When the seriousness of COVID-19 first started to set in, there was no clear consensus on what the effects on the Aussie startup funding landscape might be.
Back in March, for example, SmartCompany chatted to one startup that had actively backed out of its first funding round, with the founder citing concerns that the growth he had promised his investors just wasn’t possible any more.
We’ve also, however, seen recruitment startup alooba secure $1.1 million in early-stage funding — although founder Tim Freestone says his growth plans are somewhat “out the window” for the time being.
In the same week, SaaS startup Longtail UX secured $5 million, and AEV robotics closed a $2.5 million round.
Since then, proptech startup Archistar has raised $6 million in a round led by AirTree, while flying car racing startup Alauda and quantum computing startup Q-CTRL both closed funding rounds but did not disclose the values.
We’ve also seen some very sizable deals coming through the pipeline. In April so far, neobank 86 400 has secured $34 million in Series A funding, Internet of Things startup Myriota has raised $28 million, and SafetyCulture has scooped up $60 million, becoming a new Aussie unicorn.
Then, just last week, fintech Airwallex announced it had raised $250 million in Series D funding, bumping its valuation up to $2.85 billion.
If you follow startup funding news as closely as we do, it really doesn’t look like there’s a shortage of cash about.
But, the numbers paint a different picture.
According to Right Click Capital’s Internet DealBook funding report, a total of 50 deals were closed in Q1 2020, compared to 90 in the same three months last year.
The majority of the damage was done in March. Just 12 deals were closed last month, according to the data, compared to 49 in March 2019. That’s about a 75.5% drop, year-on-year.
At the same time, we’ve also seen M8 Ventures, the early-stage venture fund of Alan Jones and Emily Rich, go into hibernation — something that hardly screams positive things about the state of the ecosystem.
So, what’s going on here? Are we in the throes of a funding drought or are we not?
Protecting the portfolio
Speaking to SmartCompany, David Burt, director of entrepreneurship at the University of New South Wales, suggests one of the factors here is that institutional investors are protecting their existing portfolio of companies.
Since the pandemic hit, they may well have been meeting with their portfolio companies and offering additional capital to those who need it to survive.
“From a strategy perspective, the play is to ring fence their portfolio,” Burt suggests.
“So there has been this incredible amount of extra attention from institutional investors onto their portfolio companies.”
The nature of this particular economic downturn means many investors are more willing than usual to offer bridging rounds, or top up a company’s liquidity. The consensus in the startup sector seems to be that businesses should have a two-year runway, just to be safe.
“They recognise it’s a once-in-a-generation economic shock,” Burt suggests.
“They don’t want to see their portfolio wither and die because of this economic event.”
Looking at the Internet DealBook figures, it is noticeable that, despite the steep decline in the number of deals last quarter, the average value of deals has leapt from $6.7 million in the first quarter of 2019 to $11.7 million. The median is also up significantly, from $1.6 million to $4.4 million.
Benjamin Chong, partner at Right Click Capital, also points to the massive Airwallex round, which will be included in April’s reports.
The companies securing funding at this time are, for the most part, not first-timers.
In fact, they may be companies that secured their first batch of capital five years ago, and are now back for their second, third or even fourth raise.
“Airwallex is not a young company. It wasn’t started by two people in an accelerator program in 2019,” Chong says.
“They’ve been going on for some years.”
It’s a positive thing, Chong says, that companies like Airwallex are growing, and continuing to attract sizable cheques.
“But the big question is, does that mean there is now a shortage of funding from angels, from early-stage VCs, for pre-seed and seed style rounds?”
We could see both early-stage investors, and the founders that would be seeking funding, hanging back, “just to see what the impact of COVID-19 might be”, he says.
“Is this going to be a pronounced trend as we go into the next quarter?”
“I’m waiting with baited breath to see the April figures … to see whether the numbers have changed.”
Rushing to close
At the same time, no startup funding round closes overnight. So, perhaps we could just be seeing deals that have been in the pipeline for some time wrapping up now, before the economy gets any messier
Before the impact of COVID-19 became clear, there was a lot of momentum in the Australian funding landscape, Burt explains. Although he does note it was better in the institutional space than at an angel and seed funding level.
“The institutional fundraising landscape was pretty good, before coronavirus happened,” he says.
“You’re seeing all that momentum that was existing in the system rush to close.”
We don’t know what the ongoing economic effects of COVID-19 will be, Burt adds.
“It’s very hard to measure and quantify. Therefore, the ambiguity is a great incentive to get those deals done and close them out.”
