Beyond Valuations: How India’s Tech Startups Embrace the Era of Prudent Growth?

As the fervor of chasing unicorns gives way to a more cautious approach, the nation’s entrepreneurial spirit remains undaunted. Startups and their investors are adapting, redefining priorities, and embracing new business models and cost efficiency. This cover story delves into the remarkable evolution of India’s startup narrative, exploring the forces behind the shift, the sectors that shine amid challenges, and the strategies propelling these visionary ventures toward a future of lasting success

Amit Singh

In the not-so-distant past, India’s tech startup ecosystem experienced an unprecedented boom, riding high on waves of funding and soaring valuations. The year 2021 witnessed an investment frenzy that seemed surreal, as startups scaled at an astonishing pace, capturing investors’ imagination both domestically and internationally.

Fast forward to 2023, and the landscape of many Indian startups and their once-celebrated founders appears marred by controversies, corporate governance lapses, employee layoffs, and more severe issues. A prime example is prominent Edtech player BYJU’S, which achieved a remarkable $22 billion valuation in 2022. However, the present scenario finds it facing severe criticism for non-compliance with local regulations, undisclosed financial outcomes, and adopting aggressive sales practices, among other concerns. Influential investors have significantly reduced BYJU’S valuation by more than fifty percent, a noteworthy shift that hasn’t stemmed from formal funding cuts.

Other startups grappling with devaluation include OYO in hospitality, Ola Cabs in ride-hailing, Swiggy in food delivery, PharmEasy in healthcare technology, and Pine Labs in financial technology, among others. Not long ago, these entities gained accolades for entering the coveted ‘unicorn’ status (startups valued at $1 billion or above), and even the esteemed ‘decacorn’ status (valuation exceeding $10 billion). Yet, the current year of 2023, in stark contrast to the dream-like trajectory of 2021, resembles a blazing house engulfed in flames, endangering any startup lacking prudence. This situation raises a fundamental concern: Has the era of unicorns reached its end? A more pertinent question arises: Have startups recognized the pitfalls of chasing valuations?

Experts point out that during the pandemic, central banks globally adopted expansionary monetary policies, leading to significant investments flowing into alternate asset classes like private equity and venture capital. This resulted in an unsustainable surge in startup valuations. Vikram Gupta, Founder & Managing Partner of IvyCap Ventures, shares, “The inflation surge in 2021 led to a remarkable spike in asset values driven by overwhelming demand that far exceeded their available supply. This phenomenon was particularly pronounced in India, where investments of over $100 million in Series C and D deals experienced a massive surge during that period. Investors were willing to accept deals at significantly higher valuations, contributing to inflationary pressures.”

“However, as the pandemic’s impact subsided, central banks raised interest rates due to spiraling inflation, signaling the end of easy money. Geopolitical tensions arising from the Russia-Ukraine war added to uncertainty and risk aversion. Investor sentiment towards the startup ecosystem plummeted as a result,” adds Surya Mantha, Managing Partner of Unitus Ventures.

Redseer’s analysis reveals that these macro factors led to a 70 percent decline in total funding, plummeting from ~$50 billion in FY22 to $15 billion in FY23. Recession in developed markets like the US and Europe, along with a decline in technology stock values, dealt blows. The slowdown in consumer internet growth further contributed to the downturn.

Bhawna Bhatnagar, Co-Founder of WeFounder Circle, adds, “Closing rounds, which previously took three months, now extend to six months or more. This particularly affects Series A and above rounds, impacting market sentiments.”

Sentiments amidst fluctuating valuations

The race to enter India’s coveted unicorn club seems to have paused. Amid the funding winter, no new startup has secured the unicorn tag after Tata 1 MG entered the club of 108 unicorns in September 2022. Valuations that once appeared invincible now wear humbler attire, prompting profound questions about the sustainability of these sky-high assessments.

From a psychological perspective, a valuation drop can dent a startup’s confidence, perceived as a decline in market sentiment and investor trust. Sandeep Goel, Managing Director of Moglix, details, “Founders and team members buoyed by previous valuations might feel disillusioned or concerned about the company’s prospects. It can also lead to questions about the business’s viability and its ability to fulfill its mission.”

However, it’s crucial to note that while valuation is important, it’s not the sole indicator of a startup’s worth or potential. “A valuation drop should be viewed as a recalibration of expectations and an opportunity for introspection. Startups should look beyond valuations and focus on the core problems they’re solving and the value they provide to customers. This perspective can help maintain confidence and motivation within the team,” adds Goel.

Vinod Keni, Co-Founder & Managing Partner of Qi Ventures, supports, “The shift towards caution and devaluations isn’t a negative development; rather, it marks a return to more prudent investment practices. For quality companies with sound business models, sustainable capital availability remains unaffected.”

According to Goel of Moglix, “Startups with high burn rates and regular funding requirements may need to negotiate lower valuations to continue their operations during the funding winter. Conversely, startups with a healthy financial position may comfortably wait for market conditions to improve before fundraising.”

