Start-up funding still down but mood more upbeat

The latest Cut Through Venture report on Australian venture capital funding says capital raised remains down from the peak of early 2022 but the mood across the start-up sector seems more optimistic.

In a preface to the Q2, 2023 report, Cut Through Angels co-founder and Five V Capital investor Chris Gillings says: “The fog of fear and uncertainty looming over local and global markets in the latter half of 2022 and Q1 2023 appears to have lifted.

“Professional investors, including our Five V Capital and Cut Through Angels teams, have moved past the uncertainty that previously dominated the market. Instead, they have adopted a measured investment approach, with detailed diligence underpinning each investment decision.”

This has inevitably resulted in a slower pace of dealmaking although it offers considerable advantages for investors and founders, reducing the likelihood of surprises and ensuring alignment between all parties.

But, Gillings adds, macroeconomic headwinds apparent across many pockets of the global economy are now undeniable and start-ups won’t be immune to the challenging business conditions these headwinds are creating.

The report says start-up funding of $1.5 billion in the first half of 2023 was the lowest first-half-year amount since 2019 and was just one third of funding in the corresponding period of 2022.

Q2 2023 did, however, surpass Q1 both in capital raised by start-ups and the number of deals. A total of $810 million, 20% more than in Q1, was raised across 90 reported deals. The report notes that the lower size of deals raised might have discouraged reporting but estimates this would be unlikely to have reduced the total recorded by any more than 10%.

Despite both median and average deal sizes falling since the highs of 2021 and early 2022, pre-seed funding bucked the trend with deal sizes well above historical averages. The report theorises this was the result of a shortage of later-stage opportunities pushing some professional investors to shift their focus to earlier stage deals.  

Turning to sectors attracting investment, Cut Through Venture said despite excitement around artificial intelligence (AI) this had not yet translated into substantial funding for “pure play” AI start-ups locally.

Globally, the report notes, AI start-ups have been defying the overall trend toward lower valuations, in many instances achieving what some might regard as ‘bubble territory’ valuations.

Many investors are, however, seeking indirect exposure to the advantages of AI by focusing on companies that, although not exclusively AI-based, are strategically leveraging AI tools to boost productivity and performance.

Fintech continued the resurgence it has experienced since Q4 2022 and again accounted for the largest number of deals. Blockchain/web3 and e-commerce/retail remained at the bottom of the pile both in funded deals and forward-looking investor excitement.

Larger deals remained almost non-existent and overseas investors maintained a low profile apart from in the quarter’s largest deal, a $US150 million ($224 million) raise by spinal cord stimulation technology company Saluda Medical (APE&VCJ, May 2023) which attracted “an ensemble of global mega funds”.

The lack of larger deals suggested that later-stage venture-backed companies had shifted their strategies toward conserving capital. Many that had secured larger funding rounds over the last two years would have been well placed to make that switch and postpone capital raising, but that luxury was not shared by early-stage companies.

The report quotes one anonymous investor as saying: “The era of colossal deals is on pause. Start-ups that brought in $100 million plus in recent years are now expected to stretch those funds until their growth and size matches their valuations. Due to preference stocks, many founders can’t entertain the idea of down rounds, meaning that dramatic belt-tightening across some of Australia’s most celebrated start-ups will continue into the second half of 2023.

“There are whispers in investment circles about an impending ‘funding cliff’ threatening many of our largest start-ups – but no one seems brave enough to point fingers at their own portfolio.”  

Image: Saluda Medical’s spinal cord stimulation technology is designed to provide drug-free relief from lower back pain. The company attracted the largest Q2 venture capital fundraising round.