As start-up funding slows, venture capital firms back in the driver’s seat
Even some well-funded start-ups are feeling the heat. Last week, grocery delivery start-up Grofers shut operations in nine cities, citing poor demand. Photo: Ramesh Pathania/Mint

Even some well-funded start-ups are feeling the heat. Last week, grocery delivery start-up Grofers shut operations in nine cities, citing poor demand. Photo: Ramesh Pathania/Mint

Venture capital (VC) firms are again wielding strong control over their portfolio companies, as a funding slowdown helps shift power back to the investors after more than a year when start-ups were spoilt for choice of backers.

Apart from demanding that start-ups slow expansion, slash costs and cut discounts, many VCs are setting performance milestones; some investors are only releasing funds in instalments.

Even some well-funded startups are feeling the heat. Last week, grocery delivery start-up Grofers India Pvt. Ltd, which raised $120 million from Japan’s SoftBank Group and Tiger Global Management in November, shut operations in nine cities, citing poor demand. Rival PepperTap (Nuvo Logistics Pvt. Ltd), too, has frozen expansion plans. Restaurant discovery app Zomato Media Pvt. Ltd said this week that it would shut delivery operations in four cities. The company had already cut 10% of its workforce, or 300 jobs, in October.

“Investors are realizing that later-stage money may not be available as easily as before and are urging companies to focus on extending their runway by cutting burn,” said Tarun Davda, managing director at VC firm Matrix Partners India. “In many cases, founders are being asked to think how they would run their business if this was the last round of funding of the company.”

The instances of retrenchment referred to above and others like them are the result of VCs and other long-term investors demanding that start-ups run their businesses in a cash-efficient manner.

Investors led an unprecedented funding boom in the year to mid-2015 when deals were being struck in a matter of weeks and valuations across the board skyrocketed. Start-ups received more than $9 billion in capital over the past two years, according to Mint research.

Over the past few months, however, investors have turned cautious because of a mix of global macroeconomic factors such as an economic slowdown in China and an interest rate hike in the US, as well as concerns about the unproven business models of start-ups.

Since late August, the rush of funding has ebbed, even though predictions of a bust haven’t come true yet. Money isn’t as easily available now, partly because of the flight of hedge funds that dominated India’s start-up scene in terms of funding in early 2015 and were pushing traditional VCs out of deals by offering higher valuations. As hedge funds fled late last year, VCs came back, and are now in control.

The shift in power back to VCs will likely lead to even more cost cuts and consolidation in the next six months.

There is a now strong focus on setting and achieving key performance indicators and financial metrics over 3-6 months, rather than 2-3 years down the line, said Sanjay Nath, managing director at Blume Ventures India, an early-stage investor.

“Existing portfolio companies are being urged to show these metrics before going for the next fund raise. Implementing corporate governance practices have come to the forefront and board of directors are getting involved in big spending decisions. These processes will help create fundamentally strong businesses and discipline is healthy for the ecosystem,” Nath said.

VCs are negotiating stronger rights, especially around the cash-burn rates of e-commerce firms. Investors are defining limits on cash burn, or spending on marketing, salaries and other overheads, said a lawyer, speaking on condition of anonymity.

If a company wants to spend more than the specified amount, they need board approval, the lawyer added. Other metrics being favoured by investors are those around the number of paying customers and spending per customer rather than just the number of mobile app downloads, seen, not so long ago, as an indicator of a company’s popularity.

“Even for mobile app companies the discussions are no longer around downloads and engagement but monetization,” said Mahesh Bhalla, an angel investor and an advisory board member at Innoventure Partners, a venture capital advisory.

To be sure, the largest venture-backed companies, Flipkart Ltd, Snapdeal (Jasper Infotech Pvt. Ltd), Ola (ANI Technologies Pvt. Ltd) and Paytm (One97 Communications Ltd) are splurging cash as freely as ever on discounts, new businesses and hiring. These companies together have hundreds of millions of dollars in cash and are engaged in intensive market share wars that require constant spending.

For smaller start-ups, things are much less rosy.

Funding discussions between entrepreneurs and investors are stretching out over several months and valuation expectations of many start-ups have become lower, with many just looking to survive.

Mid-stage deals over the next three months are likely to be struck at valuations that are, on average, anywhere between 25% and 50% lower compared with 2015, according to investors at Matrix, SAIF Partners, Accel Partners, Nexus Venture Partners, Blume Venture Advisors and Sequoia Capital.

Matrix’s Davda said the funding slowdown is at its worst at so-called series B and C stages and for large rounds of more than $100 million.

“Investors are shy of writing series B or C checks (which are larger) if they feel later-stage investment will be hard to come by. Series A valuations (of start-ups), which had gone as high as $20-$25 million, have come down back to $10-$12 million levels,” he said.

Investors are also banding together in larger numbers in mid-stage deals to diversify risk. That way, the risk gets split among several investors and it becomes easier for a start-up to raise its next round.

When home services start-up Housejoy (Sarvaloka Services On Call Pvt. Ltd) raisedRs.150 crore in December, as many as five investors stumped up the cash. Even though all of the five, Inc, Vertex Ventures, Qualcomm, ru-Net Technology Partners and Matrix Partners India, have deep pockets, they still invested small amounts individually.

Logistics start-up BlackBuck (Zinka Logistics Solutions Pvt. Ltd) raised a similar amount last month from four investors including Tiger Global and Flipkart. Another start-up Craftsvilla (Supera Investments Pte. Ltd), an ethnic products marketplace, raised $34 million from five investors in November.

Some investors said the funding slowdown marks a return to normalcy after a year of hedge fund-cash fuelled expansion.

“The traditional VC-style of investing has returned, with focus coming back on building business models that can be sustained over the long-term,” said Sharad Sharma, co-founder of iSpirt, a lobby group for the software products sector. “In this phase, you will see firms that cater to Bharat (the whole of India), rather than just the top 10 cities, succeed. Additionally, frugally run enterprise start-ups will start being favoured by investors. These start-ups require a fraction of what consumer Internet firms do, but generate sizable sales and profits, unlike e-commerce companies.”


About the author

Related Post