As investors get ready for global headwinds, 2023 will be the year of start-ups

The year 2023 could, well, be the year of start-ups. Both founders and experts feel Indian start-ups and investors are ready to face global headwinds and build resilience in the future. A recent report by Redseer Strategy Consultants confirms this, when it says that India has significant room for growth in the public market cap compared to other countries and has a strong pipeline of over 80 IPOs of profitable start-ups over the next five years.

The funding winter could push the smaller start-ups to sell out to larger peers or revamp their cost structures by opting for retrenchments to improve the cash runway and bracing for down rounds in 2023. Investors also indicate that the new year could see more consolidation as more small- to mid-stage start-ups may find it harder to raise cash on favourable terms. Manu Rikhye, partner, Merak Ventures, in an interview with FE, said the funding crunch will drive more M&A activity in the new year as both founders and investors may rush to protect existing valuations.

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Consumer demand continues to remain strong, and start-ups should focus on getting to profitability, say industry observers. “A clear slowdown in investment activity will continue in 2023 but start-ups should realise that capital is not easily available. This will lead to consolidation opportunities for start-ups that are well funded and getting close to profitability,” says Darpan Sanghvi, group founder and CEO of DTC beauty and personal care conglomerate The Good Glamm Group.

Image: Darpan Sanghvi

“Start-ups should consider the worst-case outcome and prepare to ride this phase out. In the long run, India is the best opportunity compared to all the other developing economies,” says Nithin Kamath, founder and CEO of zero-brokerage stock trading platform Zerodha.

Image: Nithin Kamath

The year 2022 witnessed an unprecedented scale of layoffs, funding winter, and crashing valuations in the start-up ecosystem. As consolidations continued with 230 M&A deals reported in 2022, there was a massive 35% drop in funding from $37.2 billion in 2021 to $25 billion, as per data from market intelligence platform Tracxn. Clearly, this is a testing time for the ecosystem facing macroeconomic challenges. Slow hiring activity, inflationary trends in developed economies, continued fed rate hikes and brewing global crises have demolished investor confidence in most markets and are giving credence to recession forecasts.

Investment scenario

The slowdown in overall funding was driven by a slump in late-stage funding which fell to $16.1 billion in 2022, reports Tracxn. Start-ups have been termed as the ‘biggest value shedders’ in the second edition of the ‘2022 Burgundy Private Hurun India 500’ list, which ranks the 500 most valuable companies in India. Start-ups such as Policy Bazaar, Paytm, Zomato and Nykaa lost 68%, 59%, 50% and 48%, respectively, in value since 2021—a cumulative loss of over `2 trillion.

However, Bain & Company’s ‘India’s Private Equity Landscape in the First Half of 2022’ reveals that India’s strong showing in 2022 has surpassed investor expectations both in the PE and VC markets and continues to show the strength of Indian assets. India consolidated 2021’s gains with more than $40 billion in investments eight months into 2022, and overshot expectations amidst a global slowdown. Even though the deal count has reduced, the first half saw approximately $34 billion in deal value at a 25% growth over the same period last year with $27 billion.

Foodtech platforms like HealthKart raised $135 million in a funding round led by Temasek, with participation from A91 Partners and Kae Capital, breaking the bad funding cycle in December. Blume Ventures, a seed-stage Indian investor, raised more than $250 million for its fourth and largest fund to court more early-stage start-ups. The new fund will focus on edtech, fintech, health and commerce and consumer Internet.

So, will the start-up funding dry up in the near future? The whole notion of drying up of funding is weighted towards later-stage deals (Series C, D, E) which go upwards of $100 million. In 2021, businesses and funding environments were impacted with Covid; so, interest rates were very low, and liquidity was at a historic high, especially with economic measures undertaken by countries like the US. “This paved the way for easy access to liquidity in countries like India. The year 2021 was a huge windfall for start-ups, and funding numbers have grown from $2.3 billion invested in ‘seed to series A’ start-ups in 2021 to $2.7 billion in 2022 YTD and it is expected to go up to $4-5 billion in 2023. This shows that there is no funding winter from a pre-series A funding perspective,” says Vikram Gupta, founder and managing partner of IvyCap Ventures, a $530-million fund company that invests through the alumni ecosystems and manages over 30 portfolio companies.

In 2023, for those allocating capital into growth start-ups greater than $500 million in valuation, there will be a lot more ask around the paths to profitability, the ability of the companies to be a listed business, and potential exit outcomes, feels Ashish Fafadia, partner, Blume Ventures, whose portfolio includes Unacademy, Dunzo, Slice, Spinny, Purplle and Exotel. “It’s going to be a measured approach and capital will be available for those who are going to price their companies fairly, where business models are shaped up, and there will be interest at global level,” he adds.

