Less jostling and more deliberation by VCs as startup fever cools

FOUNDERS were flooded with term sheets from venture capital (VC) investors just a year ago. But now, those same investors are scrutinising financials and gripping their purse strings tightly.

The party has ended with the onset of tough macroeconomic conditions, including the ongoing Russia-Ukraine conflict, inflationary pressures and recession risks. This has tipped the scales away from founders and in favour of investors, industry players tell The Business Times.

In the last 12 to 18 months, funding cheque sizes and valuations had skyrocketed and VCs had to compete to get into deals. But they are now getting access at much better prices, said Tushar Roy, partner at global tech investor Square Peg.

“I think investors are also taking the view that whatever is available today may also be available in the next 3 or 6 months for them to invest in. So they just sort of hold back unless they absolutely have to deploy now and the level of competition between investors has reduced significantly,” he said.

As a result, funding has slowed for startups in the Series B stages and above, with more VCs focused on the seed stage and Series A levels. “I think it’s very tough out there. Anything in the later stages is difficult,” said Roy.

Amid the challenging landscape, many startups are seeing their business models tested. Players in high-cash burn businesses, such as e-commerce platform Shopee and food delivery service foodpanda, have made layoffs in recent months, and more retrenchments could come.

“Investors are focusing more on business fundamentals - demanding to see better margins and longer track records. Sectors that require a long period of burn to get to scale while remaining unprofitable for a long time will find very few takers,” said Lim Kuo-Yi, co-founder and managing partner at Singapore venture firm Monk’s Hill Ventures.

Such developments are beginning to spook institutional and high-net-worth investors who invest in VC funds, otherwise known as limited partners (LPs).

One industry watcher said: “LPs are sort of sending messages back to VCs saying, ‘Hey, our public portfolio looks bad, and we’re seeing these things happen at the later stage. So please exercise caution at the earlier stage (because) capital calls will be harder to come by. Make them prudently and make sure you justify them.’”

When capital was freely flowing, startups were given great latitude to explore and pivot to find the right product-market fit. However, as the funding environment tightens, startups are increasingly being forced to be deliberate in their quest for product-market fit, rather than going in many directions hoping that one would work out.

Pet projects and experimental ventures are expected to help companies achieve profitability or be put to the sword.

“Previously, the focus has been on growth, but now it’s a lot more on profitability,” said Chik Wai Chiew, chief executive of Singapore-based venture investor Heritas Capital.

“For those startups that require a longer runway, maybe they’ll need to rationalise or pause developments to reduce the burn, so this is what’s happening in many boardrooms.”

There have been some signs of trouble in the ecosystem, such as Indonesian grocery delivery startup HappyFresh’s appointment of a turnaround firm and raising capital to turn things around. Opportunities in the storm

That said, the tough funding environment could be a blessing in disguise for both investors and founders. A crisis could force clarity for boards and founders, helping them allocate the right resources to calculated bets.

Founders can now focus on solving problems that matter and building businesses that last, noted Monk’s Hill’s Lim.

“The noise over the last couple of years is quickly receding behind us, and strong founders can now recruit good people and attract capital without the distraction from all the hubris,” said Lim.

The pressure could also lead to more mergers and acquisitions as founders ponder if it’s better to continue fighting or join forces with a competitor to carve out a bigger slice of the market, noted Heritas’ Chik.

“When people are under pressure, they are more likely to look for more options and broaden their horizons, and realise they could partner with other people,” he said.

Investors too could potentially score multi-bagger deals in such a climate, with founders now willing to discount their valuations in order to secure more cash for runway.

“They are looking for companies that they can get access to for a much better price than they could have the last 12 to 18 months. The deals that are happening are at prices that are much more attractive for investors than they were previously,” said Square Peg’s Roy.

Chik further points out that the current climate is very different from the Global Financial Crisis in 2008. Back then, LPs were actively telling funds not to call for capital as they might not be able to fulfil it.

With VCs managing to raise some of their biggest funds yet, it appears that the situation has not reached those depths yet. For now, investors can bide their time in riding out this uncertainty.

“(It’s about) making sure your portfolio’s balance sheet is well funded, but at the same time also open and waiting for the right opportunities for the right investments,” said Chik.