Funding Winter shuts over 35,000 startups in 2023. Will VCs fund tech platforms this year?

Indian startup ecosystem faced multifaceted challenges in 2023 with more than 35,000 ventures shutting down during the year as funding winter intensified, according to a report by Bain & Company in collaboration with the Indian Venture and Alternate Capital Association (IVCA). 

A convergence of domestic and global factors including stubborn inflation, heightened investors' performance expectations, and persistent higher interest rates prolonged the funding winter, the report said, adding that softening global consumption and ongoing geopolitical uncertainties hindered startups from showcasing the necessary performance.

These challenges led to a decline in both deal volume and average deal size. The deal volume compressed by approximately 45%, falling from 1,611 deals to 880 over 2022–23; average deal value decreased by about 30%, from $16 million to $11 million over 2022–23, while the share of seed deals rising from approximately 60% to 70% during the same period.

In terms of deal flow shifts, the number of mega rounds plummeted by almost 70%, from 48 to 15 over 2022–23. Also, the emergence of unicorns experienced substantial declines reaching pre-2019 levels, the report noted. 

As per the latest data, small and medium deals (less than $50 million) witnessed milder compression, declining by about 45% from 1,501 to 852 over 2022–23, indicating investor confidence in India’s medium-to-long-term prospects.

In addition, over 20,000 employees were sacked by leading startups with edtech contributing the largest share, the company said. 

However, India still retained its position as the second-largest destination for Venture Capital and growth funding in the Asia Pacific region, despite the decline in funding value and volume. 

The previous funding winter cycles, during which valuations fell and profits were prioritized once again, were succeeded by the current state of affairs, in which founders and investors placed a premium on high valuations and growth at all costs.

Tech sector dwindles, focus on traditional businesses

In India, tech startups witnessed a significant decline in 2023 as the deal flow to consumer tech, fintech, software, and SaaS decreased from $18 billion to $5.6 billion over 2022-23. Investors directed more focus to traditional sectors with notable headroom for consumption growth, ongoing formalization, and improving technological enablers like BFSI, consumer brands, and healthcare. 

Tracxn, a data intelligence platform, has earlier reported that funding in tech startups of Karnataka, Gujarat, and Tamil Nadu dropped in 2023. The report revealed that the Karnataka Tech startup ecosystem saw a total funding of $3.4 billion in 2023, which is a 72% plunge from the $12.2 billion raised in 2022. On the other hand, funding in Gujarat-based tech startups fell 66% to $139 million in 2023 from $412 million in the previous year.

Sai Deo, partner at Bain & Company said that the company expects more investment into traditional sectors this year because there have been several successful investments that VC firms have made here. She believes that there are good businesses in traditional sectors including offline retailing, financial services, credit-focused banking, insurance (BFSI) companies, etc. 

Generative AI - a prominent theme

Approximately 80% of generative AI application funding was attracted by existing companies integrating generative AI in their extant workflows, in comparison with 20% funding to such native startups, the report stated. While generative AI infrastructure startups have experienced initial success, India has seen a slower start compared to peer economies—for instance, AI21 Labs, based in Israel, closed a funding round of $155 million in 2023. 

Investments impelled by strong early signs of product-market fit for generative AI use cases in marketing, support, and legal. The report said funding was attracted by companies that seamlessly embedded generative AI in business workflows and drove tangible outcomes. In contrast, fewer companies have exhibited substantial data advantages, such as large and expanding proprietary datasets for continual model enhancement. 

Fundraising - dry powder build-up

The report revealed that overall fundraising declined by 50% as dry powder accumulated with record fundraisers in 2022 and capital deployment softened. There is also a decline in high-value fundraisers, that is, $200 million decreased from 10 to 4 over 2022-23, while the largest fundraiser in 2023 was $700 million (Nexus Venture Fund VII) as compared to $2 billion in 2022. The domestic VCs comprised over 90% of fundraising including Creaegis, Trifecta Capital, 3One4 Capital, and Omnivore Partners. 

Last year, it was reported that investors have lined up about $20 billion in dry powder–capital waiting to be deployed in startups. With this, the stage is set for a potential revival and the startup ecosystem stands on the cusp of transformation.

2024 outlook 

While the landscape witnessed flux by way of executive departure and funds trimming exposure to the Indian market, investors adapted to the “new normal” and positively influenced the maturity of the Indian startup ecosystem. They turned their focus from tech bets to traditional sectors. However, startups demonstrated resilience and glimpses of optimism for 2024. 

Despite large-scale shuttering, layoffs, and restructuring, startups stayed the course on profitability. Several notable companies turned green in 2023 like Groww, LendingKart, Indifi, Arya.ag, Urban Company, and continued to drive deep-tech innovation including generative AI, and aerospace).

The report also noted that many promising sectors and themes are primed to draw investors' interest in the near term. Dominant sectors like B2C commerce and software & SaaS are expected to rebound as structural tailwinds persist. Several emergency themes such as sustainability-centric agritech, energy transition, and India-nuanced AI tooling are expected to witness a surge in funcidng activity. 

In the long run, global investors are likely to remain bullish on India as an investment destination because the market’s demonstrated macroeconomic fundamentals, fiscal and monetary discipline, latent talent pools, and ever-expanding digital backbone present attractive prospects for venture building.