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Start-ups: As VCs demand traction, funding gets tough

After a period when they got a long rope, start-ups now find VCs demanding to see tangible progress before any more cheques are written

Bengaluru-based Dazo had to shut shop after its funding dried. Its business model was considered too similar to the bigger and much more established players, and investors lost interest.

SpoonJoy has begun shrinking its services; it is no longer active in Delhi and Bengaluru. Smaller entities such as Langhar in Delhi and Order Snack in Chennai seem close to calling it quits. Online grocer LocalBanya has pared its services and is reportedly on the block.

After a glut of funding in the past 18 months, late-stage money for me-too start-ups is drying, leading to consolidation in many segments

This trend, say venture capitalists (VCs) and investment bankers, is set to continue. Some segments that were the toast of the town are now too overheated to consume, say VCs. The money, founders say, is difficult to come by and VCs have changed tack, shifting to early-stage investments.

“There is a lot of money available for Series-A (funding) but the challenge comes when people reach Series-B and C, where $20 million cheques are not available easily,” said Sasha Mirchandani, founder and managing director, Kae Capital.

With too many me-too start-ups, the first bunch which got capital can manage but the second lot gets stuck, he says. Unless there is something uniquely different, it is very difficult for them to raise capital.

“Though a lot of VCs are writing early cheques, one will see them increasingly slow down.  VCs now want to see traction and then write the next cheque. So, while initial-stage funding is doable, later-stage (funding) will get more and more difficult.”

A Mumbai-based education start-up, looking to raise Series-B funding, says it has got difficult. “Even if you have marquee investors with you in the past rounds, VCs want to see tangible numbers. We have been trying to raise Series-B but it is getting longer and longer,” said its founder.

VCs are now demanding focus on revenue generation, along with customer acquisition. The likes of Swiggy, currently in the same “overheated” food tech space, say the warning lights are flashing but it isn’t yet time to hit the panic button.

“Yes, two big companies are struggling but the macro trend hasn’t changed too much. The focus has, however, turned to profitability. The time of charging zero commission and deep discounts is over. There are no more free lunches,” said Nandan Reddy, co-founder of Swiggy. It is not only profitability in the future. Investors, who have had millions of dollars stuck in non-performing companies, demand to know the plan for reaching positive cash flow early, and even push for a pivot if they feel the plan won’t work.

“It is difficult to raise money with the conditions put in place. When I raised money for Series-B, I was already getting offers for Series-C. A few months later, the market is deserted. No one is interested,” said the co-founder of a company in the test-prep segment.

VCs explain they have started to feel pressure from institutional investors as the investment cycle comes to a close. “It is now exit season. They all want out. If it means selling out to competition, so be it,” said the founder of a VC fund, in the process of announcing three exits from its six portfolio companies.

According to an investor banker from a private lender, though consolidation is being seen only in the food-tech and hyper-local segments, others will see some action as well. “Though the existing set of players might find fresh funding, consolidation is inevitable and could happen in segments like furniture, food-tech and logistics. Lack of scalability will give a fillip to consolidation. Besides, valuation would be on a revenue basis and not profitability, as start-ups are not yet on their way to profitability.”

Sector veterans say big deals will happen for mature players but would be angled more towards acquisition.  “I am aware of several deals that will happen over the next two quarters, aimed at only acquisition,” said Prashant Mehra, partner, Grant Thornton, India.

He said a lot of reasons led to easy investment. “Primarily because of the new government, there have been a lot of international funds in India,” he added. What is missing, he said, was that the domestic mergers and acquisition market was still dormant. “That will change, especially in mature segments where growth is almost complete. How do you make that $80 million company a $100 million animal? Acquisition” he said.

The article appeared in Business Standard on 23 October, 2015.