In a matter of three months, Covid-19 has turned upside down even the best laid out business plan across various sectors. The start-up ecosystem is no exception. Founders are trying to combat the crisis by conserving cash through various means ranging from pay-cuts to furloughs and re-evaluating expenses in a bid to extend their cash runway. They are now ready to accept funding at reduced valuations, said investors.
“Valuation is a function of the business’ growth prospects, quality of management and quality of business. And in the current times, growth prospects across the industry have diminished. This has led to a correction in pricing for start-ups wanting to raise capital. Valued on annual recurring revenue (ARR) basis, the average multiples have declined by 30-40 per cent,” said Pankaj Raina, Managing Director, Research and Investments, Zephyr Peacock India, a private equity firm.
With the road to recovery seeming long, even profitable firms are witnessing a similar diminution in value, investors said. According to a recent Nasscom report, approximately 90 per cent start-ups in India are facing a decline in revenues due to the pandemic. Furthermore, nearly 30-40 per cent of them have temporarily halted their operations or are in the process of closing down and 70 per cent firms have a cash runway of less than three months.
To stay afloat, many of these start-ups have started pivoting to new business models, diversifying their offerings, reaching out to their existing investors for immediate access to working capital. Many start-ups have also been raising bridge funding to keep their businesses up and running.
Anuj Golecha, co-founder of Venture Catalysts, noted that the impact has primarily been on companies which were/are in the process of raising Series A/Series B rounds. “There, they have seen some push-back from institutional investors for the larger rounds. So, a number of start-ups have actually come to raise bridge rounds in between,” he added.
Golecha explained that by doing this, start-ups don’t have to take a larger valuation sheet by raising the entire round: rather they take a smaller portion and don’t set any benchmark for Series A. Thereby, the valuation is lower but the capital that they are raising is also pretty much smaller compared to what they had planned earlier. “A lot of these bridge rounds are also happening at convertible modes, which are related to the next round,” he said.
More room for negotiation
Over the last three months, investors have also become increasingly cautious on what they place their bets on. Their focus has now increased on cash flow, on how sustainable the start-up is, and its profitability. That being the case, founders who have identified investors willing to fund them, are looking to close the round as quickly as possible. Plus, to make the deal work, they are also being more accommodative compared to pre-Covid-19 times, be it on valuation or on investor rights.
Anisha Singh, founding partner of She Capital, said that earlier, there used to be little room for budging and entrepreneurs would rather wait for the next investor to come along. But now they are more than happy to sit at the table, discuss the different contours of the deal and make it happen, she added. “We are definitely seeing a lot more adjusting, a lot more conversation around valuations, on ‘what we can do to get you in’, ‘what’s going to happen’, and ‘how do we make this happen’. There is a lot more interest from the entrepreneur’s side.”
Zephyr Peacock’s Raina noted that in addition to valuation, they are seeing founders being relatively more flexible on other parameters as well, such as exit rights, board seats, investor affirmative/veto matters and liquidation preferences.