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Early-stage startups are up against stronger filters for their next round of funding than before as the downturn in risk capital investing has investors taking a harder look at some of the ventures they funded.
A new study by data analytics platform Venture Intelligence showed only one in four startups that secure seed funding manage to raise follow-on capital in the form of a Series A round. In the last 12-15 months, several startups have been shuttered for the lack of product market fit.
These include Tiger Global and Peak XV Partners-backed software firm Toplyne, Elevation Capital and Lightspeed-backed edtech venture Bluelearn, Peak XV-backed artificial intelligence startup Nintee, and GSV Ventures-backed upskilling startup FrontRow.
While Toplyne raised a total of $17.5 million, Bluelearn and Nintee had raised $3.95 million and $3 million respectively in funding from venture capital investors before shutting down.
In line with the broader funding slowdown in India’s startup ecosystem, the number of companies that attracted series A funding in 2023 dropped by 45% to 127, down from 232 startups in 2022, the Venture Intelligence report showed. This is 23% below the average of 166 deals recorded over the past eight years.
“Early stage investing is all about risk taking…obviously the power law comes into play and so you will see a lot of startups shutting down after raising seed funding but that doesn’t create a negative force on the larger ecosystem. It is a healthy trend that those without a PMF (product market fit) take a call to move on without burning a single dollar more than is justified,” a partner of a Bengaluru-based early-stage firm said.
He added that this trend could rise as more investors take “bolder bets on the new AI wave.”
According to a report by 1Lattice, for the quarter-ended September 30, software-as-a-service and artificial intelligence (AI) were the most attractive sectors for early-stage investing garnering a total of $142 million. This includes a $27.5 million round for Mukesh Bansal’s AI startup Nurix.
Karthik Reddy, founder and managing partner of early-stage venture capital firm Blume Ventures that backed startups such as Unacademy, Purplle, Spinny and Exotel, said that the funding funnel takes a long time to develop and that short-term seasonality should not be confused with long-term averages.
“There’s a natural funnel anywhere in the world. You cannot have the same amount of series A players as you have seed players, and therefore there is always a rapid funnelling,” he said.
Reddy added that in the first half of the last decade, when Blume was established, there were only ten micro VCs. Now, there are over 150 micro VCs.
“Thus, the top of the funnel has widened, providing many investors the capacity to offer decent amounts of capital and fostering hope for entrepreneurs to get started. However, there has been minimal series A expansion in the past ten years, as larger funds tend to focus on writing checks for Series B and beyond,” he said.
Over a longer timeline, of the 3,246 startups that raised seed funding between 2015 and 2023, only 821 companies – about 25% – managed to secure any follow-on round, the Venture Intelligence study found.
However, once a startup reaches series A, its chances of raising further capital improve significantly to 41%, it added.
“There is a very clear segment in the overall funnel where a strong quality filter applies. Typically, seed investors, whether VCs, angel networks, or individual angels, invest in the founding team, but there is no proof of product-market fit. But series A funding comes only when there is some evidence of product-market fit,” Arun Natarajan, founder of Venture Intelligence told ET.
The study also found that tech and tech-enabled businesses accounted for over 85% of seed investments between 2016 and 2023. Consumer-facing (B2C) startups were the dominant focus, making up 54% of seed investments, compared to business-to-business (B2B) ventures.
“Startups are inherently risky, with 90-95% of them never making it to big companies and the riskiest stage is from seed to series A. However, for us, this data has been a little better, around 45-50% of companies that we fund at a pre-seed and series A level secure series A funding within two years of our funding,” said Gaurav Chaturvedi, general partner at early-stage venture capital firm Kae Capital.
Chaturvedi added that the bar for securing series A funding has become higher compared to the period from 2021 to early 2023, when there was an influx of capital, and many large funds were participating in series A rounds. Kae Capital has backed startups such as beauty and personal care brand Foxtale, hair loss treatment firm Traya Health and logistics platform Porter.
Mayuresh Raut, managing partner of Bengaluru-based early-stage VC firm Seafund which has backed startups such as insurtech startup Finsall and logistics startup Zippee, noted that while difficulty in securing series A funding is a global trend, India faces a more acute challenge due to the rapid growth of its startup scene coupled with a relatively nascent venture capital industry.
“As India’s entrepreneurial ecosystem evolves and matures, this funding gap may gradually close. The fact that both homegrown and funds registered outside India have raised enormous amounts of capital and are coming to the end of their deployment period will also unlock the funding slowdown in the coming days,” said Raut.
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