VCs may look at secondary exits as startups delay IPOs

M&As in growth and late stages on the cards to exit investments.

tech stocks, M&As, venture capitalists, startups, IPOs, Markets
During the current funding winter, convertible notes have emerged as an attractive investment option for tech startup founders.

With the global market rout causing significant drops in the value of listed tech stocks in India and the US, domestic startups may put their IPO plans on hold indefinitely, several venture capitalists (VCs) and analysts told FE.

VC firms, who poured money into pre-IPO rounds and were expecting cash exits from the IPOs of their portfolio firm, may now consider exiting their investments through secondary market deals, primarily through mergers and acquisitions (M&As) in growth and late stages, experts pointed out.

On Monday, Reuters reported that Mamaearth has decided to postpone its plans to raise $200-300 million via an IPO due to unfavourable market conditions. The company, however denied the reports stating that it is still awaiting approval from Sebi.

According to data sourced from private investment platform Tracxn, the number of M&A deals went up sharply in CY22, especially after the funding boom in the previous year in CY21. Even during the funding bull run in CY21, there were around 255 M&A deals announced in the startup ecosystem, which was slightly higher than the 250 deals recorded in CY22.

However, there were fewer M&A deals in the year before the funding boom in CY19 and CY20 with 145 and 123 deals, respectively.

Not all is gloomy for domestic startups however. VCs and analysts indicate that although global volatility is expected to impact startup investments, profitable businesses will be able to tap public markets successfully to raise sizeable funding.

As the current market situation remains volatile, VCs are also re-evaluating their investment strategies and portfolio management approaches. According to Sanjeev Bikhchandani, co-founder of Info Edge, the fund itself is considering factors such as the amount of funding a company will need throughout its lifetime and its likelihood of receiving additional funding from investors while writing new cheques.

Info Edge, a leading Indian Internet company with investments in various tech startups, has made successful investments in tech startups such as Zomato, PolicyBazaar and ShopKirana.

“Due diligence is becoming increasingly critical, leading to more time spent on calculations and assessments. VCs are now asking companies to prioritise profitability with the funding they already have in the bank,” Bikhchandani added.

In a move to conserve equity, several startups have also turned to alternative financing options such as venture debt and convertible notes to fund their short-term operational and capital expenses.  

However, VCs and analysts warn that this may not really be a prudent option unless the firm has shown some amount of profitable growth.  

“At this point in time, founders have to figure out a mechanism to extend the runway without having to raise considerable capital… rationalising and reducing costs may be the smartest move rather than raising debt at this point in time. However, smaller quantities in debt are fine,” said Sunitha Viswanathan, partner at Kae Capital.

Also, during the current funding winter, convertible notes have emerged as an attractive investment option for tech startup founders. According to Abhishek Goyal, co-founder at Tracxn, these notes offer flexibility and can help founders raise capital quickly without committing to a specific valuation. However, the same cannot be said for investors, as the current market conditions pose a significant risk for them. Due to the reset of valuation multiples in the funding market, investors holding convertible notes may not be able to exit at an attractive valuation.

“The crazy valuations multiples of 21X and above seen in CY21 are unlikely to return, and this will inevitably lead to a slower growth rate in valuations for these companies. With markets becoming increasingly tight, it may not make sense for investors to invest in convertible notes as they will not be able to exit at a profit. Therefore, while convertible notes can be beneficial for founders, they may be a risky investment option for VCs in the current climate,” added Goyal.

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First published on: 29-03-2023 at 01:15 IST