Layoffs slowing down, gig economy growing

In 2022, more than 60,000 job losses were reported by edtech and e-commerce platforms alone. Severe dearth of funding and rising fears of an imminent global recession led HealthifyMe to sack 150 employees in the year gone by. IPO-bound hospitality chain OYO fired 600 employees from tech roles in product and engineering teams, decided to merge the two teams and hire 250 staff in relationship management teams to ensure better consumer and partner satisfaction. Zomato became the first in its segment to fire employees, laying off 3-4% of its workforce. Cryptocurrency exchange WazirX laid off around 40% of its workforce; Amazon has sacked hundreds of employees and shut down multiple businesses in India, and so on.

In 2023, however, the layoffs are expected to slow down and those who possess skills in niche areas will be hired by multinationals across sectors. “Start-ups in India still have a very large workforce with high attrition of 25-30%. This means even as they cut back on jobs, many will continue to hire to fill attrition. With the next academic year, fresher hiring will be back in full swing, especially among start-ups… and I expect layoffs to slow down fully by the first quarter of the financial year,” Sekhar Garisa, CEO of Monster India, told FE.

As per Jang Bahadur Singh, senior consultant, AON, a global professional service, the threat of layoffs has seen two trends. “Either the highly skilled employees have returned in droves to established and stable brands or employees in the customer services/ operations have turned to the growing local financial services/ NBFC firms or other start-ups with similar profiles,” he says.

As per Fafadia of Blume Ventures, the layoffs are relatively small in number as compared to those employed in the sector. “In a country still growing at 7% net GDP, tech continues to grow at a faster pace and start-ups even faster. I don’t see a cause of concern for start-ups and their employees; there is going to be balance in the market,” he says.

At the same time, the overall hiring activity in start-ups indicates a strong revival of economic growth. KR Sekar, partner, Deloitte India, says, “If start-ups continue to bring innovation, disruption in spacetech, femtech, healthtech and fintech, it brings tremendous opportunities for investors and start-ups.”

Companies will be careful in not creating bulky structures, says Kulin Shah, co-founder and COO of Onsurity, a healthtech platform. “The focus will be on core problems and companies with proven business models and driving unit economic profitability will continue to hire in 2023. There will be focus on hiring talent who have proven capabilities in tech, operations and revenue functions,” he adds.

The demand for gig or part-time workforce has also shot up as the recent big tech layoffs have created gaps in various roles and skill sets. India’s gig economy is expected to nearly triple from 7.7 million people in 2021 to 23.5 million by 2029-30, according to a report by NITI Aayog. “The growing gig economy has the potential to change the nature of work in the future by influencing a radical change in the workforce, workplace, and work models,” says Daya Prakash, founder, TalentOnLease, a provider of IT talent on demand.

“We can expect a significant rise in the number of freelancers/contractual workers. This will give an impressive boost to the gig economy-focused platforms and businesses,” says Supriya Paul, CEO and co-founder of content platform Gurugram-based social tech start-up Josh Talks.

Emerging sectors

Spacetech, healthtech and femtech are emerging as investors warm up to these new sectors in India. “Investors continue to invest in businesses which solve real problems and cater to large markets, and which have lower burn and higher visibility to profitability,” says Shah of Onsurity.

“The next five years are going to be amazing,” says Deep Bajaj, CEO and cofounder of Sirona Hygiene, which was bought by The Good Glamm Group nearly a year ago and now eyes sales of `500 crore in the next five years, adding, “Our pipeline of tech as well physical products looks promising and will solve unaddressed intimate and menstrual hygiene issues.”

Inventory-led business models have worked well in the beauty and personal care segment so far. “Beauty and personal care category in India is nearly a $15-billion industry now. Consumers are willing to experiment and try new brands, leading to more funding possibilities, and D2C brands or consumer-first brands will thrive regardless of market sentiment or the economic outlook,” says Ashutosh Valani, co-founder of Renee Cosmetics that raised $25 million in Series B funding in 2022.

A key mantra to sustain is to include long-term value proposition, growth with good metrics, strong focus on profit and loss management and unit economics. Nishchae Suri, MD of executive search firm Cornerstone India, says, “For professionals, given the evolving nature of the job-skill matrix and the widening gap of skills, they need continuous skill attainment to remain relevant.”

Key verticals that Fafadia of Blume Ventures has been investing in the past 12 months include SAAS, cleantech, fintech, and consumertech and these will continue to be areas of focus through the next year as well. “Businesses that have a long-term positive trend in average revenue per user (ARPU) and whose market size is established will be the flavour of the season. SAAS, climate, financial services other than lending, will be drivers of big opportunities for people to allocate capital,” he adds.

Models that focus on the most pressing customer needs (core HRMS players like Darwinbox or Personio), build infrastructure to enable these (e.g. developer tools or banking infrastructure) or deep technological innovation (robotics, generative AI) creating efficiencies or addressing labour shortage will weather this recession. “Like we have seen, the strongest category leaders emerge from crises: Uber, AirBnB, Square, etc,” says Florian Reichert, partner and MD, Picus Capital, which is expected to invest approximately 20% of funding in India in 2023.

