Funding Winter- Meaning and impact on startups in India

If you are part of the startup world, you would have come across the term 'funding winter'. At the same time, it is one term startup founders would never like to come across. In this article, we will talk about funding winter in the Indian context. So, let us get started.

Meaning of Funding Winter

Startups often encounter periods of financial uncertainty, and it is referred to as 'Funding Winter.' This phenomenon describes a challenging environment characterized by reduced venture capital investments, stricter due diligence processes, and heightened risk aversion among investors. While Funding Winters are cyclical and temporary, they can pose significant challenges for early-stage companies seeking capital to fuel their growth. In such times, startups must adopt strategic approaches to weather the storm and emerge stronger on the other side.

Indian startup funding culture over the last five years

The Indian startup funding culture over the last 5 years has been on a rollercoaster ride, marked by a period of phenomenal growth followed by a recent slowdown. 

Let us go a little back in time. The period starting 2014 witnessed a significant rise in startup funding for different reasons:

• Government Initiatives: Policies like Startup India aimed to boost entrepreneurship and attract investments.
• Increased Investor Confidence: Growing internet penetration and the success stories of startups like Flipkart and Zomato attracted investors, both domestic and foreign.
• Easy Availability of Capital: Venture capitalists (VCs) and angel investors were eager to fund promising startups, leading to a funding boom.

The funding since then has been stable, with $13.41 billion in funding in 2019. After 2014, in 2020, the startup funding declined for the first time because of the pandemic, but numbers were still healthy - $11.37 billion.

The year 2021 marked the peak with Indian startups raising a staggering $38 billion in funding, the highest ever recorded. Post that, there was a shift and start of funding winter. A significant shift occurred with a sharp decline in funding. Some of the reasons for this were:

• Global Economic Slowdown: Rising interest rates and a slowdown in the global economy dampened investor sentiment.
• Focus on profitability: Investors became more cautious, prioritizing profitability over high growth.
• Overvalued Startups: Concerns arose about some startups being overvalued during the funding boom.

As of December 2023, Indian startups have witnessed a significant decline in funding compared to 2021 and 2023, raising only $11.3 billion. It is the lowest funding amount in the last five years.

Sector-wise impact

The funding winter gripping the startup world doesn't affect all sectors equally. While some sectors feel the frostbite more intensely, others might experience a milder cooldown. Here is how the winter impacts the different sectors:

• Businesses with high upfront costs and a long runway to profitability, like e-commerce grocery delivery or hyperlocal logistics, are finding it challenging to secure funding. Investors are prioritizing sustainable business models with a clear path to profitability.
• Seed funding and early-stage venture capital might dry up as investors become more cautious. It could stifle innovation and hinder the emergence of promising new ventures.
• Fintech startups, particularly those focused on lending, have faced difficulties due to increased regulatory scrutiny and investor wariness around non-performing assets (NPAs) in the lending space.
• Sectors like Artificial Intelligence (AI), Machine Learning (ML), and enterprise software continue to receive investor interest due to their potential for long-term growth and disruption across industries.

Unicorns in 2023

Before we get to the names, let us understand the term. Unicorns are privately held startup companies valued at over $1 billion. The term was coined by venture capitalist Aileen Lee in 2013. It refers to the rarity and mythical nature of such high-valued startups. Unicorns are typically tech-based and disruptive, with rapid growth potential. These companies attract significant attention from investors, media, and job seekers due to their potential for high returns and market disruption.

In 2023, only two startups acquired the unicorn status - Zepto and InCred Finance. 

Reasons behind the decreased capital deployment

The funding winter can be attributed to several factors - global and domestic. Here is a breakdown of the some reasons behind decreased capital deployment:

Rising Interest Rates: Central banks across the globe, including the US Federal Reserve and RBI, have raised interest rates to combat inflation. It makes borrowing more expensive, reducing the capital amount available for venture capital firms to invest in startups.

Geopolitical Uncertainty: Global events like the Russia-Ukraine war have created instability and uncertainty in the financial markets, leading investors to adopt a more risk-averse approach.

Focus on Profitability: During the funding boom, investors were more forgiving of high-growth startups with less emphasis on immediate profitability. Now, the focus has shifted towards sustainable business models with a clear path to profitability.

Overvalued Startups: Concerns have arisen about some startups being overvalued during the previous funding frenzy. Investors are now demanding more reasonable valuations before putting their money in.

Performance of Existing Startups: The success (or failure) of startups funded during the boom will influence investor confidence in the Indian startup ecosystem.

Burn Rate: Investors are more cautious about funding startups with high burn rates (excessive spending on customer acquisition) and a long runway to profitability. 

Way ahead for startups in 2024

The funding winter is likely to persist in 2024. Startups need to demonstrate a clear path to profitability, with strong unit economics, to attract investors. With tighter purse strings, startups might need to focus on bootstrapping and maximizing resource efficiency. Exploring alternative funding avenues like debt financing or revenue-based financing could be crucial.

However, startups working in deep-tech sectors like AI, ML, and Blockchain will likely continue to attract interest due to their potential for disruption and innovation. Sustainability solutions and Green-Tech ventures might also find favor with environmentally conscious investors.