Does this uncertainty mean fewer deals will be entering the pipeline now? Will we see an even bigger drop in the numbers of funding rounds in a few months’ time, when there are no deals to close?
Chong doesn’t think so, necessarily.
Enquiries at Right Click Capital haven’t really dried up, he says. And he’s encouraging startups to get conversations started and reach out to work with potential investors.
“We have the good fortune of seeing how the situation is impacting other businesses across the portfolio, and we’re able to provide feedback,” he explains.
“I’m not saying we know everything …. But what we can do is share what’s happening with some of our portfolio companies, but also what we’re seeing across the world.”
Chong doesn’t approach the question from the point of view that startups will struggle to find investment. Rather, he considers whether startups will be seeking capital at all.
And for him, the answer is yes, probably.
“If we talk about the crystal ball — I would say that I expect that startups will still want to get funding,” he says.
“Whether they choose to show a bit more traction or wait until they’re able to demonstrate more customer validation, that may well happen.”
The third reason it might seem like there are a lot of funding rounds closing is because of what Burt calls the “amplification effect”.
The reason we’re even talking about this is that it seems strange to see so many headlines about startup funding at a time when the economy is undoubtedly heading downhill. And that’s exactly the point.
“It seems surprising that these companies are raising. Therefore it’s a bigger story than it otherwise would have been,” Burt says.
“Those stories are echoing louder and being amplified.”
The founders of those businesses may also be shouting from the rooftops a little more readily than they usually would.
Securing funding at a time like this is “a big signal of credibility”, Burt says. It acts as reassurance to employees, but more importantly to potential and current customers.
“Most customers are pretty sceptical of buying from a startup in the first place,” he notes.
There’s never really a guarantee that the business will be around in a few years’ time.
“They’re even more sceptical in the current environment.”
Both Burt and Chong express some concern that this new landscape could lead to a dip in funding, if not for established and already funded startups, for those looking for seed or angel rounds. That is, those businesses that are arguably already most vulnerable.
“The probability that we’ll see less deals being done is really high,” Burt says.
“Angel investing is really difficult at the moment — especially the non-traditional angels,” he adds.
Many companies raise their first funding rounds through ‘friends, family and fools’ rounds, securing anywhere between $25,000 and $250,000 from their personal contacts and connections.
“That’s going to become really hard right now, with the general economic environment and the uncertainty.”
As for whether that will have a negative knock-on effect on the ecosystem as a whole, Chong says “it depends”.
This doesn’t mean startups at this stage are doomed to fail, but it may be the time to focus on product and — crucially — profit.
“What we will see more of over the coming months is bootstrapping,” he explains.
“We’ll see people try to make more progress, particularly on product, without as much funding and without as much customer interaction.”
Face-to-face testing of pilots with customers is obviously tricky, he notes. But many of the startups he’s been in touch with are “continuing to beaver away on their product”.
For Burt, the focus has to shift from focusing on proof-of-concept and proof-of-use to focusing on proof-of-revenue.
If a startup is going to survive, it will need its pilot customers to bring some money in. Startups that can do that “are going to have a much easier time”, he says.
“The decision-making criteria for what product you’re building now needs to include, at least in the short-term, ‘can my prototype actually be revenue-generating?’”
Not all doom and gloom
What happens in the Aussie startup funding ecosystem now depends on how long the COVID-19 crisis lasts, and on what happens on a global scale, economically.
“Startups are very mobile, and talent is very mobile,” Chong notes.
“If funding everywhere is constrained for whatever reason, then of course in Australia we will see more of the same … less early-stage companies getting funded.”
However, Chong is holding out hope that both investors and the government recognise the importance of early-stage funding, and don’t let it disappear altogether.
“In order to find that next Airwallex you need to hopefully fund those businesses,” he explains.
“What funding provides is the opportunity for businesses to scale in a timeframe that is less than what you would normally do if you bootstrap,” he adds.
“If we want for there to be new paths of employment; if we want for there to be opportunities to export to international markets; and if we want to have jobs that are interesting and that are well paid, then it does make sense to support the startup sector because of the economic benefit that it provides.”
At the same time, while things do look bleak for many, the current environment also brings opportunities.
If nothing else, there’s a lot of startup talent available at the moment.
“I don’t want to trivialise the current situation. It’s not great. It sucks for a lot of people. But there are opportunities,” Burt says.
If you can start, or continue, a company that will survive without a funding boost, there will likely be fewer competitors in your space, and a lot of talent available to you.
“Yes, it’s a harsher environment to start a company in some respects. But in other respects it’s easier,” Burt adds.
“On balance, once you sum those two things together, is it harder or easier?
“That depends on the market you’re playing in.”