I have been actively investing in the Australian venture Capital Market since 2006. With 17 years unbroken investment experience I’ve have seen many economic and market cycles, including the Global Financial Crisis, and the Pandemic crisis.
The current market conditions in Australia for startups and venture capital are, in many ways, the healthiest and most robust they have ever been. Over the last few years we have more capital allocated to venture in Australia than ever before, with many venture capital fund managers managing over one Billion dollars and we have a greater diversity of fund managers bringing specialised domain expertise. For instance, fund managers that are focussed on sectors (for example B2B), stage (seed versus later stage funds) or function (venture studio versus expansion assistance) to complement the ‘generalist’ managers. As a result, both the depth and the breadth of the venture capital market is better and more sophisticated than ever before.
However, this has created a new set of challenges, which, combined with the economic challenges a post-pandemic world has created, has meant the capital deployment rate has slowed for VC managers.
There are many reasons for this, but in my view, one reason is because fund managers who were deploying capital in 2020/2021, have invested at high valuations at the top of the cycle, evidenced by the fact following the market correction in 2022, valuation metrics have stabilised closer to, (or lower than) the 10 year median and show no sign of returning to the 2021 levels in the near term.
As a result, fund managers who deployed capital in 2020/2021 will be feeling the need to counter the fact that much of that early portfolio are likely be valued at considerably lower holding values, and this has made them ‘gun shy’ or biased towards smaller new investments that may considered ‘undervalued’ in order to return their fund portfolio to above water. Further, I wonder if newer or emerging fund managers who have not previously experienced prior economic cycles have been hesitant to make new investments because perhaps they are influenced by the reticence of the larger funds, don’t want to make the same valuation decisions investors made in 2020/2021, or perhaps the larger funds typically lead rounds and if they currently aren’t doing that the smaller/emerging fund managers aren’t able to follow a lead as usual.
In an effort to reduce runway and avoid raising new rounds at lower valuations, or because investors are not necessarily seeking growth alone, technology driven high-growth companies have laid off staff in a so called ‘tech wreck’. Having seen this cycle happen a few times, this rubber band expands and contracts in natural response to push/pull of growth versus profitability and of course this is tied to capital supply and demand.
The positive from this most recent cycle is a subset of companies that have flexed their growth engines and have a sense of what works and doesn’t, and have now better trained their muscle around unit economics and capital discipline, hopefully creating businesses that can move between the two with ease in response to a dynamic environment. This experience and ability to adjust accordingly between cyclic conditions is not common, and we now have a larger pool of knowledge-based workforce looking for new and interesting companies solving challenging problems and lower valuations.
Our view is that investing throughout the next 24 months represents a substantial opportunity for Limited Partners in Australia, that may not present again for quite some time. To be clear this doesn’t mean, great venture investments can’t be made beyond this time frame, but we believe the next 24 months represents an opportunity maybe seen once in a decade. The good structural tailwinds are a combination of:
- Valuations sitting below to the 10 year median, which provides opportunity for great upside when the market inevitably improves (we have seen boom/bust economic cycles repeat consistently since the early 20th century) the last being post the GFC, where we saw the same dynamics play out and VC funds which had capital deploy have produced out-performing fund vintages.
- The excess of talent as a result of layoffs helping to ensure we can resource companies on a high growth trajectory well.
- Those companies that have persisted, developing the skills to respond to and succeed in both a growth optimised and a profit optimised environment.
- The large quantum of funds under management with the larger fund managers in Australia and the fact that superannuation funds are investing directly into companies, means there is a significant amount of capital availability for later stage investments. Ensuring that those early-stage investments that are made in the next 3-5 years and succeed, will not starve from lack of capital, which has historically been a challenge for companies in Australia until recently.
- And importantly, we are seeing what we hope is a large co-investment and policy strategy from Federal government through the National Infrastructure Fund which should improve the pipeline of investment opportunities over the mid to long term.
Collectively, we believe this will set up the market for once in a decade investment opportunity in the near term, and a period of stable opportunity growth in the mid to long term. Whilst of course this prediction makes several assumptions – amongst them that the NRF will be executed well and receive bi-partisan support, and that the existing fund manager market remains broadly active and successful – our conviction around this market view is stronger than ever.