Rise and rise of India's startup story: Growth beyond the funding chill

Amid the current funding winter, investments in the Indian start-up ecosystem have taken a big hit. But the question that arises is should we equate what Indian startups have achieved to only funds raised during the year 2022?

Before we agree to do that, let’s look at what the Indian startup ecosystem has achieved so far. India has a total of 88,395 startups, recognised by the Department of promotion of Industry and Internal Trade (DPIIT).

Moreover, to date, India has over 58,000 tech startups launched. The Indian startup ecosystem has raised a total of $136 billion in funding, of this $5 billion was raised in the seed stage, $32 billion was raised in the growth stage, and $97 billion was raised in the late stage, said the National Startup Day report by Inc42. The funding data is for the period of 2014-2022. India has over 108 unicorns, which have a combined value of $345 billion.

Clearly, the Indian startup story has moved away from being just about raising funds.

“Today, India’s start-up ecosystem is not only the world’s third largest but also the fastest growing. In fact, we are on right track to becoming the world’s second-largest, only behind the United States,” said Padmaja Ruparel, co-founder of Indian Angel Network (IAN), India’s largest network of angel investors.

As the start-up ecosystem has matured over the years, the average time taken by start-ups to cross $100 million in revenue has come down from 18 years in 2000 to 5 years in 2017, a recent report by consulting firm Redseer said.

Importantly, Ruparel added that entrepreneurial failure has become acceptable. “The launch of Start-up India by the Government of India on January 16th, 2016 was a critical milestone for the Indian start-up ecosystem. The government has implemented a series of programmes, including the Fund of Funds for Start-ups, private capital (both domestic and foreign), and high-quality founders who have gone entrepreneurial. It has made going entrepreneurial the first career choice,” she said.

As of April 2022, the Fund of Funds for Startups has invested Rs 7,225.45 crore.

“Now that the Indian start-up ecosystem has matured to a greater degree, we are seeing a lot of 2nd gen founders building new solutions. It is also becoming increasingly frequent to witness experienced operators emerging from unicorns and leveraging their experience in creating new opportunities,” added Pearl Agarwal, Founder and Managing Director, Eximius Ventures, on behalf of the Indian Venture and Alternate Capital Association (IVCA).

2022 & beyond

There is no denying that the year 2022 was a disappointment in terms of fundraise but not all was bad.

For instance, unlike late-stage funding, early-stage funding has not witnessed a decline. On the contrary, investments in the segment have increased in 2022 compared to the previous year. As a result, early-stage start-ups are expected to be at the forefront of investments this year.

Due to a shortfall in funding, the trend of chasing high valuations has also declined among start-ups.

“Lofty marketing budgets and extravagant employee benefits are no longer sustainable and founders are now focusing on survival and profitability. There has been a clear change in the characteristics that investors are looking for in the current market scenario,” said Neha Singh, co-founder of market intelligence platform Tracxn.

Singh claims that several start-ups that had based their business models around chasing valuations and depended on hype and buzz to attract business are now struggling to justify their valuations. “This is clear from the heavy declines such tech start-ups are facing in the public market like Paytm losing 75 per cent of its stock price in its first year of IPO and Nykaa losing 55.8 per cent of its stock value in 2022,” she added.

According to PwC India’s Start-up Deals Tracker — CY22 report, start-up funding in the country fell 33 per cent year-on-year (YoY) in the calendar year 2022 (CY22) to $23.6 billion from $35.2 billion in the previous year. This is primarily due to the dearth of large funding rounds as a consequence of rising interest rates, high inflation, and fears of the global recession.

This current state of uncertainty is anticipated to last for the next 12-18 months. “The recent surge in interest rates and rising inflation rates show no indications of easing. The latest variant of covid has also made global affairs more uncertain,” Singh added.

To combat the prevailing uncertainty, start-ups have started taking unit economics more seriously to manage the current situation, which resulted in cost-cutting initiatives like widespread layoffs that were seen in 2022.

Given the lack of large deals, early-stage funding saw a 12 per cent increase this year compared to CY21, as per the PwC report. It accounted for 60-62 per cent of the total funding in terms of volume.

Industry watchers say this trend is likely to continue into 2023 given that investors are expected to remain cautious until the global macroeconomic and geopolitical situation stabilises.

“In the case of early-stage companies, investors have a chance to enter at a lower price and exit during the growth stage, resulting in higher returns. Along with that, compared to late-stage companies investment amounts in the early stage are way less resulting in comparatively lower risk for investors,” Singh added.

A focus on early-stage start-ups will further incentivise more founders to enter the start-up ecosystem as raising early-stage capital is considerably more feasible. “This should also encourage them to lay a greater deal of emphasis on ensuring stronger fundamentals for ensuring long-term sustainability,” said Agarwal, of IVCA.

“Larger VC firms will also focus more on early-stage as they allow greater innovation and newer opportunities within the market. However, as a result of this inordinate focus, the expected mortality within this segment is expected to rise,” she added.

Aside from an increase in early-stage investments, the ecosystem will also benefit from large amounts of dry powder this year. “Despite such adverse factors for companies, there is still considerable dry powder in the private market. We expect a huge proportion of this amount to be released in favour of premium early-stage companies,” said Agarwal said.

Dry powder refers to cash reserves that corporations and private equity funds have available to deploy when an attractive investment opportunity arises or to weather a downturn. India-focused VCs are sitting on a dry powder of $12.8 billion.