India has seen over $108 million of investments in the private space tech sector in 2022. Pixxel, a space data company with investors such as Lightspeed, Radical Ventures, Blume Ventures, Seraphim Capital, Accenture, Inventus and others, raised the largest Series A round for a space-tech, and it was the first time international investors had invested into an Indian space company. “Going ahead, enabling an easy FDI process will be key to weather the current economic and investment downturn and emerge with continued investment and support from global investors,” says Awais Ahmed, CEO, Pixxel.

Image: Awais Ahmed

Will others shrink?

During the pandemic, cloud kitchens offered services at a higher margin compared to restaurants. Yet, their novelty faded given every restaurant became a cloud kitchen and there was a slump in delivery demand as dining out opened up. Swiggy shut its cloud kitchen brand The Bowl Company in Delhi-NCR recently. Swiggy’s operating revenue for the fiscal year ended March 2021 dropped 26.6% to `2,547 crore. In 2020, it had shut a number of its cloud kitchens and laid off more than 1,000 employees.

However, Ankush Grover, co-founder of Rebel Foods, says foodtech platforms will contribute to a cash-positive economy in 2023. “Customer experience will be a trend adding to a consequent rise in the share of online orders as a percentage of the total revenue of a restaurant,” says Grover, who plans to add 250 locations across Southeast Asia, West Asia and the UK.

Despite massive fundraising and incentives, can the edtech bubble burst in 2023? Right from pre-product to late-stage, edtechs across stages managed to mop up back-to-back rounds. After spending record sums in 2021, investors in edtech recognised that perhaps too much money went into too many large rounds at unsustainably high valuations. The sector saw global slowdown and low profitability in 2022, leading to layoffs.

Vedantu, Byju’s and Unacademy announced massive rounds of layoffs in 2022 as the pressure to cut costs and turn profitable mounts. In June 2022, Noida-based PhysicsWallah (PW) became the seventh edtech to enter the unicorn club as it raised $100 million in a Series A funding round from Westbridge and GSV Ventures. As edtechs have laid off more than 6,000 employees, PW’s headcount has grown from 600 in 2021 to more than 5,000 till date. “We hired equivalent to what all edtechs in India laid off cumulatively. We have been a sponge that has soaked up a lot of talent that was laid off. We never had unsustainable hiring practices with wrong expectations and inflated salaries. We are hiring and scaling into 10 other exam categories and quadrupling our offline presence in FY-23-24,” explains Abhishek Mishra, chief strategy officer of PW, who feels the biggest takeaway from funding winter has been the righteous focus on business models, cash burn, a visible path to profitability, and positive unit economies. “These were forgotten in a FOMO-induced funding rush. But investors have enough gun power; by August 2022, there were at least 90 India-focused funds that launched their new funds worth $16 billion. It’s a good sign for companies with strong fundamentals that focus on the right metrics,” he says.

Impact on economy

Rising interest rates, recent Russia-Ukraine war, energy supply, depreciating GBP/EUR, rising inflation, and public market volatility have made venture capitalists cautious in investments. “There has been a downward trend in the funding amount as well as the number of start-ups getting funded. This is a temporary phenomenon, and we expect corrections in February in the Union Budget,” says Sekar of Deloitte.

Start-ups are predicted to contribute about 4-5% to India’s gross domestic product (GDP) over the next three-five years, up from 2.5-3% currently, as per a report by StrideOne, a tech enabled NBFC.

Recently, the Indian government said there were 84,012 start-ups registered in the country till November 2022, up from 452 in 2016, underscoring the growth in the space. It added that the success rate of start-ups was much higher than in other countries. India is the third largest start-up ecosystem, behind only the US and China.

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India will be a $25-trillion economy in the next 25 years, and a substantial part will come from the start-up ecosystem. “I don’t see any decline in start-ups. These businesses will grow and contribute to the economy,” says Gupta of IvyCap Ventures.

Extra points:

• Funding numbers are expected to grow from $2.3 billion invested in ‘seed to series A’ start-ups in 2021 to $4-5 billion in 2023, as per IvyCap Ventures
• India has significant room for growth in public market cap. It has a strong pipeline of over 80 IPOs of profitable start-ups over the next 5 years, as per Redseer
• Start-ups will contribute 4-5% to India’s GDP over the next 3-5 years, up from 2.5-3% currently, as per StrideOne, a tech-enabled NBFC
• Number of jobs created by start-ups grew at a CAGR of 78% from 2017-22 and are projected to grow at a CAGR of 24% from 2022-27, as per reports
• India’s gig economy is expected to nearly triple from 7.7 million people in 2021 to 23.5 million by 2029-30, according to a report by NITI Aayog
• Cloud kitchens are set to be a $2-billion industry in India by 2024, up from $400 million in 2019, as per Redseer Management Consulting