FUNDING WINTER IS HERE

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A look into the 2023 global funding winter and what that means for young entrepreneurs and venture capitalists.


 

Funding winter refers to a period in which venture capital inflows are fewer than projected. This duration is especially challenging for entrepreneurs to raise funds. A funding freeze is frequently followed by layoffs, delays in capital allocation choices, departmental budget cuts, and lower valuations than previous fundraising rounds. Practitioners are of the understanding that a funding winter will be a battle for survival for startups. However, creative thinkers see it as a golden opportunity for company founders to put their skills to the test against altering market circumstances, as well as for investors to uncover excellent investment prospects.

A funding winter began in early 2023, striking India the hardest, resulting in a 77% decline in investments in the first 6 months, compared to the same time period in 2022. Startups throughout the world are going through a funding dry spell caused by market insecurity, a global economic downturn, shifts in industry focus, or simply a lack of interested stakeholders.


THE FUNDING WINTER HAS ALREADY RESULTED IN ENTREPRENEURS PUTTING REALISTIC VALUATIONS ON THEIR STARTUPS THAT ARE MORE IN LINE WITH MARKET REALITY.


Current market conditions have compelled central banks of different governments to hike interest rates to survive global inflation. The Russia-Ukraine conflict added to complications due to sanction-induced supply chain disruptions leading to scarcity in commodity access in several developing countries. Investors’ confidence has also been dented after some behemoth startups went public but later started to fail. It is difficult to predict when the funding winter will be over. Surveys indicate that both investors and entrepreneurs have mixed responses and differing opinions on when venture capitalists will start investing again.

Over the last decade, startup valuations have been ‘bold’; several business analysts have commented on investors enabling startups to courageously do sky-high valuations and back them up without worrying about contingencies. Since the 2023 funding winter is a result of external influences, there is little that investors and entrepreneurs can do to thaw out the frozen investment environment. While the funding downturn is likely to end gradually in the years to come, analysts are seizing it as an opportunity to observe how good and strong entrepreneurs are surviving the winter.

Most of the knowledge on surviving the winter is coming from India, the country needing to adapt the most after almost a decade of relentless venture capitalism. Lessons so far have indicated that entrepreneurs must implement resource-optimisation tactics in their business operations, such as managing existing working capital by limiting research and development and employing only proven marketing strategies. Startups that have raised funding in the last year must consider ways to prolong their liquidity runway as much as possible, including, but not limited to, deferring big capital commitment choices and reconsidering loan payback conditions.

Founders must concentrate on revenue creation by tracking and optimising the most important indicators such as minimising customer acquisition costs, maximising customer lifetime value, and increasing customer retention through products that offer high value. Founders can also look to incubators to tackle funding winters. An incubator is an organisation or program that aims to help budding startups by providing seed capital, training, and, in some circumstances, a physical workplace.

Working with fundraising sites is another useful method for overcoming the funding winter. The platforms enable startups to generate funds through equity fundraising, allowing firms to benefit from several modest investments at the same time. Some equity crowdfunding platforms have gained prominence in recent years. As long as a startup has a minimum viable product and the potential to undergo monthly growth, it can receive crowdfunding even in times of financial instability.

For investors, the funding winter could be a blessing in disguise. The myriad of million-dollar startup valuations has created lethargy among venture capitalists. The funding winter has already resulted in entrepreneurs putting realistic valuations on their startups that are more in line with market reality. This has started trimming the ‘fat’ down in the market, leaving only strong, lean competitors which are far more lucrative to investors.

Investors should now look for ambitious and competent entrepreneurs with good business acumen. It is most sensible to only invest in companies that display passionate ideation with sound execution. Additionally, due diligence is non-negotiable, especially in a funding crisis. Investors must establish a strict filtering process to guarantee that only the most eligible companies with the greatest potential for success enter their portfolios. Finally, investing is no longer a compartmentalised activity. Investors should look for ways to expand their network of fellow investors to supplement their holdings.


STARTUPS WILL NEED TO FOCUS ON EXTENDING THEIR RUNWAY TO GET THROUGH THE BLEAK FUNDING WINTER. THE SIMPLEST METHOD TO ACCOMPLISH THIS IS TO REDUCE THE BURN RATE WHILE ALSO PRODUCING REVENUE.


Now comes the question of when this funding winter is likely to end. Results from a survey conducted by consulting firm Redseer suggest anywhere between six to eighteen months. The funding trend in 2023 is predicted to follow long-term patterns that were seen between 2017 to 2020. After that, a bullish trend is expected for 2024. Despite a decline in funding deals in early 2023 Redseer expects a comeback in 2024.

This feeling is reinforced by this year’s transaction distribution, with 90% of anticipated agreements being seed or early-stage investments, consistent with patterns observed since 2017. According to a recent Redseer analysis, new-age enterprises could become publicly traded or ready to offer shares on stock exchanges by the 2025 fiscal year, indicating an increasing emphasis on profitability within the ecosystem. Redseer also forecasts that various industries, including app studios, personal loans, customer relationship management, B2B e-commerce, insurtech, and finance have the highest potential to become the next generation of unicorns over the next decade. However, the current funding winter will slow down these innovative startups.

Thus, the mandate is clear: startups now need to master the fundamentals of business. Even if it will be challenging for entrepreneurs to secure capital in the next twelve to eighteen months, it is not all doom and gloom. Venture capital firms have enough cash on hand to invest in entrepreneurs who are obsessed with customer-market fit and have a clear path to profitability.

Startups will need to focus on extending their runway to get through the bleak funding winter. The simplest method to accomplish this is to reduce the burn rate while also producing revenue. For the first time, start-ups must ensure that their acquisition cost is less than the income earned by a customer onboarded. Prior to the 2008 Great Recession, investors and founders may recall Sequoia’s iconic ‘RIP Good Times’ presentation. While the scenario is far from ideal, entrepreneurs must approach this winter with a clearer understanding of their issue statement.

According to Yagnesh Sanghrajka, Co-founder and Chief Financial Officer of seed-stage venture capital fund, 100X.VC, what is happening now is partly a correction following the euphoria of 2021 and early 2022, when many Indian startups raised back-to-back funding rounds, with their valuations increasing significantly each time. She explained that in every business cycle, there are corrections that happen, and the 2023 correction cycle is being called a funding winter. Kalsoom Lakhani, Co-founder of Pakistan-focused venture capital fund, i2i Ventures, believes the funding slowdown will likely stay the full length of 2023, but good companies that are not burning lots of cash indefinitely will be able to raise funds in the coming year.

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