The funding slowdown in India, which is paired with a large amount of unallocated dry powder, could lead to investors taking a “wait-and-see” approach on late-stage startups — with expectations of fair valuations and a keen eye on unit margins, a report titled ‘Road to Hyperscaling in India’ published by the Boston Consulting Group (BCG), Times Bridge and TiE Delhi-NCR said.

The report pointed out that India-focussed funds are sitting on the highest-ever unallocated capital at $23 billion in 2022. The dry powder will continue to be mostly deployed at early-stage startups in 2023 with investors exhibiting patience with “growth and late-stage startups” with the focus being on profitability metrics, it said.

“Category leaders will continue to be successful. We look at the opportunities of backing a few category leaders a year, who have the likelihood of being in the pole position. In addition to that, there’s going to be a lot of consolidation,” said Rohan Joseph, vice president, head of global investments & corporate, at Times Bridge, the global investments and venture arm of The Times Group, which publishes ET.

The report comes in the backdrop of a so-called funding winter, with venture capital investors taking their foot off the gas pedal in 2022, after a record year of funding in 2021. Growth and late-stage startups are the most affected by this.

Speaking to ET about the growth versus profitability debate that startups are facing, Nimisha Jain, senior partner & managing director at BCG, said: “In the environment, which we are in right now, we need growth and profitability, or what one may call profitable growth. It is essentially about rewiring business models to chase opportunity but with the right set of unit economics.”

“One of the ways to do that is to think smartly about partnerships. At times, there may be a natural desire to say that we want to be full-stack, which can become an expensive operating model,” Jain added.

The report pointed out that while the time taken by startups to turn into unicorns, or privately held companies with valuations exceeding $1 billion, has reduced over the years, there were only 18 profitable unicorns in India. It also said the tendency to “buy scale could backfire, if done without clear sight of long-term customer value and unit economics”.

“What’s important for investors is that the product-market fit is validated, and there is customer retention. Once that is achieved, then startups should typically look for the right investors who can act as mentors,” said Geetika Dayal, executive director, TiE Delhi-NCR.

The report pointed out the trend of startups tapping smaller towns and cities of India, but eventually having to scale back on account of lack of viability. Given the current macroeconomic environment, where startups are short on cash in addition to consumer sentiment being tepid, it underscored the importance of the companies having to create new business models and channels that fit the preferences of tier-2 and tier-3 cities.

“While tapping into the ‘Bharat’ potential has been tempting for all, many leading Indian startups had to scale back after launching in small towns, as solutions that worked in larger cities were not as viable for small towns,” the report said.

Elaborating on this point, Joseph said: “There are going to be companies that are highly successful because their models are digital first, logistics-dependent, which are certain areas where urban centres offer a lot more scaleability but at the same time, there will be startups that are online only and do not necessarily have a deeper operational component, and those companies will go deeper into India.”

“When we look at global companies and try to bring them into India, rural remains an opportunity because it works very well for social-first companies, or those which have digital products. When they look at India, they look at all 1.3 billion people, and not just the folks in urban India,” he added.