2022, what a year! From record deal volumes and valuations in 2021, the Australian start-up and VC ecosystem was booming as 2021 drew to a close. Record levels of investment from both domestic and international investors gave plenty of confidence.
As 2022 took shape, buoyant optimism made way for apprehensiveness as to what the downturn in tech valuations would mean for companies relying on venture capital investment. 2022 was the year the system took pause. VC investment deployment dropped, albeit from a record high 2021. Yet generally the Australian market has proven resilient with some marked success stories.
1. Raise to the occasion
With tech valuations down, most companies that didn’t have to raise in 2022 opted to wait. Our recent survey of Australian founders revealed that 76% plan to raise capital in the next 12 months, and we expect to see most founders turning their minds to their next priced round from as early as January 2023.
Blackbird’s Rick Baker has recommended founders don’t wait too long, telling Forbes Australia’s recent Australian Business Summit that with plenty of dry powder around, it is better for start-ups to raise now if possible to ensure that they have the capital needed to deliver on their plans.
2. Playing it SAFE
We saw a wave of bridging rounds in 2022 for various reasons, including to lengthen cash runways and defer landings on valuations. In some cases, investors also wanted to provide certainty and peace of mind to founders so that they can focus on the business with fewer distractions. We expect this trend to continue through 2023, particularly if tech valuations are slow to recover.
Companies and investors should be mindful of the complexities of SAFE (a Simple Agreement for Future Equity) and convertible note economics, especially when multiple instruments are ‘stacked’ on each other. They should also avoid unintended down rounds by considering a floor on any discount at the last valuation.
3. Due diligence is the new black
In 2021 speed to term sheet was a critical competitive advantage. Going forward we expect an enhanced focus on due diligence and a challenging of the assumptions behind forecasting, ensuring a clear path to neutral or positive cash flow.
So how can founders set themselves up for success in this environment? Prior planning, organisation and responsiveness are key. Getting your ducks in a row and keeping your information for prospective investors up to date before you need to.
In the long run we think this will be a positive development and will see a more confident deployment of capital by investors.
4. An evolving market for secondaries?
Secondaries have performed an important function in incentivising founders and employees by providing a partial equity liquidity event. However, we did not see as many secondaries in 2022 as previous years, probably due to the uptick in use of SAFEs and convertible notes and the uncertainty on valuations (a secondary really requires agreement on price). We believe the rationale and motivation for these secondaries will continue, notwithstanding it may not have taken the same pride of place in 2022 as in 2021.
Also, with some companies contemplating a longer pathway to IPO or other exit, secondaries may increasingly be looked at by investors as a mechanism for liquidity.
The recent close of Second Quarter Venture’s $83m fund focussed on secondaries provides a strong signal that secondaries will continue for solid companies.
5. Exit stage left?
With a changing cost of capital, we expect to see some founders and boards review exit and liquidity strategies and any opportunities for sales and consolidations that may emerge.
These kinds of discussions should take place recognising that different stakeholders may have different drivers and in any exit while a company is still in a growth phase, the founders remain critical to the go-forward business.
6. Market for talent
Downsizing by Big Tech has talent on the move and may even see some expats returning home. This will present an opportunity for well-funded home-grown businesses who’ve found it harder in the competition for talent. It also has the potential to spawn a raft of new start-ups as people consider starting a business of their own.
7. Employee incentives
With a focus on cash burn, start-ups will increasingly look to employee equity to reward and motivate staff. In Australia, regulatory changes in 2022 have sharpened the focus of founders, start-ups and their boards on the disclosure rules for offering employee equity. The nature of the new reforms may increase the adoption of zero exercise priced options (ZEPOs), rather than options with an exercise price equal to the market value.
In a market where valuations are difficult to determine, ZEPOs provide more comfort to employees that they will derive some value from the options, even if this may come at the expense of accessing the startup ESOP tax concessions.
Companies wanting to rely on the startup ESOP tax concessions, or that want to offer employee equity structures that only reward increases above the current market price, will likely need to take the more regulated pathways which require robust offer documentation.
8. PE Funds reaching earlier into the business life cycle
Venture capital has been the stand-out performer of the alternative asset classes in APAC over the past five years and is forecast to continue to lead the pack in APAC for the next five. Coupled with being a gateway into tech, it’s no wonder Private Equity funds have been looking earlier into the business life cycle for opportunities and return. We expect to see this interest translate into more announced deals, with the first already coming out of the blocks.
9. Circle of life
As the first generation of Australian unicorns consolidate their growth and global reach, we expect them to contribute back to the ecosystem that gave them their first opportunities way back when.
Founders and family offices of Australian success stories like Atlassian, Canva, Culture Amp, Safety Culture, Linktree and Mr Yum are strongly supportive of the Australian ecosystem, and we believe many founders will continue to back local start-ups, including through initiatives like Sidestage Ventures and The Fund.
10. Green shoots emerge
Amidst the negative press, don’t miss the bright lights — there is reason for founders to be optimistic in 2023.
The last three quarters of 2022 saw some stand-out raises including Sonder, Vexev, Greener, Gamurs, Reejig, 6Clicks, Great Wrap and Rentbetter, and announced equity capital raised for April to October 2022 is not substantially below the same period in 2020.
And there is no shortage of dry powder – this year we’ve seen record fundraises by leading Australian VC Funds including Square Peg, OIF Ventures and Blackbird, and we expect to see more from these players in 2023.
HSF is the pre-eminent venture capital law firm in Australia, and one of the leading VC firms in Asia Pacific. It advises on more VC transactions than any other Australian law firm and is proud to have supported companies such as Atlassian, Mr Yum, Carma, Sonder, Culture Amp, SafetyCulture, Linktree, Who Gives A Crap, :Different, Gamurs, Pearler, Vexev, and Instant Checkout.
The firm’s core Australian VC team of over 25 legal experts works closely with the firm’s other private capital experts globally to advise start-ups from their earliest raises through the full company lifecycle to realisation, including pre-company formation.
For more information on the firm’s VC expertise and its recent founder survey visit: https://www.herbertsmithfreehills.com/our-expertise/services/venture-cap...
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