Show your cash flow, PEs tell start-ups

After the flurry of investments in startups last year, funding by private equity (PE) firms has stagnated in 2016. Focus on generating cash flows, realistic valuations and quality deals are among the factors governing investment choices of PE firms.

“After the initial round of funding, investors are pushing start-ups to focus on generating cash flows. Moreover, valuations of these start-ups are also getting moderated,” said Raja Lahiri, partner at Grant Thornton India. The current funding crunch is in contrast from last year, which was a golden year for start-ups, Lahiri said.

As many as 1,214 start-up deals were clocked in 2015, valued at $2,474 million. However, this year-to-date, the momentum in terms of number and size of deals is lower than the same period last year. Even the government’s start-up policy, launched in January, couldn’t uplift the mood significantly.

“With moderation in valuations setting in, deal numbers also tell that the sector is going to the next stage of business lifecycle (focus on profitability),” explained Lahiri.

Experts said focus on quality deals was another reason behind slowing PE funding this year. PEs are looking at finer details such as team mindset and sustainability of business plan and have become cautious, bringing down the number of deals, said Sharad Moudgal, partner at Khaitan & Co.

The example of Housing.com cofounder Rahul Yadav is often cited when it comes to team mindset at a start-up. Last year, Yadav was fired from the company as the board unanimously agreed to end his tenure because of his behaviour towards investors and the industry ecosystem.

Though the deal-clinching momentum has dropped, executives are of the view that start-ups continue to be promising. “The start-up segment is no bubble, it is a real thing,” said Lahiri.

Even as the deal volumes are not expected to grow significantly this year and fund raising will remain challenging in the coming months, deal strikes are expected to continue in internet and mobile related start-ups in sectors such as travel, lifestyle, and e-commerce. Start-ups are looking at niche segments with practical and sustainable solutions such as Ola and Uber, said Lahiri. “Our overall outlook remains positive for this sector as it is expected to stay for long-term despite the high risk.”