In this scenario, embracing frugality becomes an indispensable virtue. “Startups must introspect whether they are allocating resources excessively to processes, personnel, or infrastructure. Drawing a parallel to dining choices, comparing dining at a Michelin-star restaurant to preparing a meal at home can yield insights,” highlights Sunil Kumar, CTO of Shiprocket.

He adds that the funding winter essentially acts as a filter, segregating substantial businesses from the plethora of startups. A robust foundation of fundamentals will inevitably emerge as the touchstone determining which entities will endure this phase.

In essence, startups need to construct a robust case that evokes investor confidence, effectively showcasing their steadfast fundamentals and the latent potential for exponential growth.

Criteria shaping funding decisions

The shift in the funding landscape isn’t exclusive to startups; investors are recalibrating their funding criteria in this new era. The cost of capital has risen, and one can no longer afford to continue burning capital. Founders must judiciously deploy capital, as investors now seek metrics like profitability, return on equity (RoE), and return on ad spend (RoA), which wasn’t the case earlier.

Investors are returning to basics, focusing on business models that exhibit capital efficiency. “With the era of abundant cheap capital fading, startups must showcase their ability to operate efficiently and achieve profitability within a reasonable timeframe. Investors now seek visibility into the startup’s financial trajectory, including projected profitability and the path to positive cash flow. There’s also an emphasis on realistic capital needs and how efficiently these resources can be utilized,” explains Keni of Qi Ventures.

He adds that startups should realize that investors are more than mere capital providers; they’re partners in the journey. This partnership demands open and consistent communication. Entrepreneurs should maintain transparency about their business’s progress, challenges, and strategies, fostering a collaborative atmosphere.

Mantha of Unitus Ventures emphasizes that while early-stage investing remains robust with competitive deals being funded, later-stage deals have become more challenging. Investors now demand startups demonstrate positive and sustainable unit economics. As startups progress to Series A and beyond, investors demand proven ‘Product Market Fit’ (PMF) and a scalable business model with a clear path to profitability.

Experts point out that rapid growth within five years could elevate the probability of subsequent failure. “Investors are thus inclined towards founders grounded in their approach, well-versed in their industry, and dedicated to crafting enduring, profit-generating ventures. Building with the expectation of a swift acquisition in 4-5 years might be tempting, but it’s a risky assumption to stake an enterprise on,” shares Mayuresh Raut, Co-Founder of Seafund.

He further adds that in 2023, businesses with solid product-market fit, positive economics, and strong leadership will still secure funding. “We’re essentially reverting to valuation norms of 2019-2020. Hence, startups that haven’t found their market fit, lack positive unit economics, or face internal leadership issues will struggle to attract capital. Many of them might even fail,” he highlights.

Overall, investors are taking a more cautious and informed approach, ensuring startups are well-prepared to navigate potential challenges. This shift doesn’t hinder quality startups; rather, it promotes a more sustainable and resilient ecosystem.

Pursuit of profitability

FY22 was an era of free money, and market sentiment revolved around chasing growth. Investors made risky bets on high-growth companies for better returns, while startups burned more cash, aiming for hyper-growth. However, with purses now clenching tighter than before, investors have taken a backseat, focusing only on startups that prioritize profitability, unit economics, and revenues.

Hence, startups across sectors are leveraging profitability levers to expedite their journey toward profitability and reduce burn rates. Listed tech startups have notably improved their EBITDA margins over the last 5 quarters. For instance, Zomato increased take rates from restaurant partners and improved delivery cost recovery from customers. Similarly, Airbnb raised take rates from guests and hosts and optimized cost discipline in workforce and marketing.

The April-June earnings posted by companies like Zomato, Freshworks, and Delhivery showed that frugality could yield favorable results even in a short time. While Zomato grabbed headlines for its first-ever quarterly profit, Freshworks and Delhivery saw significantly narrowed losses.

According to a Kotak Institutional Equities report, Zomato’s employee costs as a percentage of revenue fell by 1,069 basis points to 14%. Similarly, its advertising expenses as a percentage of revenues declined by 664 basis points to 13%. Policybazaar reduced its losses by cutting customer acquisition cost-related marketing expenses.

Freshworks kept operational expenses in check, with cost heads like research and development, sales and marketing, and general administration marginally falling to $163,507 despite a 19% increase in revenue.

Delhivery’s operating revenues increased 11% to Rs 1,930 crore, while expenses declined slightly. A decline in its largest expense category — freight, handling, and servicing costs — contributed to this improvement. Delhivery embraced backward integration through acquisitions across the value chain.

Furthermore, a Redseer analysis suggests that startups improved their profitability in FY22, with around 50% of unicorns projected to become profitable by FY27. However, ~20% of unicorns may face challenges due to unclear business models, plummeting demand, and regulatory roadblocks. Some startups might pivot, get acquired, or cease operations.

Marketing innovations to stand out

In a crowded and competitive market, startups are innovating in branding and marketing strategies to differentiate themselves. From leveraging social impact narratives to fostering authentic connections, these strategies exemplify the power of unique positioning.

“Amidst budget-conscious marketing strategies, startups are increasingly embracing hyperlocal marketing, focusing efforts on specific geographic regions or communities. Founders are becoming influencers, building personal brands to guide narratives and reach target customers,” says Bhatnagar of WeFounder Circle.

