The Indian software-as-a-service (SaaS) industry is witnessing a funding slowdown as investments dropped nearly 81 percent to $635 million in the first half of 2023 compared with the massive $3,406 million seen during the same period of 2022, as investors turn cautious towards a sector that’s most affected by macroeconomic pressures.
“Many investors are concerned that they have overpaid for startups last year. While smaller fund houses would have run out of money and larger funds are taking a wait-and-watch approach because, in the last two years, many did too many investments too quickly,” Prasanna Krishnamoorthy co-founder and Partner, Upekkha of SaaS accelerator fund Upekkha.
While the first half of 2022 witnessed the completion of about 147 deals, 2023 saw the number fall to about 70, according to data sourcing and analysis firm Venture Intelligence.
Many investors are re-evaluating their bets and experts say that the time taken to complete deals has become longer.
“The deal velocity has come down. While earlier the deals were getting done in two weeks, it is now taking three-four months. The cycles are on but it is delayed,” Rahul Chandra, co-founder and managing partner of early-stage venture capital fund Arkam Ventures, said in an interaction with Moneycontrol.
Investors are also concerned by the steep demand slowdown for SaaS. A recent report published by VC firm Chiratae and Zinnov, a management consulting and advisory firm, said that delayed sales cycles are a key challenge for founders as customer spending caution increases as they aim to optimise cloud costs.
“There is a risk of decreased customer demand in 2023 due to a recession-like situation which may reduce gross margins,” the report said.
Investors are sitting on a pile of cash, risk-off mode on
Many venture capital firms have recently launched new funds to invest in SaaS startups.
Chandra’s Arkam Ventures last week announced the launch of its Fund II targeting a total corpus of $180 million. Arkam has invested in SaaS Startups like SpotDraft and Signzy.
Similarly, in April, SaaS-focused VC Boldcap launched its $25 million Fund II. Around the same time, venture capital investor Iron Pillar, which has backed the likes of FreshToHome, Uniphore, Servify, and Curefoods, closed a $129-million fund
In May, Chiratae Ventures, which has invested in SaaS firms like Active.Ai, Pando, and CloudCheery, announced the close of its Rs 1,001 crore growth fund.
Macroeconomic pressure continues for SaaS
The Russia-Ukraine war and its impact on supply chains, high inflation rates, and the US Federal Reserve’s aggressive interest rate hikes are causing fears of a recession in the US, adding to the sector’s worries.
In fact, large SaaS firms have undertaken layoffs and cut down on their marketing and other spending drastically to brace for the macro pressures. SaaS major Freshworks undertook at least three rounds of performance-based layoffs, while many other SaaS firms like Zoho have cut down on hirings including placement hirings.
“Globally the deal activity has slowed down due to macroeconomic pressures. Interest rates are going up and even the money available with many funds is less and thus the lull in funding will sustain for at least another 18 months,” said Manav Garg, founding partner of Together Fund.
Together Fund along with Peak XV (Formerly Sequoia Capital), Better Capital, Accel and India Quotient were among the top active investors in SaaS in the first half of 2023 as per Venture Intelligence data.
Public market is more attractive
There are large investors like WestBridge that have now put in a sizeable amount into public markets, a source said on condition of anonymity. In fact, as per reports, WestBridge Capital is now Freshworks’ second-biggest institutional investor, owning around $215 million worth of shares.
“Many investors are moving towards the public market now, because the stocks are available at a discount. If you see Saas sticks are trading at a discount as compared to peak of 2021 “said Garg of Together.
Valuation mismatch barrier to raising funds
The decline in SaaS company valuations in the public markets has greatly affected private markets, driving down late-stage funding, said the report by Chiratae Ventures.
“We are in no hurry to raise funds, we have enough cash runway. Also, even if we decide to come to the market, the valuations are slashed by at least 2 times the percentage we raised in our last round,” said a unicorn SaaS startup founder, who asked not to be identified.
While startups are yet to agree to the changed valuations, investors say it is not all bad.
“The valuations have come down in a big way, but I think it’s a good thing. Now it is becoming more meaningful and appropriate… It is no longer like companies are getting whatever multiple they want, investors are looking at the cash flows, revenue projections and then taking a call.” said Upekkha’s Krishnamoorthy.
Many firms that were trying to raise $10 million with $0.5 million of revenue got rejected. They are unable to raise even $5 million, he added.
The shift to AI is significant
Segments like DevOps remain of great interest to VCs, but sectors like compliance and payment-related SaaS or SaaS spend management segment are falling out of favour.
However, the SaaS segment is shifting towards AI. Venture Intelligence data showed AI and AI-related startups have scooped up investments of about $583 million through 32 deals from the start of 2023 till the end of June.
SaaS still remains hopeful
SaaS firms also have a bright spot — an early predictable revenue. SaaS is actually one of the most attractive areas at times like these, said multiple investors.
“The only dark cloud is the public company valuations, otherwise investors are keen. Deals are looking up,” said Arkam’s Chandra.
While many sectors including e-commerce and edtech saw a situation where startups are out in the market and are yet to raise funds even after 8-12 months, the SaaS sector is yet to witness such a situation, say industry experts.
“I have not seen any company coming to the market and struggling to raise capital at least now in India. That’s also because many companies have already raised large funds and they will have a good runway. We may see it maybe in the next 6-8 months,” said Krishnamoorthy.
“Whoever raised a lot and cut down costs like talent acquisition or marketing can easily stretch the runway to 18-24 months. B2B SaaS, as against B2C, also has the recurring revenue model which helps companies,” said a SaaS expert advising investments to VCs.
“We are very cautious however early-stage and seed-stage deals are still happening. In fact, we are looking to close the year with investing in five-six more companies,” said Garg of Together Fund.