The funding winter turned India’s early-stage startups into investor favourites as growth and late-stage tech companies struggled to demonstrate solid metrics to qualify for further investments amid a global liquidity crunch. Going by an InnoVen Capital report, this trend led to overcooking of valuations with bigger deal sizes in the seed-to-Series A rounds in India.
“One out of two investors believe that early-stage companies were overvalued in 2022”, said the report, which spoke with 20 early-bird investors, including Blume Ventures, Better Capital, Omnivore, IAN Fund, Kae Capital, India Quotient and WaterBridge Ventures.
Respondents highlighted that higher activity levels in seed stage by large established venture capital firms (including Tier-1 VC seed programs) have driven up valuations and blurred the lines between Seed and Series A. Some of the Tier-1 VCs who run seed programs—Sequoia (Surge) and Accel (Atoms)—were among the top-5 most active early-stage investors in India last year.
In addition, "Angel syndicates have led to many founders skipping institutional seed rounds, crashing of deal diligence timelines and a higher entry valuation," the investor respondents said with only a third of them feeling that the emergence of Angel Syndicates has been positive for the overall ecosystem.
Despite the overall venture capital funding slowdown in 2022, valuations for seed or Pre-Series A rounds remained at a similar level to 2021, with half the deals signed in the $5-$10 million valuation range. Two out of ten early-stage startups secured a valuation above $10 million, the InnoVen report said.
To be noted, most early-stage investments were made at a pre-revenue stage. For 6 out of 10 investors, less than a third of their portfolio was generating revenue at the time of investment, as cheques were written on the quality of founding teams and their ideas without "much traction or track record to evaluate at early-stage".
Investors stayed away from businesses addressing niche markets with limited deal activity in edtech, agritech and logistics, while B2B platforms, Fintech, and Enterprise SaaS were the favourites. For 2023, early-stage investors have once again picked Fintech and Enterprise SaaS as their top sectors with an increasing interest in ClimateTech.
However, pace of investments across the board have slowed considerably since the second half of 2022. As it stands, 1 out of 2 investors expect a slower or flat funding environment for emerging startups in 2023, but they don’t expect it to be severe.
"As we head into 2023, we anticipate the slowdown that began in 2022 to persist. However, we expect the early-stage environment to maintain its momentum, with an increased focus on governance and more extensive due diligence process…" said Tarana Lalwani, Partner, InnoVen Capital India—a venture debt provider to startups.
Among the key findings is the investor belief that the top reason for governance issues was poor balance between being “founder friendly and asking tough questions". Ignoring warning signs, weak management teams, insufficient oversight by investors and the absence of a strong CFO were other reasons identified for governance issues, the report noted.
Lalwani believes an increased focus on governance and more extensive due diligence process will lead to viable and sustainable business models getting funded in 2023.