Unique experiences through gamification, collaboration, and experiential marketing foster early community building, she adds.

Technology, often seen as growth fuel, is now an essential tool for startups seeking marketing efficiency. “By leveraging advanced analytics, startups gain deeper insights into customer behavior, preferences, and pain points, enabling more precise marketing efforts. Customer acquisition strategies embrace a multi-channel approach, diversifying platforms from social media and influencer collaborations to content marketing and personalized email campaigns. This approach widens reach and effectively resonates with diverse audience segments,” elaborates Gupta of IvyCap Ventures.

In the pursuit of revenue growth, tech startups increasingly adopt value-driven marketing principles. Rather than merely showcasing product features, they strive to articulate unique value propositions addressing specific customer needs. This value-centric approach fosters brand loyalty and generates word-of-mouth marketing through satisfied customers, he adds.

Experts highlight partnerships as valuable assets during this transition phase. “Collaborating with other businesses helps startups access new markets, reduce costs, and expand their customer base. These partnerships are mutually beneficial and contribute to controlled spending,” says Keni of Qi Ventures.

He adds startups can consider tiered pricing models or freemium offerings to cater to a diverse customer base. The goal is to balance revenue generation with customer value.

Maintaining a culture of innovation is equally crucial. “Startups should consistently strive to improve products or services, responding to customer feedback and market trends. Innovation doesn’t require exorbitant spending; it can arise from a focused approach to addressing customer needs,” adds Keni.

Customer experience should remain a top priority. Exceptional customer service generates positive word-of-mouth and drives sustainable growth.

Alternative fundraising tactics

The fundraising playbook is being rewritten as startups explore alternative tactics to secure capital in a post-boom era. As traditional VCs tighten their purse strings for equity investments, venture debt emerges as a viable alternative. “Venture debt not only provides an alternative funding source but helps founders avoid dilution at less-than-optimal valuations,” shares Mantha of Unitus Ventures.

Besides venture debt, revenue-based financing (RBF) has gained substantial traction. RBF providers receive a regular share of revenue until a predetermined amount is paid, he adds.

Crowdfunding platforms, both reward-based and equity-based, have emerged as popular avenues, allowing startups to tap into a wider pool of individual investors, Gupta of IvyCap highlights.

Shining Bright: Thriving industries

Despite challenges posed by the funding winter, certain industries have thrived. Notable sectors include fintech, securing $2.1 billion in funding, followed by e-commerce ($1.1 billion) and enterprise tech SaaS ($683.9 million). Cleantech also performed well, with $271.3 million raised across 32 deals. Moreover, the resurgence of interest in AI, particularly Generative AI, has boosted investments. Additionally, agritech has seen significant investments recently, shares Bhatnagar of WeFounder Circle.

According to a report by Chiratae Ventures and Zinnov, Indian SaaS startups secured triple the funding in 2022 compared to 2019. Funding to the sector increased from $871 million in 2019 to $2.7 billion in 2022.

Sectors like AgriTech, HealthTech, and DeepTech with a focus on IoT and Generative AI, along with various areas in B2B SaaS, hold tremendous promise. E-commerce, cleantech, cybersecurity, AI & machine learning, and biotechnology have also demonstrated resilience, offering lucrative opportunities for startups despite the funding winter, Gupta of IvyCap Ventures discloses.

These sectors are poised for substantial growth. According to Redseer analysis, the top four sectors expected to drive the highest profit pool are fintech and financial services, B2B SaaS, and eCommerce.

Envisioning India’s startup landscape

All investment cycles experience ups and downs. A period of funding slowdown is essential for startups to achieve massive growth. As the world’s third-largest startup ecosystem, India will rebound from this short funding winter. After all, if winter comes, can spring be far behind?

The future of India’s startup ecosystem is undeniably promising, driven by the nation’s burgeoning macroeconomic strength and inherent entrepreneurial spirit. Investors will increasingly shift focus from growth metrics alone to a holistic evaluation of startups’ health. “Metrics like gross margins, free cash flows, and sustainable unit economics will gain prominence alongside growth indicators. Startups will place greater emphasis on achieving sustainable growth rather than rapid expansion at any cost,” shares Goel of Moglix.

He adds that the startup ecosystem will extend beyond metropolitan hubs, with increasing activity and innovation in Tier 2 and 3 cities. This decentralization will contribute to a more inclusive growth narrative.

Moreover, awareness among domestic high-net-worth individuals (HNIs) and family offices about startups’ potential is growing. This increased interest will ensure a steady availability of capital. “As startups gain access to diverse funding sources, they’ll have more flexibility to choose partners aligned with their vision and goals,” says Keni of Qi Ventures.

Furthermore, China’s altered global position presents a golden opportunity for Indian startups. With a unique vantage point, they can capitalize on India’s emergence as the last substantial frontier market with democratic governance and corporate standards. This provides an optimal environment for Indian startups to collaborate with global corporations, details Raut of Seafund.

He concludes that the industry is transitioning from software-focused businesses to those built on physical assets, such as material science, pharmaceuticals, robotics, defense, and aerospace.