Venture Capital In 2022. Will The Current Trends Reverse?
The moderation in capital markets and liquidity will likely increase focus on the underlying economics for startups.
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Despite the pandemic and the tough economic environment, 2021 proved to be an extraordinary year for the Indian start-up eco-system. Some may say it was too good to be true. The addition of Pristyn Care brought India’s current total of unicorns to 79, 43 of which achieved this coveted milestone in 2021. The ecosystem has recorded over 1,060 deals—about three transactions each day—generating an estimated USD 60 billion in investments. What’s more encouraging is that these investments are coming for a diverse spectrum of industries, with a good balance of B2B as well as B2C investments. Another significant development this year was the healthy number of VC exits and much-awaited IPOs, which saw strong demand from both institutional and retail investors. We witnessed a few significant IPOs from market leaders such as Zomato, Nykaa, and PayTM. This would assuage overseas investors’ concerns about the exit possibilities for their Indian portfolio. We are advancing towards 2022 on this high note as the momentum is strong and so are the expectations.
So, what can we expect from the coming year? Crystal ball gazing is a risky business – nobody would have expected 2021 to pan out as it did. However, our team at Cactus Venture Partners can hazard the prediction of some trends in the coming year.
Behavior change will be sticky
The pandemic has altered the digital adoption cycle and accelerated digital acceptance in a wide range of verticals such as online education, business collaboration, online shopping, grocery shopping, and medical services. This behavioral change will be sticky as forced adoption (in some cases) has allowed people to get rid of their mental inertia. The digital possibilities are visible and some previously widely accepted inefficiencies are being questioned. While the growth momentum witnessed this year might not be sustained (partially thanks to the base effect), the adoption curve has been rebased.
Capital markets may not be as accommodating as they were in 2021
2021 was a year of disparity between economic growth and asset valuations thanks to the abundance of liquidity. While GDP growth across countries has been under pressure, stock markets and other financial asset prices are at an all-time high. Though economists are best equipped to explore the reasons for this, one visible cause seems to be governments predominantly taking demand side measures to counter supply side shocks. While the pandemic caused supply chain and production disruptions, central banks worldwide increased the amount of money in people’s hands to stimulate the economy, with the predictable outcome of higher inflation. No wonder inflation in the US—the largest capital supplier in the world—surpassed 6% in October 2021; this is the highest in more than three decades. On the other hand, treasury yields are less than 2%, implying an unsustainable negative real interest rate of 4%+. Central banks will need to reverse their accommodative stance sometime in 2022 and start managing fundamental metrics such as inflation and real interest rates, which will inevitably lead to a reduction in liquidity. One tailwind offsetting some of the impact might be India becoming a preferred investment destination after the recent less-than-favorable policy changes in the tech sector in China. Capital markets, on the other hand, are unlikely to be as strong as they were in 2021. However, the extent of the offsetting factors and the net headwind is hard to predict at this point.
Return of focus to discipline in economics
The moderation in capital markets and liquidity will likely increase focus on the underlying economics for startups. 2021 had been a sellers’ market thanks to liquidity, where investors have been fighting for good deals. Though most of the businesses who raised capital have robust fundamentals, there have been some exceptions. The buoyant capital markets and relatively easy accessibility to capital took the focus away from the hard task of balancing the growth–profitability (or lack thereof) trade-off. We believe 2022 will likely bring the focus back to economic discipline. The growth-focused capital investments are understandable and should be encouraged, but non-sticky, GMV-enhancing burn creating artificial demand will likely be questioned. We believe investors will be more focused on underlying economics in 2022, and the disconnect between valuation and underlying economics will tighten.
Consolidation seems imminent
The large amounts of capital raised during the year will provide the necessary dry powder for industry leaders to acquire complementary assets. Moreover, the need to justify the valuation will necessitate companies finding alternative and faster avenues to exhibit strong top-line growth, which should drive the adoption of inorganic initiatives. We are already seeing strong consolidation in certain industries such as online education and content/commerce businesses. We will likely see this trend expand to new verticals and sub-verticals.
Indian businesses will assert themselves in international markets
India is a competitive market, and over the last two years we have seen accelerated growth of new business models among competing businesses in the country. Also, it’s hard to generate revenues due to limited per capita incomes and low willingness to pay. On the other hand, geography-agnostic or easily customizable businesses will find it easier to build scale in relatively wealthier markets with higher willingness and ability to spend. On the softer side, the global success stories of companies such as Freshworks, Innovaccer, and many more have provided a new confidence to Indian entrepreneurs to explore new markets. They are keen and ready to assert themselves on the international stage.
Fund eco-system in India has lot of ground to cover
Despite the strong VC activity in India in 2021, India might have the lowest density of VC funds among the large tech eco-systems. To provide context, China has more than 15,000 GPs, while India does not have more than 500-700 GPs. Hence, there are very few players in the VC market across stages. We will likely see a continued increase in the number of funds across stages and series.
With all these recorded trends, 2022 holds a definite promise for start-ups to find bigger and better investors.
Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house
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