limited partners who invest in VC funds, may also be affected by economic headwinds, and in some cases may refuse to honour their capital commitments, and may delay fund infusion if a capital call is made.


When VC funds raise capital, not all capital is collected upfront. LP commitments may be drawn on a quarterly or on annual basis over the first four to five years of the fund. For smaller funds, the situation is grave, since these funds raise capital from smaller institutional investors, high net worth individuals and family offices, who are likely clamping down on risky holdings.


Moreover, once the situation improves, it would still be challenging for startups to raise funding. Cheque sizes would be smaller. There would be much harder questions on profitability by VCs, with clear timelines required for portfolio milestones. These would be harshly imposed. Existing backed companies are likely to face more difficulties in raising bridge or Series B rounds, leading to lower valuations.


But the situation is bound to get better. Deal activity in fintech has been broadly on par over the past 17 months, according to a MEDICI report. There is a strong belief among the VC community that seed investing is likely to pick up sooner than later.


Once funds have analyzed capital availability, reassessed their valuation and exit expectations, both of which have undergone a sea change in the current times, they are more likely to invest again – in newer categories that have received widespread consumer acceptance. Live streaming, Edtech, gaming, e-sports, online training are expected to receive a fillip. India is still a consumption-led economy and would continue to remain so. The internet is probably the only thing which is making things available for some urban citizens, and technology is what is going to drive our future.


About the author: The post is written by our EZPP partner Aman Jain with relevant edits from our editorial team. Aman is a graduate from IIM Kozhikode and has a PPO from the Boston Consulting Group.


Disclaimer: All views expressed in the post are personal, and not related to any organization to which the writer belongs.

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