In August, we wrote about how the venture capital market in India is becoming bubbly and precarious. It seems that this market is now starting to show some signs of a bust. Ola, India’s largest car-hailing service, is currently raising money at 40% discount to its last valuation of $5bn.

If true, this will be the first down round (i.e. raising money at a lower valuation) for a unicorn in India, and is likely not going to be the last. Why? Because the VC market in India has been very bubbly, and a deal like this could spread fear, destroy investors’ confidence and pop the valuation bubble.

Let’s discuss a few key issues one by one.

After Bubbling Up, VC Funding Is Drying Up in India

Venture Capital firms have been growing in both number and size. Some of this is because of the huge successes achieved by a number of startups like Facebook, Uber and AirBnb. But some of it is also because many hedge funds have been venturing out of the stock markets into the start-up funding world in search of higher returns.

Capital markets poured billions of dollars into startups, and VC funding peaked in Q3 2015 when global VC financing reached a record of $40bn during the 3 months between July and September of 2015.

This changed in 2016. Pretty much across all major markets, VC funding has been drying up. India was hit especially hard, with VC funding declining by 70% in Q3 2016 compared to its peak in Q3 2015, compared to a 30% decline in the US and 40% decline globally. This contraction in funding left in its wake more than 800 dead or dying startups in India.

Global VC Funding ($ bn)USChinaIndiaSE AsiaGlobal
Q2 ’14           19.5             2.6             0.8          0.12           23.7
Q3 ’14           16.0             2.3             1.5          0.18           22.0
Q4 ’14           19.1             5.3             2.1          0.79           28.9
Q1 ’15           20.1             3.2             1.2          0.09           28.2
Q2 ’15           20.0             6.2             2.3          0.23           35.0
Q3 ’15           21.0          10.9             3.4          0.57           39.6
Q4 ’15           17.7             7.3             1.5          0.39           28.3
Q1 ’16           17.5             4.5             1.4          0.40           26.9
Q2 ’16           22.3             5.7             0.6          0.26           28.1
Q3 ’16           15.0             3.9             1.0          1.50           24.1

In India, Drought is Spreading Even to Unicorns

When a market panics, it usually begins by taking “flight to safety.” Investors tend to take money out of risky assets to buy other things that they believe are safer, regardless of the price they are paying for them. A similar pattern seems to have taken place in India. Beginning of this year, most of the startups in India that were reporting failures or hardships were small companies. However, big startups known as unicorns continued to get more funding at higher valuations.

However, at least one of them is now in trouble, with possibly more to come. After raising $500mn at $5bn valuation in September of 2016, it is now trying to get more cash from investors at just $3bn, representing a 40% decline in value. If completed, it will be the first down round in the country.

In India, there are a total of 9 unicorns: Flipkart, Snapdeal, Mu Sigma, InMobi, Paytm, Zomato, Shopclues, Ola and Quikr. All of these companies were awarded with high valuations because there were regarded as leaders in their respective fields in India. Seeing their fellow unicorn in this situation must be a sobering moment for the other 8.

Clearly, investors were too optimistic and paid too much for Ola at $5bn. Why might have this happened? Perhaps, investors previously believed these firm’s statuses as local category leaders were secure. However, unlike China, India does not have protectionist policies that prevent foreign tech giants like Amazon or Uber from competing head to head with local players. In face of tough competition with deep pockets, some of these companies have less chance of success or even survival.

Or maybe investors were content investing in these companies as long as most other investors were also happy to do so. Or perhaps they were just too deep in the water to get out. With so much capital invested in these unicorns, they couldn’t afford to let any of them fail; but they couldn’t continue on this path forever.

Whatever the reason, what’s becoming more clear is that VC market in India was very bubbly and is now contracting. This started with small firms in India, but the contagion is spreading to big firms, and possibly outwards to more places.

Possible Further Contagion

What does this mean for investors? In our opinion, this phenomenon is likely to spread to other parts of the financial world. First, US and China have also been showing some signs of contraction that have been largely limited to smaller firms. As such, average deal sizes have been increasing in these markets despite the fact that overall funding has been declining.

Now that we’re seeing a declining trend in India for even big unicorns, we might start to see similar signs in China or India. After all, most of these big companies share the same venture capital investor base. When these investors lose money & tighten their pockets, funding will dry for everyone.

$ Per Deal ($ mn)USChinaIndiaSE AsiaGlobal
Q2 ’14             7.5          36.0          13.3            3.7           11.1
Q3 ’14             6.0          21.8          21.2            4.4           10.0
Q4 ’14             7.5          54.3          29.8          21.8           13.3
Q1 ’15             7.6          39.9          14.0            2.1           12.5
Q2 ’15             7.4          71.4          19.1            5.7           15.1
Q3 ’15             8.3          77.2          21.9          10.7           16.8
Q4 ’15             7.7          87.0          12.0            4.7           13.7
Q1 ’16             8.5          48.3          11.3            5.4           12.9
Q2 ’16           11.7          72.3             5.5            5.0           14.2
Q3 ’16             8.3          46.7             9.7          27.2           12.2

Secondly, this trend in India does not bode well for the SE Asian VC market. SE Asia has been seeing a booming VC market of late, with both funding and deal sizes increasing over 100%. However, as investors begin to suffer big losses in India and elsewhere, their pockets could tighten & lead to a less vibrant funding environment in SE Asia.

In fact, SE Asia’s average deal size of $27mn is already one of the highest in the world. This could be the next bubble in the making.

This article originally appeared on ValuePenguin

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ValuePenguin is personal finance company based in New York. DJ is responsible for building ValuePenguin’s presence in Asia, from researching personal finance topics in the region to building relationships with financial and media institutions. He previously worked as an investment analyst at leading hedge funds in New York including Cadian Capital and Tiger Asia. His expertise is in the global technology, consumer and financial industries. He graduated from Yale University with a degree in Economics, and speaks Korean, English and Mandarin Chinese.

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