Tech Wreck, Crypto Winter… the new terms coined in the difficult year 2022 for fintech startups do not inspire much confidence in the market.
But while valuations have fallen and easy money has dried up, there is a lot to be positive about in 2023.
Quality over quantity
The tougher conditions we all face this year will require those companies that survived last year’s downturn to be much more conservative in their approach to spending and governance. Now that the 2021 exuberance is over, investors are taking a close look at the company’s fundamentals.
This is good for the local ecosystem as it improves the quality of the sector as a whole.
With less cash available, founders and CEOs must be rigorous in controlling costs and cash flow to ensure they clear a long runway as raising new capital is taking 3-4 times longer than before.
Investors are even more focused on investing in quality companies – they are chasing strong teams, robust technology and sound financial models, not just good ideas.
In general, when it comes to new raises, “a flat round is the new round.”
While we are still seeing slight upside, companies across the board have cut costs and refocused their resources.
This has created a new paradigm – where investors used to put money in based on the idea that companies would grow through new capital, the lens now applied is much more like that of listed entities – the need to become profitable as soon as possible .
That’s a much more difficult task for a new company, especially in Australia where there is very little government support.
We see new companies offshoring faster in this tougher environment – Singapore and the UK are the winners when founders look for easier environments to grow their new business.
International investors are well aware of this and we see more of them coming here to find promising Australian ideas to take home.
The government must act quickly to avoid a protracted period of pain for startup founders here on our coast.
On the other hand, for VCs, this means it’s a good time to find new investments.
While there are fewer deals, the opportunities that are still coming through are definitely being considered better than they were 18 months ago. We no longer see millions being raised from the back of a pitch deck, and that’s healthy.
As we know, the best performing funds are those that make most of their investment during a recession, then exit when the cycle picks up again – and they will. Now is a good time to invest – innovation is still happening and great companies are still being created.
We have always specialized in working very closely and hands-on with our portfolio companies, and during this more difficult period we see founders eager to extract non-monetary value from investors in terms of mentorship, advice and board positions.
We’ve supported our founders through a myriad of challenges over the past year, one of which is now headed for a good exit.
One of our blockchain investments has undergone a major restructuring and recapitalization and is coming back with new management.
Another time we appointed a new CEO and members of our team joined the board of directors and another time we provided on-the-spot advice and management support when a founder became unwell.
Like Seed Space, other VCs are likely to do more to support the companies they invest in.
With the focus shifting from growth to profitability, startup founders need the guidance of experienced business leaders who can help with management and governance – two areas where we often see startups under-resourced.
Where to from here?
The worst of write-offs is largely behind us and valuations have stabilised, but consolidation is still underway in a number of areas.
Valuations will remain neutral to slightly lower until markets are more bullish again.
The exuberance we saw in 2020-2021 is over for the foreseeable future, but as the quality being created today matures, the fintech market is sure to get stronger. The nice thing about early stage investing is that as companies move from start-up to scale-up and begin to meet revenue and growth targets, valuations rise very quickly.
From a digital asset perspective, we have a lot of confidence in the future of that market. There were many low quality, low value products and those companies, products and services have now been flushed out of the system.
Where the real use cases still exist — in places like self-sovereign identity, supply chain, immutable records, currencies, highly secure networks — those technologies are still moving full steam ahead.
We’ve always believed that digital asset technologies are best suited for that type of ‘piping and plumbing’ infrastructure, rather than day trading or as retail investments.
The defi/tradfi dichotomy is becoming less acute and that is accelerating rapidly. Now that the “foam” of the crypto bull market is out of the way, it’s easier to talk about the role digital assets will play in our financial landscape. All traditional financial entities are well on their way to developing their future models – from platforms to a wide range of digitized assets to defi services – the major institutions are well advanced in carving out their niche.
This decentralization is a one-time social opportunity to address some of the inequalities that are ingrained in the traditional financial system and we’re very excited about that.
In terms of our fund’s performance, there were of course some significant write-downs in 2022, but we also saw quality companies able to raise on solid upside valuations. So overall, we’re very pleased that we’ve still been able to meet our performance targets, even in the recession.
2023 will be a very interesting year in terms of performance.
We have several companies raising money right now and there is solid backing from investors. Likewise, we have a good pipeline of deals that are being reviewed by our investment committee that are likely to accept investments at half the valuation they expected in early 2022.
These gems will really shine when the market picks up again in the next cycle.
* Cathryn Lyall is a director of Seed Space Venture Capital