India could see a 25-35% drop in annual private equity and venture capital (PE/VC) investments this calendar year, after six consecutive years of record funding, a report jointly published by Indian venture and alternate capital association (IVCA) and EY showed on Thursday.
As a result, new-age companies will have to either accept the new valuation reality or sell to their well-funded peers as startups will witness consolidation across all sub-segments as high-burn companies struggle to raise funds in at a higher valuation than in the past.
“After a multi-year bull run, over the past 4-5 months, private equity investment and exit activity globally has been weighed down by inflation woes, recession fears, the rising cost of capital and elevated levels of uncertainty driven by geopolitical reasons,” said Vivek Soni, partner and national leader private equity services, EY India.
“In India, investors have reset their valuation appetite, but sellers have yet to get there, leading to a bid-ask spread in most transactions, which has delayed and in some cases derailed PE-backed transactions negotiated pre-March 2022. It will take time to narrow this gap.”
That view was echoed by a KPMG India report released on Thursday that said funding in Indian startups was expected to remain muted next quarter. The predicted slowdown comes at a time when capital infusion has already fallen to a nearly two-year low in Q3CY22, declining to $2.7 billion, compared with Q2CY22’s $7.4 billion. Investors have turned cautious in backing companies because capital has become difficult to access, thanks to soaring inflation that has forced central banks to push interest rates higher across the globe, among other reasons.
“With no end in sight to the global macroeconomic uncertainty VC investment is expected to remain subdued heading into Q422 as VC investors only become more cautious,” KPMG said in its report.
“Interest in a number of sectors that thrived during the height of the pandemic, including food and grocery delivery, faltered as inflation remained high and interest rates climbed…energy, business productivity, and cybersecurity will likely remain relatively hot tickets for VC investors globally (while) other sectors could see a major drop-off in interest,” the report added.
Between 2020 and 2021, when interest rates were low across the world, which saw PE/VC firms accumulate capital and several of them now sit on record levels of funds, waiting for an opportune time to invest. According to an earlier PwC report, globally VCs have about $562 billion of dry powder, the highest since at least 2006, indicating that “we could see strong investment cycles ahead.”
However, with investors prioritising value creation over valuation, only startups with a clear path to profitability will continue to make gains, reports highlighted.
“Structured trades will increase as a means of bridging valuation gaps and with the days of low cost of capital behind us, an active value creation agenda is expected to occupy top-of-mind recall for funds and portfolio companies,” EY’s Soni added.