Early-stage deals accounted for close to 60% of the total funding in the first half of 2023 volume-wise, but when it came to value, early-stage funding only contributed to about 15% of the total funding — the lowest in the past two years.

"Funding in the Indian start-up ecosystem continues with cautious optimism. Despite the significant dry powder earmarked for Indian start-ups, the ecosystem reported the lowest six-month funding trends in the last four years during H1 CY23 (first half of the calendar year of 2023) at $3.8 billion across 298 deals,” Amit Nawka, partner, Deals, PwC India, wrote in a report titled, ‘India start-up deals tracker H1 CY23’.

This sombre mood on the startup deal street is in sharp contrast to just over a year ago when it was raining unicorns, and Indian startups raised more than $42 billion across 1,583 deals (across all stages) in 2021.

It is fair to say that this could well be a calming down after an irrational exuberance seen on the funding side, when there was just too much capital and the private markets got ahead of themselves.

“We have had a bull run for almost a decade in the private markets. There was too much irrational exuberance with no unit economics in place and that we are now coming off that,” said Sateesh Andra, managing director, Endiya Partners, a venture capital firm that invested in various startups across cycles.

The scrutiny is higher now as the narrative has shifted from mere “storytelling” to actual execution and producing concrete results. “Startups have to grow their revenues four-five times to justify the revenues that they promised to their investors. Now, harder questions are being asked around execution metrics, the path to profitability and what problem are they solving,” Andra added.

What this means is that startups cannot demand unrealistic valuations anymore. “There will be down rounds,” Andra said.

Down rounds — when the valuation of a fundraising round is lower than the valuation of the previous round— seem to have nearly quadrupled in number in Q1 2023, compared to a year earlier, which may be leading to unhappy investors, significant dilution and employees worrying about their equity, among other things.

There has been a significant change in funding in a post-pandemic world. While COVID-19 had many deleterious effects, it was a golden period for Indian startups. The Indian startup ecosystem experienced a remarkable rise, attracting substantial investments and fostering a period of growth. The global economy paved the way for Indian startups to become the favoured destinations for investors worldwide and 2021 emerged as “The Year Of Indian Startups” for the Indian economy. However, in a post-pandemic world, the party seems to be over, judging by the subdued state in 2022 and in 2023 so far. During the party period, investors were gripped by FOMO (Fear Of Missing Out). Deals were swiftly sealed in as little as 48 or 72 hours, bypassing the usual due diligence process that typically takes several weeks or months for investments.

The euphoria that led to rapid deals and skyrocketing investments dissipated to a more cautious and diligent approach with investors taking the time to thoroughly evaluate startups before committing their funds, which is another reason why startup funding plummeted.

“The appetite for new investments still remains subdued. Investors are focused more on their existing portfolios at this stage. The focus for many is to help their portfolio companies reduce their burn rate and move towards a profitable and sustainable business model,” said Ravindra Bandhakavi, partner and head, of Private Equity (PE) at Cyril Amarchand Mangaldas.

Joebin Devassy, senior partner at Desai & Diwanji added, “As the world struggled with COVID, deals that were in advanced stages or that were already happening went from deals being physically negotiated to deals being negotiated over virtual platforms, which had been done before, but only for preliminary purposes, not to get a deal pushed through. When the change happened, people were adapting to it. As things petered out, the focus came back on issues like financing, balance sheet numbers and governance. There’s a lot more intensity with regard to promoter checks. The general focus on governance has gone up and consequently, the need to ensure diligence covers all pieces, be it compliance, governance or integrity. Diligence, as a construct, has deepened and expanded. Due to the funding winter, investments have slowed down, giving time to focus on these pieces. With regard to the funding winter, there would be certain sectors affected, because valuations went a lot faster than they were supposed to go and when the pullback happened, valuations were taking a hit. But, there are sectors that continue to go strong.”

Startup funding has also been reduced, because private equity (PE) and venture capitalists (VC) are spending more time managing their portfolios, rather than making fresh investments, so that the companies they invested in grow into their valuations. They are trying to ensure that their dry powder lasts well into future years, so that upcoming funding cycles don’t get impacted. Even VCs or PEs that are making fresh investments are being fastidious about factors like governance and transparency. This can be seen in the way contracts are being signed, due diligence is taking up more time.

And corporate governance issues are popping up. Digital payments platform BharatPe, for example, faced allegations of money laundering and tax evasion. E-commerce platform Zilingo was accused of alleged financial mismanagement, like fabricating invoices and over-reporting revenues. BYJU’s was accused of alleged financial reporting compliance failures and governance lapses.

There are also valuation markdowns happening in Indian startups. For instance, online pharmacy startup PharmEasy, reportedly, has plans to take a 90% cut in valuations in an upcoming internal funding round. So, these issues will continue to plague Indian startups and there is a feeling that the startup cookie is crumbling, unless the right steps are taken.

“Investors are very focused on governance and transparency. Contracts are being tightened to address these issues and provide protection against downside risks”, added Bandhakavi.

“In my mind, it seems to boil down to ‘Are the companies robust in terms of governance systems? Can they go ahead and support themselves? Are their balance sheets clean? Do they have a future?’ There’s always a frenzy to get things done and promoters want to put their best foot forward. At times in the past, investors were willing to look the other way, now investors are taking more time to go ahead and complete diligence. They’re probing and asking deeper questions, but they’re also telling promoters to be very sure about what they’re doing and the organisation can actually function the way they’re telling them it can function,” said Xerxes Antia, partner at law firm, BTG Legal.

So, Indian startups are going through a tumultuous time. There was so much easy capital before, people actually mistook that for the new normal. But, it's a mistake to confuse exuberance for the new normal. That's why Indian startups are feeling the pinch now.

However, industry participants are hopeful of a brighter future.

“2023 may see a dip, because of the risk factor happening around the world and the cost of capital is going up. This is more of a foundation or building year and the India story is very strong. 2024 and 2025 are going to be stellar and standout years with records we’ve never seen before,” Antia said.

Shrija Agrawal is a business journalist who has covered startups and private capital markets before it was considered cool in India

The views expressed are personal