Startup investors are hunting outside unicorn zone

There were 318 deals in companies valued below $1 billion this year against just five in those valued over a billion, one valued over $2 billion and none for companies that are valued over $3 billion, data from Tracxn showed. To be sure, these are primary investments, where investors bring in fresh funds, and not secondaries where one investor buys out another.

Late-stage investors are drawn to high-quality companies with robust growth and a clear path to profit, said Pankaj Naik, managing director and co-head, digital and technology investment banking, Avendus Capital. “Their ability to pay valuation is highly linked to exit returns. Hence, for companies that are valued more than $2 billion, the key question investors are asking is whether this company has the potential to become 3X (after dilutions) over the next 5-6 years. In that case, investors are happy to underwrite 5X returns in companies valued less than $500 million, and have marginally cushioned their return expectations,” Naik said.

Unicorns, or companies valued above a billion dollars, have been finding it difficult to raise capital in the last 12-18 months of the funding winter. While many companies are close to exhausting capital, existing investors are ready to fund them further, albeit with more stringent terms. These transactions are mostly structured in a way where investors get to protect their investments and ride the upside, if any. Some of India’s prominent unicorns looking to raise funds currently include Ofbusiness, Lenskart, GoodGlamm and Zepto.

Amid last year’s liquidity crunch, 1,419 deals were inked in the sub-billion-dollar category against 30 in those valued over a billion, data from Tracxn showed. Around 11 deals in companies valued over $2 billion and 9 deals in those valued over $3 billion got sealed.

Earlier this month, new-age media company Sharechat raised a bridge round of $60 million from existing backers as structured debt, which will be convertible in the next equity round. A person aware of the development said the valuation is being capped at $1.6 billion for the deal, and in the next funding round, the investors get to convert their debt to equity at that value. In an emailed response, however, the company denied the development.

The size of the economy and the opportunity in a particular sector will determine whether a company will be able to clock billion-dollar revenues, experts said.

Niren Shah, managing director and head, India, at Norwest Venture Partners said India is a smaller market compared to China and the US and therefore, it’s hard for investors to take large bets in new-age companies.

“There’s a lot of competition in India, and therefore again, execution has to be absolutely impeccable. So, it’s much easier to come in at, I would say, the $500 million mark. And find a company which can then get to $2 billion, as compared to coming at $3 billion or $4 billion and then seeing that company go to $15 billion. Our GDP per capita might be a barrier to sort of grow this stuff. So, I think people have become more cognizant, I think. There was a time in 2021, where a lot of people invested thinking every company will go to $20-25 billion, but that’s not going to happen for all markets,” Shah said.

The founder of a consumer startup looking to raise money said bankers have advised valuing the company rationally. “Even in private rounds, the froth of 2021 is gone. You are more likely to raise money if you are not valued more than $800-900 million,” the founder said on condition of anonymity, as the company is in the process of raising funds in near future. “We are likely to hit the market in the second half of this year,” he added. 

At many unicorns, growth slowed as investors pressed for profitability and governance, and deals slowed due to a funding winter. Hence, exponential growth and corresponding increase in valuations of large start-ups plateaued, said Bhavin Shah, partner and private equity leader at PricewaterhouseCoopers India.

“The mark-down in valuation of select start-ups also pulled back large investors to deploy significant sums of money. Overall sentiment in the private funds market seems to be giving an impression that this trend should reverse in the second half of this year,” he said.

While most large companies that have managed to demonstrate stronger unit economics and either achieve profitability or inch towards it, public listing seems to be the most viable outcome to generate liquidity and give its investors an exit. And for those looking for private capital, there are growth and late-stage equity funds. “The classic private equity investing style is pushing the bar high on justification of growth and margin levers in the future,” Naik added.