The shadow over cost of capital startups shudders

In the banking sector, according to an old quip, work follows a 3-6-3 routine: borrow at 3%, lend at 6% and play golf at 3 p.m. In a globalized scenario, thanks to a flood of easy money in a political adventure of pandemic proportions, some rates have been pushed into the negative zone. Lazy banking doesn’t have to translate into lazy investing, but the drift is clear in this cartoon from our recent unicorn hunt: get funding today, burn through your stash tomorrow to buy clientele, and cash it in the next day. . The reality is far more complex, of course, but among online startups, “the money for asking” almost rang true for a while. In 2021, venture capital (VC) deals in India were booming. Their value rose from a quarterly average of around $3.1 billion in 2019 and 2020 to $5.6 billion in the first quarter of 2021, according to PwC data, and then exceeded $10 billion for a race that started last July and lasted three quarters. It was too good to last. As a spike in inflation forced the start of a U.S. Fed monetary reversal, venture capital funding fell 40% in the three months to the end of June 2022. While venture capital funding Early-stage fintech has held up and India-focused funds may have ballooned this year, but how long the global squeeze will last is anyone’s guess. Our start-up challenges have clearly increased.

The free credit at the top of the system acted as a stimulus. A massive dose of easy money for lenders – some cheaper than free – has been used to facilitate additional loans, debt returns (and rollovers), investments, other expenses and more, injecting the fuel taken for granted as an economic stimulus. For large capital investors, this has reduced break-even points to new lows. However, as with any prolonged glut of capital, a global hunt for yield among those with funds would surely also have led to riskier bets. Some of those bets could have had an expiration date set by a change in Fed policy, which explains today’s concern about a big rout as interest rates rise. Not all VC players will feel the same heat. Large investors tend to operate as risk spreaders, with diversified portfolios to ensure that a few successful companies can make up for an accumulation of failures. Many online games have taken place in “winner takes all” markets, where success requires do-or-die scaling; for the data collected to reach critical mass and form a competitive advantage, it had to be done quickly, so large sums of money spent to attract customers made strategic sense. But such large projects now face a more expensive capital phase.

As the calculations are redone, startup valuations have been rattled, public issuances postponed and austerity embraced. Unicorn status or otherwise, business plans that fail to withstand rising rates and collapsing risk being exposed as the tide of liquidity turns. Control over cost bloat was to be expected, but there may also be room for strategy changes in some cases. Especially in areas like fintech, value creation models don’t need to be size-driven. Digital finance, for example, could use the open ledger power of blockchain to exploit the inefficiency of a brick-and-mortar old sector, perhaps even profitably from the start; our central bank will have to balance its innovation deals with financial stability, as its governor pointed out in his fintech comments on Friday. But even in other areas of play for startups, the paths to profit could rely on the value of an idea in itself. A company whose sales pitch is attractive enough to remain viable regardless of size would not only grow steadily, but still merit venture capital funding. Regardless of the scale of the game, the lure of a “best mousetrap” remains more relevant than ever. Needs satisfaction remains the basic game.

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