Ongoing Valuation Markdowns: The Reasons and Repercussions The markdowns are not just limited to large startups like BYJU's, Ola, they are happening across the spectrum, from unicorns to early-stage companies

Many Indian startups including BYJU'S, Ola, Meesho, Gupshup Eruditus, Swiggy and Pine Labs have witnessed valuation markdowns recently. In fact, the markdowns are not just limited to leading startups, we are seeing them happen across the spectrum, from unicorns to early-stage companies.

The macro reasons behind these markdowns are the interest rate hikes by central banks, most notably the US Fed, the rising cost of capital, lower growth expectations due to a global recession, correction from the digitization hype of the post-COVID world and a shifting focus to business fundamentals.

Experts say that the median enterprise value(EV)-to-sales multiple for high-growth tech companies has gone from 20x at its peak in 2021 to 7x. "The average dispersion in these valuations has come down dramatically. It was not unusual to see the top quartile companies trade at a 30x multiple, which is now down to 8x. These comps are, slowly but surely, being reflected in the private market and driving valuations lower," said Ravi Srivastava, partner, Leo Capital.

We spoke to more investors to understand the reasons at the micro level.

A deep dive into reasons

As discussed above, macroeconomic factors and policy changes can impact valuation markdowns. Economic fluctuations, regulatory changes and geopolitical uncertainties have created a volatile business environment, leading to investors becoming more conservative in their valuation assessments.

Valuation markdowns can happen because of various other reasons as well. To begin with, startup valuations may decline if the broader investment climate is unfavorable. "We have witnessed - an overall slowdown in funding, changes in investor sentiment, and alterations in funding terms and conditions which is significantly impacting start-up valuations. The funding environment has become more cautious, with investors scrutinizing startups' financial performance, sustainability and long-term growth potential more carefully," said Prasad Vanga, CEO, Anthill Ventures.

Investors may also lower their valuation if a business struggles to generate revenue or fails to advance as expected. "Markdowns may be caused by inadequate financial performance, missed deadlines, or scalability issues. Investors may reduce their valuation if a startup confronts intense competition from both current market leaders and fresh competitors," said Somdutta Singh, founder, Assiduus Global.

Another key reason is the cluster in certain sectors, meaning, too many players entering one sector or segment. For instance, startups in D2C, e-commerce and edtech are struggling to differentiate themselves. This has led to investors reassessing these companies' milestones and growth prospects, thereby marking down the value.

Further, most of these startups saw an upsurge in valuations during the pandemic as at that time it was perceived that the online business shift was permanent and long-term. "But these uplifts were temporary as the lockdowns didn't last too long and online businesses could not meet projected growths. Also, the post-pandemic era, global central banks infused a lot of liquidity, trickling down to emerging markets like India. This led to the concentration of funds within a few deals. But, as the liquidity was sucked back, startups could no longer sustain raising funds at astronomical high valuations as they were able to do in the era of easy liquidity," said Milan Sharma, founder and CEO, 35North Ventures.

Valuations are also driven by demand and supply. "Due to dried-up funds across global financial markets, the demand side has significantly fallen. On the contrary under growth pressure, a lot of grown startups have earlier taken the acquisition route which gave them overnight multi-fold growth but eventually required heavy lifting through continuous fund infusion. This forms a vicious cycle where reduced marketing budgets lead to serious implications on growth numbers which compounds add on to the lower liquidity in the ecosystem," said Sunil Shekhawat, co-founder and CEO, Sanchiconnect.

Also, ideally, funds should regularly assess the value of their portfolio companies and some experts say that current markdowns are part of the routine assessment. However, since in the Indian scenario, this is probably happening for the first time, that too all at once, it has raised many eyebrows.

What these markdowns imply

A valuation markdown can also prompt a reassessment of growth strategies for the startup and shift the focus on profitability. However, a markdown may create challenges for companies when seeking additional funding. "Potential investors may view the reduced valuation as a sign of decreased confidence or potential risks associated with the company. This can make it more difficult for the company to secure external capital and may limit its growth prospects," said Ankur Bansal, co-founder and director, BlackSoil Capital.

On the plus side, he added, it allows for a recalibration of expectations, potentially enabling new investors to enter at a more favourable valuation or offering existing investors the opportunity to increase their stake in the company at a discounted price.

Will these markdowns permanently alter the valuation? A valuation markdown does not necessarily permanently change the valuation of a startup, say experts. Valuations are dynamic and subject to change based on various factors, discussed above, such as market conditions, company performance, investor sentiment and more. While a markdown represents a downward adjustment in the estimated value, it is the perceived value at a specific point in time.

Experts also explain that a valuation markdown also does not imply that the startup has raised a down round. Valuation markdowns can happen even if the company has not raised new funding or experienced a down round. "They are often based on internal or external assessments conducted by investors or market analysts. As a startup evolves, it has the potential to regain or increase its valuation through improved performance, achieving milestones, or demonstrating sustainable growth," said Assiduus Global's Singh.

Some experts feel that this is a watershed moment, and there is no going back as valuation multiples have contracted 30-50% from 2021. "This seems like more of a permanent shift than a temporary one. Only the ones which have proven unit economics, have shareholder backing and/or are profitable and have a decent business on their hands, which can eventually grow back into the previous valuation," said Shauraya Bhutani, co-founder, Capital Connect Advisors.

However, overall, most experts are optimistic that it will be a temporary markdown and that many startups will grow, attract new investors, and increase their value over time.