2022 Year in Review & 2023 Expectations
2021 was the year of outliers. The year when ‘Golden Tap’ overflowed leading to VC funding ballooning to an all-time high.
Last year, I had written a 2-part series on my first year at Bertelsmann India Investments- Part 1 and Part 2. 2022 has been a complete contrast. It’s as if the roaring Wild West Party ended abruptly as the cops (read: Fed) arrested liquidity to bust growth. Through 2021 and 2022 we have witnessed the massive pendulum swing — boom and unbridled optimism on one hand and caution and restraint on the other. A misplaced sense of buoyancy ruled 2021 where up rounds happened at a crazy pace and 1 or 2 opportunistic (lucky?) exits made VC investors think of themselves as Gods!
In 2022, ‘profitability’ became the buzzword replacing Growth (at all costs?) and the deployment frenzy mania. The year when tight liquidity differentiated the resilient unicorns from the cash guzzling steroid fuelled ones with poor unit economics, when late-stage start-ups raised convertible notes or debt to extend their runway, and when a lot of them postponed their public listing plans after seeing the debacle of tech start-ups’ performance in the public markets.
Expectations have moderated among investors and entrepreneurs with rationality kicking in. The dizzying pandemic led digital explosion growth which was expected to continue forever did not play out. Traditional industries which had started to rapidly digitize due to lockdowns unlocked offline channels and consumer behavior reverted to the pre-pandemic era in most sectors (God bless the online extra-curricular Edtech startups :p).
Crucially, VC’s long wait for exits extended further as public market and institutional investors searched for profits amid sustainable growth. Most importantly, a lot of bad behavior built into the system through cash backs, heavy discounting, high growth overshadowing poor governance practices, FOMO based investing, etc. has given way to a sharp focus on building sustainable businesses with clear product-market fit and strong unit economics that can scale.
The fag end of 2022 has seen massive Tech layoffs with layoffs in the US alone topping 90k+ as of mid-Nov 22. Things will invariably become a lot tougher and painful for startups (more on this later). Most investors have advised companies to heavily cut down burn (eliminate experimental, new initiative spends, reduce marketing and sales budgets, freeze hiring). No one knows how dark it will be before the sun rises again.
We are already seeing consolidation play out in sectors like Fintech where start-ups struggling to raise capital will be bought out at a steep haircut to their last-round valuation. 2023 will see that trend accelerating across sectors.
All in all, we are heading into a painful although sanity driven 2023 where only the toughest will survive. The silver lining is that VCs are sitting on record dry powder of $290b globally and even in India with as much as $16b ready to deploy. Given a typical fund cycle of 7–9 years, VCs might request a 1–2-year extension from their LPs but can’t wait indefinitely to deploy. I expect the deployment pace to pick up slowly and revive towards the last quarter of 2023 (more 2019ish than 2021ish :p)
This piece talks about my experience of evaluating companies and working with our portfolio companies in 2022 and what I expect in 2023.! Without further ado, let’s dive in!!
Key Lessons from 2022
Reset with healthy detox already underway
- Time taken by growth stage investors for diligence has reverted to 3–4 weeks which is a big relief and a much-needed reset from the 2021 era when it crashed to 1–2 weeks! Sanity prevailing in evaluation will also ensure a more rigorous evaluation through which only the best in class will pass muster and raise funding.
- Only the most serious and passionate startups are staying for the long haul. This means that the quality of entrepreneurs has been and will continue to be stronger in 2023. ‘Tourist entrepreneurs’ who were lured in by the easy liquidity or start-up glamour will vanish.
- Profitability is dominating boardroom discussions. Startups are sharply focused on cutting burn with plans to target profitability in the next few quarters. Business building is back to plain old fundamentals
2021 Funding rush ain’t glamorous
- Too many companies raised Too much capital Too easily in Too short a time period in 2021! While some bought growth through acquisitions, sustainable company building takes real grit, patience, and razor focus. Plain and simple!
- Geopolitical tensions, global inflation, and dismal IPO performance of tech startups created a heady cocktail with liquidity crunch providing the final sucker punch. When cycles change and things go bad, it does not take long for things (macroeconomic conditions, pessimistic outlook, slower deployments) to change funding conditions from bad to worse.
Expectations for 2023
Pain will continue for at least 2–3 quarters ….
- More mortality (unfortunately) will be seen in Series A-C startups as they fail to secure growth capital. Late-stage funding has already seen the sharpest decline in 2022 and is unlikely to pick up in 2023. Real agony will ensue for companies and VC funds (excluding the top 50th percentile) and the bottom 25–30th percentile will have to evaluate options to survive
- Companies that raised at crazy multiples in the 2021 era (50–200x of ARR what?!) will face the toughest time. Unless they become FCF-positive and self-sustaining or execute exceptionally to retain higher growth rates than sector median growth, they will find it tough to raise fresh equity rounds from new and existing investors.
- I expect a lot of price resetting (flat/down rounds) at early growth stages (Series B-D). Companies that raised huge amounts in 2021 and spent aggressively to gain market share will come back to the market. Founders will have to drastically change their mindset and be prepared for the worst including anti-dilution kicking in for existing investors to survive.
