The unprecedented depreciation of rupee has the start-up and venture capital ecosystem worried about further slowdown in funding and capital flows into an already pressured market.
The rupee touched a new low on Wednesday after the US dollar climbed to new highs following the White House's statement that the US is not looking at any accord to weaken the dollar. Besides, hawkish remarks from Federal Reserve policymakers added more fuel to the skyrocketing greenback. The domestic currency slumped 40 paise to an all-time low of 81.93 against the US dollar in early trade on Wednesday.
Start-up founders and venture capital investors fear the situation may impact foreign capital flow into Indian funds and therefore a decrease in liquidity in the system. The Fed has raised interest rates multiple times this year, which has significantly impacted capital inflows into emerging markets.
“Most of the PE /VC funds are raised in USD (US dollars), which also signifies that the eventual returns and exits are also determined in USD. Thus, any sharp fluctuation in the USD valuation for the rupee will have an impact on the overall funds' allocation in the Indian market. In the current market position where the rupee’s valuation against the dollar is depreciating, it is not a favourable trend for PE/VC fund flows to India,” Apoorva Sharma, Partner at Stride Ventures, said.
As per data from PGA Labs, after three consecutive quarters of raising more than $10 billion, the total funding in the Indian start-up ecosystem fell by 46 per cent during April-June 2022 to $8.2 billion, from the peak of $15.2 billion in Q3CY21. The immediate impact of these factors has been on late-stage investments. Late-stage funding halved —from $14 billion in the second half of 2021 to $7 billion in the first half of this year.
Prerna Kalra, Co-founder of food retail start-up Daalchini Technologies said the rupee depreciation can lead to lower revenues and higher operational costs for Indian start-ups, which can slow down their growth by impacting margins. As operational costs shoot up with low sales, start-up valuations and funding is expected to affect. “With the devaluation of the rupee, start-ups are indeed bearing the brunt. While the start-ups are still facing the challenges of the funding winter, the fluctuations in the rupee value are making it more difficult for start-ups to scale up,” she said.
After the US Fed instituted a string of interest rate hikes starting March 2022 to counter soaring inflation, marquee tech stocks began to fall sharply globally, forcing investors to reroute their funds to other attractive assets. Historically, public market valuations govern private market valuations. In the case of two companies—one public, one private—with similar metrics such as product offerings, total addressable market, margins and customer acquisition cost, the private company is likely to fetch valuation multiples similar to that of its publicly traded peer. Therefore, a sharp decline in rupee value will have a cascading impact on start-up valuations.
“Fed has been consistently increasing interest rates and it is likely that it will do so in November and December. This means more money will flow back into the US. Current US inflation rates also imply that the US is going to go into recession. The other reason is overall that despite RBI’s constant management of Dollar INR we still see a decrease in liquidity in the system which means less cash which will impact funding of start-ups. Even if an investment is attractive, funds need to be in a position to actually buy dollars,” Amit Ratanpal, Founder & MD, BLinC Invest, said.
As ultra-loose monetary policies come to an end, the gap in interest rates in the US and emerging markets like India reduces, making the latter less attractive for foreign investors. Coupled with public market uncertainties and slowing of tech businesses with fears of a recession looming large, aggressive late-stage investors are cutting down on their private market exposure.
“The overall combination of high-risk aversion, lower public market multiples and INR depreciation results in lesser capital flows into the VC space and depressed valuations. Investors that invested heavily last year and now have portfolios which are either loss making or seeing significant mark downs will go slow on new investments. They are more likely to wait for their portfolios to stabilize and valuations to climb back up,” Tarun Sharma, Managing Partner, MegaDelta Capital, said.
He also added that start-ups don’t have too many hedging options for adverse macroeconomic developments and that they may diversify their revenue base to get dollar revenues but limited companies have the business model flexibility for that. At a fund level, portfolios can be derisked by allocating capital to dollar revenue businesses such as enterprise SaaS and pharma exports.
Vishal Seth, Managing Director, Protiviti Member Firm for India, said influx of funding is expected to stay low due to inflationary pressures and further anticipated to impact on margins for most businesses and pressure on revenues, across sectors, except IT. ““Overall lower margins due to revenue pressures and increased costs will reduce valuations for start-ups. Companies with dollar-based revenues, like IT companies (SaaS or Consulting businesses) should have better valuations, if they are able to control the people cost.”
However, Vikram Chachra, General Partner, 8i Ventures doesn’t see a lasting impact of Indian venture capital funds.
“The long-term trend is of the rupee's depreciation vs the US Dollar is at a 4-5 per cent annual average. This is built into the assumptions of dollar-based investing (be it valuations or expectations of returns). Over the 7-8 life of a PE/VC fund, this means that the rupee return has to be 1.5x of the dollar return expectation (a 3x in USD would mean a 4.5x in INR over 7-8y). So long as rupee depreciation stays within this range, it's built in. If anything, if the rupee depreciates faster than India's inflation, Indian start-ups should have more usable capital in rupees when they raise in dollars - which is the norm for most rounds after seed anyway,” Chachra said.
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