As investment in early-stage start-ups dips, VCs weigh in on the year ahead

Start-ups need angels but the pipeline may be drying up. Photo / 123rf

Angel investing (activity by venture capital firms that specialise in early-stage start-ups) was down in the first half of the year.

Investors provided $71.6 million of funding for New Zealand early-stage start-ups, down 4 per cent over the first half of 2022, according to the Startup Investment report, published today by PwC NZ, Angel Association New Zealand and Crown agency New Zealand Growth Capital Partners (NZGCP).

But the dip was not as bad as expected, and bucked a global trend of steep declines in angel investing. It was also modest next to the big fall-away in capital being put into local, more advanced local start-ups.

The number of young companies funded (67) was actually slightly up on the first half of last year (66).

“Deep tech” (or R&D-intensive) ventures accounted for 49 per cent of deals in the first half of 2023, with SaaS (software as a service or cloud software) coming in at just 16 per cent. Within the sub-categories in deep tech, health tech gained 46 per cent of all funding, followed by clean tech at 22 per cent and agri tech at 17 per cent.

Around two-thirds of venture capital (VC) investment typically takes place in the second half of the year.

And that second half is seen as hard going.

“Start-up investors are eternal optimists. That said, they are also realists. The year ahead will, in all likelihood, continue to be pretty challenging,” Angel Association chair Suse Reynolds said.

“We definitely see market conditions getting tougher,” NZGCP chief investment officer James Pinner said.

Pinner told the Herald that nearly all angel investment, and nearly all venture capital investment in New Zealand overall, came from high-net-worth individuals. “We’ve only seen a couple of KiwiSaver funds dipping their toes and little from institutional investors,” he told the Herald.

Higher interest rates and a rebound in the property sector could lure those high-net-worth individuals elsewhere.

Against that: “This is the best part of the cycle to be investing in venture. You’ve got lower valuations and hungrier start-ups,” Pinner said.

We’ve already seen VCs driving a harder bargain. Speaking to the Herald after Supie’s collapse - which involved a failed attempt to raise $3m - Icehouse Ventures CEO Robbie Paul said that founders had to accept investments at lower valuations now that the low-interest-rate-fuelled bubble of 2020 to 2022 was over.

That echoed comments by Jason Graham, managing partner at Movac - who said start-ups now had to accept 2018 or 2019-level valuations (and he used a real-life example, with his firm’s investment in LawVu). Effectively, that means a VC can offer to invest the same amount of money as during the boom time, but it gets them a larger stake as founders give up more control.

Another difference: Burning through cash in pursuit of rampant of growth is out of favour.

“This is the best part of the cycle to be investing in venture. You’ve got lower valuations and hungrier start-ups,” said NZGCP chief investment officer James Pinner.

PwC partner Tereza Bebich said another notable shift in investor behaviour emerged in the first half, with 75 per cent of deals supporting ventures already in investors’ portfolios, whereas typically the split between new and follow-on deals is 33 percent new to 66 per cent follow-on.

Pinner said, “We’re in a bit of a risk-off situation. They’re preserving their existing portfolios rather than taking a gamble on new investments.”

His colleague, NZGCP associate investment director Jacques Richer, said: “The shift in funding from new deals to follow-on does speak to a change in behaviour, with investors supporting companies they have already backed. This could adversely impact the pipeline of new start-ups if the trend continues.”

“Start-up investors are eternal optimists. That said they are also realists. The year ahead will, in all likelihood, continue to be pretty challenging” says Angel Association chair Suse Reynolds.

“The greatest risk to start-ups is uncertainty,” Pinner said.

The outgoing Labour-led Government formed the Startup Advisors Council in its final months. The panel (which included Reynolds) came up with a series of big ideas to unlock more money for start-ups.

Those included refreshing the $300m Elevate venture capital fund, administering NZGCP (along with the smaller, angel-focused Aspire fund) and boosting it to $500m; removing barriers to KiwiSaver funds investing in start-ups, a global talent visa, removing a tax on unrealised games on esops employee stock ownership plans) and tax-breaks for investments in start-ups.

Labour did nothing bar say it needed time to chew over the ideas (odd, given the council had run drafts, by Cabinet ministers, who had been aware of key recommendations for months).

National backed one of the report’s ideas (a global talent visa) and promised to investigate tax changes for esops. Presumptive Technology Minister Judith Collins said it was possible other ideas would be adopted once National was in power and had a better view of the lay of the land - but that policies would not include tax breaks for start-up investments, due to high Government debt levels. As things stand, the near-exhausted Elevate - whose co-investments helped fuel the private VC boom - will soon run dry.

Act only backed one idea (making it easier for KiwiSaver funds to invest in start-ups) when New Zealand First’s manifesto made no mention of start-ups or venture capital.

Despite the paucity of hard promises, Pinner was cautiously optimistic about the incoming Government. National had displayed a close level of interest in venture capital and tech, he said.

Chris Keall is an Auckland-based member of the Herald’s business team. He joined the Herald in 2018 and is the technology editor and a senior business writer.