- Linked to the last point, investor evaluation of startups will change quite a bit from the 2021 era where growth was among the most enticing factors to invest. In the downturn, few companies and sectors will have to trade off b/w growth and profitability. For example, a company that has grown 70–100% YoY for the last 2–3 years slows growth to maybe 40–50% in 2023 and substantially improves its profitability metrics, might win investor favor over poor unit economics companies still growing 100%+. Investors will appreciate companies building real value and not relying on future value.
And it might peak by Q3/Q4 of 2023 which might be the darkest of times for the ecosystem
- Pain will intensify especially in late growth stage rounds. A lot of crossover funds and hedge funds have shifted to investing in public markets (especially in the US) as the valuations have become a lot more sensible. Hence capital may further dry up in the short term for mature companies. Already in the US, some companies like Klarna (which saw a steep 85% valuation haircut) are in limbo unable to access public markets and shunned by cross-over investors on whom they relied for cash. A similar scenario might play out in India with ‘Zombie companies’ increasing.
- Macroeconomic outlook (inflation rate, Russia-Ukraine war, liquidity, supply chain disruptions, China slowdown) will have a much stronger correlation to the public markets reviving globally which is always a lead indicator to private market optimism also improving. Unfortunately, things are expected to remain bleak on the macro front throughout 2023.
- Linked to the last point, a Lot of M&As (some expected and some shocking ones) might happen in 2023. Some late-stage companies that are unable to list or raise a pre-IPO round will face their do-or-die moment. Will too big-to-fail companies in their respective sectors be rescued — an interesting thing to watch out for! While indigestion will hurt the startup ecosystem in the short term it will pave the way for a healthier long run.
- The next 6–8 months will be the ‘Detox period’ for startups where unnecessary flab is cut out and companies become leaner and agile to survive and eventually thrive
- Innovation to survive will become dominant. Companies will have to make crazy calls- shut down verticals, pivot completely, revamp the GTM or distribution approach, or rethink their entire business model to survive. You cannot win with a knife in the gunfight era of 2023!
But inevitably things will revive and the sun will rise by Q4 2023/ Q1 2024!
- A silver lining for India is that many large LPs have shifted China-India allocations from 80–20 to 50–50 now and the China+1 strategy is benefitting India with the highest growth rates in 2023.
- Deal-making will remain slow in 2022 and will likely pick up by mid of year. Still, I expect around $20–22b with an avg. ticket size of $12–15m (overall median across rounds) to be deployed in 2023.
- As you may have already heard, the best companies are born in a recession when only the boldest and fearless decide to startup and execute ruthlessly. Microsoft, Airbnb, Slack, Whatsapp, Square, and Uber were all born during the downturn. Hence 2023 will also be among the best times to invest in a rationally priced market
- Recessions surprisingly are also the best time to build a sustainable business. Limited money forces entrepreneurs to be creative, focus only on problems, and be more frugal to spend on things that are absolutely needed to grow the business
- As a prominent VC partner mentioned recently, in times of scarcity you need to dream less! That might be true for both investors and entrepreneurs as they look to reduce risk with lower than projected upside. Evaluating range-bound outcomes and scenario forecasting for best/ base and worst cases will help rationalize key decisions.
- On the other side, this will be a landgrab moment for companies that have worked patiently to build a strong moat with fantastic fundamentals and a strong playbook business they can replicate across products/ geographies to aggressively expand. As they win investor favor with bigger rounds, this will be the best time to scout for inorganic acquisition opportunities in a buyer’s market with reasonably valued M&A opportunities
- Each boom-and-bust cycle resets the pecking order for top-performing companies and VC funds in that period. Some star companies/ VC funds of the past decade can falter, and new ones will emerge to take their place.
The dot-com bust of 2000 took 18–24 months to bottom out and recover. We might well be in the early phases of the bottoming out, with the full effects visible in 2023. Founders will need to embrace the ‘scarcity mindset’ and move into a survival-at-all-mode operation.
Building in India is already extremely excruciating and founders lead one of the most stressful lives. As a founder remarks, the entrepreneurship journey is one that involves very high highs and very low lows and the latter can be devastating.
2023 is expected to intensify the pain. ‘Resilience’ and ‘mental elasticity’ will be the key trait that will be tested out. This is especially relevant for younger founders who have just seen the bull period era (albeit the longest one!) since 2008–2020. Learning from experienced founders/VCs who have seen multiple cycles could help.
Founders who have seen and survived scarcity and real trouble/ setbacks in life could hold stead in tough times. They must cultivate the wartime CEO mindset in a year where they will be tested in all possible manners. Also, the investors and ecosystem enablers need to be more empathetic to founders and their teams in 2023. Ruthless execution needs to be evaluated through a considerate lens.
Lastly, the biggest lesson from 2022 and 2023 might be to shift the narrative from celebrating unicorns (startups with >US$1b valuation) to celebrating ‘Centaurs’ (startups with net revenue >US$100m ARR). Dimming the spotlights on the Unicorn herd to showcase the Centaur herd will probably help India emerge as the magnet to attract capital globally.
Everyone including founders, investors, and startup cheerleaders need to work with that mindset in the next few years. Founders are a rare breed and more power to them and their teams as they tackle the craziness to fight it out and win (survive!) in 2023!
The views and opinions expressed in this article are those of the author and do not necessarily reflect those of any institute or organization he is or was previously associated with.
