Why Are VC Funds Drying Up?

Naturally, with VC and PE funding showing no positive signs, company leaders and entrepreneurs now have to go back to their boardrooms, evaluate fundamentals correctly, and maintain an adequate standard of profitability

After 2021 witnessing a historic boom in VC funding, investors are concerned that the market is now drying up. According to an Entrackr report, Indian startups raised nearly USD 38 billion last year. However, according to CB Insights, VC funding for India-based startups has declined for the first time since the Oct-Dec quarter of 2020. In fact, as of April 2022, globally, the waning trifectas on startups have resulted in a 27% drop in investments of PE and VC, IVCA, and EY report. The Indian startup world is trying to withstand this funding winter (the latest black terminology of the entrepreneurial ecosystem) by speeding the layoffs and reducing cash burns, which is the exact opposite of last year when the same businesses were conducting aggressive hiring at relatively higher tech salaries. Startups in India have fired 5,000 employees and over 20,000 employees have been laid-off globally, according to reports.

Naturally, with VC and PE funding showing no positive signs, company leaders and entrepreneurs now have to go back to their boardrooms, evaluate fundamentals correctly, and maintain an adequate standard of profitability. While this may not be a growth-friendly approach and adds additional strain on ensuring the correct financial management from the beginning, there is no doubt that startups in the present circumstances will have to grasp at straws.

But the question is, what exactly triggered this downward spiral? The answer is— many factors.

The economy is a complex yet comprehensive concept. And naturally, no single turn of events can have such an enormous impact on it. Many drivers were at play in the latest slum of PE and VC funding. Three core issues accelerate this outcome: global inflation, the Ukraine invasion, and the unprecedented pandemic.

Foremost, Global Inflation: One of the primary causes of VC fund scarcity is global inflation or the hawkish stance of central banks trying to battle the ascending economic prices. To combat the unforeseen challenges of the global economic crisis, central banks globally have significantly raised the interest rates. Their goal was to reduce liquidity from the global economic system which was at historic heights post Covid.

This hawkish stance has forced investors to shift their investment portfolio from high risk assets like VC investments to relatively lower risk fixed income yielding products. While this is a good strategy for investors to ensure attractive risk adjusted returns, the same cannot be said for organizations/ businesses dependent on equity funding.

Second, The Ukraine Invasion: The massive possibility of a full-fledged war with the Russian invasion in Ukraine has significantly impacted the global VC and PE funding mechanism. Increasing uncertainty, unfavorable market sentiments, and global macroeconomic risks accompanied by the Russia-Ukraine charge filled the funding world with an eerie hush. Given that no one knows how long this war will continue and its after-effects on the global economy, most people believe that the only thing to be done is to wait and watch. And therefore, high-risk equity projects and VC investment prospects have been put on indefinite hold.

This is not merely a calculated theory but a factual reality. A Crunchbase report stated that global VC funding witnessed a drastic slowdown following the Ukraine invasion. Until February 23rd, before the Ukraine invasion, startups achieved an average weekday seed funding of USD 1.9 billion. But post-February 24th (after the Ukraine invasion), this average reduced to USD 912 million.

And Third, The Global Pandemic: Initially, the global pandemic might have given a massive boom to the startup ecosystem, but its negative impact on the global economy has continued even after two years and so back-to-back waves. In 2020, during the initial few months, when the pandemic gave a massive blow to the world socio-economic pillar, VC investments decelerated by close to 30%. In 2021, things started to look back on track, and the funding landscape became immune to the pandemic effects, resulting in a record USD 307 billion investment into startups. People started comparing the unprecedented COVID-19 situation with the unprecedented VC investment incline. However, the pandemic proved to be the mightier party in this equation.

While initially pandemic-brought demands, requirements, and need-gaps created a massive space for VC funds, these requisites also subsided as things started returning to normal. Once again, the changing consumer behavior, market trends and expert forecasts resulted in the lack of VC funding for young businesses and non-established companies. Though the irony here isn't lost on any stakeholder, that's certain.

While we have understood the problem and its causes, let’s introduce a solution—Alternate Financing Opportunities.

The depletion and exits of PE and VC funds have resulted in many businesses shaking their boots. Valuations are being mercilessly lacerated, and employee lay-offs have created a panic-stricken atmosphere. We have witnessed a flight to quality path being chosen by the investors currently.

Fortunately, companies with predictable Monthly Recurring Revenue (MRR) have alternative financing options that transform recurring revenue from the customers to upfront capital today. The reason behind this uncustomary treatment is the stability indicator accompanied by MRR. Simply put, businesses with MRR are far more attractive to investors since they have predictable recurring revenue which makes them more stable businesses and hence a safer investment option in today’s macro-economic scenario.

Unfortunately, traditional financial institutions like banks are yet to recognise the vast potential, value and stability of recurring revenue streams and consider it like regular fixed income. But, leading new-age fintech firms have acknowledged that companies with MRR should be treated differently than their counterparts. These modern institutions have introduced new financing options and methodologies for them. This includes swift, flexible and hassle-free growth capital without dilution. This is nothing short of a lifeline for companies relying solely on VC funds, which are out of the picture for an indefinite period.

Harnessing the power of an organization's recurring revenue enables businesses, irrespective of the size, to acquire appropriate financial backing to facilitate their growth plans. Also, this unconventional predictable recurring revenue investments enable investors to diversify their portfolio to a new asset class with access to growing start-ups and young companies and generate attractive fixed income yields.

Today, in the highly-competitive, volatile and fierce world, this progressive approach is vital to ensure that new businesses can survive and thrive.

(The given article is attributed to Eklavya Gupta, Founder and Co-CEO, Recur Club and has been exclusively created for BW Disrupt)

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