The Tech Winter and the Hope for Spring

Introduction

The first half of 2024 saw the level of funding received by startups fall to a six-year low. As startups and young venture capital firms alike struggle to raise funds, the 53% drop-off in startups investment sharply juxtaposes the investment boom enjoyed in Australia from 2021 to 2023. The fall in business sentiment and investor confidence is echoed in venture capital markets worldwide, from Silicon Valley in the US, to Australia’s neighbours like Indonesia. Specifically, the decline in technology unicorns has led this startups drought to be called the ‘Tech Winter’, a recession in technology-based startups. 

Graph 1&2. Bar charts depicting the amount of capital invested in startups and number of active investors in Australia respectively.

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A Cooling Economy - Causes of the Tech Winter

1 - Economic Downturn and Risk Aversion

One main cause of the Tech Winter is the economic downturn Australia is currently experiencing. With businesses and households starting to feel the full impact of monetary policy tightening over the past two years, the economy has slowed to a mere 1.1% in economic growth. Given business investment is a relatively volatile component of Aggregate Demand, declining business conditions and an 11 year-low business confidence led to falling levels of business activity. Businesses are keen to avoid risks, whether that is business expansions, or unsurprisingly, the initiation of startups. 

Graph 3. Line chart depicting changes in Australian business conditions over time

On the investor side of the equation, during periods of economic uncertainty and pessimism, we often see a flight towards investing in lower risk asset classes, as risk appetite falls. With a high investment mortality rate of up to 90% of startups failing, and initial cash deficits as illustrated by the following ‘J’ curve, investors tend to move away from investing in venture capital assets during recessions. The fall in investor sentiment is reflected through the falling number of deals signed.

This fall in VC investment would, in turn, discourage entrepreneurship, with individuals being less confident that they will secure funding. As such, the combined impacts of decreased entrepreneurial spirit and investment in higher risk startups has dampened the frequency of startups and deals.

2 - An Oversaturated Technology Market

Another cause of the fall in technology startups is the oversaturation of the technology market. Immediately following Covid, the increased use of technology after long periods of remote work and learning, alongside record low target cash rates of 0.10%, led to a wave of technology related startups. However, as predicted by the Hype Cycle, expectation and demand for new technology will often fall into a trough, after an initial period of elevated popularity. The abandonment of Metaverse, fall in cryptocurrency, and the decline of the influencer era are examples of trends fading away after being hyped, or rather, overhyped in hindsight. 

3 - The Startups Bubble Bursting

Simultaneously, the startups bubble seems to be bursting, with startup valuations expected to fall. Record low interest rates in 2020 incentivised the creation of many new venture capital funds, resulting in increasing capital available for startups. This inadvertently reduced the competition between startups, with some less profitable companies receiving more funding and being valued higher than they otherwise would have. With some startups ultimately unable to live up to the returns promised, they are either merging or going into liquidation in the tough economic downturn, resulting in a wave of write-offs among newer venture capital funds. Additionally, M&A regulations have led to a slowing of exits and closing of funds for startups and venture capital investors respectively, resulting in the startups field lagging behind the public market in rebounding from this downturn in valuations. 

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The Snowdrops of Winter - Surviving the Tech Winter

1 - The Rise in Bootstrapping

More startups are starting to shift away from relying on external funding to bootstrapping their business themselves. Instead of trying to join Linktree and Canva as VC funded start-ups, more founders are trying to secure initial funds themselves. This is initially done through founders consciously choosing to run simultaneous marketing or consulting businesses, which provides additional resources for their startup, or by saving money from previous, often finance related, jobs. Instead of focusing on raising massive funds and branding in a relatively quick timeline through public listing, these startups tend to focus on slow, steady and sustainable growth. Successful examples include Interface.ai and VR startup Phoria, though the latter is now seeking VC funding after 10 years of bootstrapping. 

Graph 4. Line graph showing the growth of bootstrapped and VC-backed startups to $1 million. 

Artificial Intelligence and the rise of e-commerce further enables the rise of bootstrapping. Notably, startups are using AI to enhance their internal operations. With AI able to provide customer service, marketing, and internal management help, startups require less labour input, leading to lower costs and increased ability to break-even. Additionally, social media and e-commerce platforms provide low-cost methods of advertising and selling products that business owners previously would not have access to. Modern startups thus require less funding, and hence are more willing to use their own savings to finance their businesses.

Additionally, some founders, anticipating high initial startup costs but seeking to retain equity, are choosing to raise capital from investors for the initial period but plan on using the firm’s generated revenue after breaking even. 

2 - Government Support

In the 2024-25 federal budget, the Australian Treasurer Jim Chalmers announced discretionary policies that would stimulate startup activity. For example, the instant asset write-off scheme has been extended in order to support business confidence and business conditions. In this way, by supporting business profitability, business activities would not fall by as much as it otherwise would have in the economic downturn.

The budget also included long-term policies that would enhance Australia’s future productive capacity and intertemporal efficiency through research and development funding. Notably, the $1.7 billion in the Future Made in Australia fund seeks to inspire innovation in the renewable and clean energy cycle, supporting the rise of green startups over the next decade. Similarly, a $470 million investment in the quantum computing startup PsiQuantum seeks to support the rise in computing technology in Australia. From these policies, it seems that both the government and venture capital funds have identified climate and quantum computing technology as future areas of growth. 

3 - A Flight to Quality

Despite the fall in the number of venture capital deals, the median value of investments following the seed stage increased, suggesting a similar flight to quality within the venture capital industry. As more venture capital funds are choosing quality over quantity, startups are encouraged to be more innovative and profitable. This would reduce the risk for venture capital funds, especially newer funds who are struggling to raise funds, such that when the deal market recovers, they are able to similarly recover. 

Graph 5. Graph showing the changes in the level of startup funding in Australia by the amount of capital and number of deals. In the last quarter, the capital to deal ratio rose dramatically.

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A Hope for Spring - Future Outlook

There is discussion that the Tech Winter is the startups space adjusting after the unnatural boom in investment experienced in the post Covid years. With startups being inherently riskier, and therefore more receptive to fluctuations in economic activity, it is not too unexpected that the technology startups market is declining rapidly as our economic growth slows. As the deal-making environment improves, there would be a return to normalcy to the pre-Covid years, with more stable levels of startup and venture capital activity. 

Although valuations of startups may fall for the next year, the more accurate pricing of firms and the increased incentives for innovation could be healthier for the long term growth of the economy. Investors and entrepreneurs would be keen to avoid another Dotcom Bubble. Back in 2000, the overabundance of startup funding, as well as the overpricing and inorganic growth of speculative ‘.com’ startups led to the panic selling and the stock market crashing, taking years to fully recover. 

Graph 6. Graph showing changes in level of VC investments as a result of the Dotcom bubble.

Thus, as AirTree Ventures partner Elicia McDonald suggested, the Tech Winter would provide a “healthy reset” after the lows of the pandemic, the highs of the post-pandemic boom, and now the lows of the Tech Winter again. The maturation of AI technology, alongside new developments in climate technology and spatial computing, would resolve the oversaturation of technology via inviting new sources of sustainable and organic growth. This may reverse the trend of rising private equity dry powder, which has accumulated over the past few years, supporting a more even field in raising private equity funds. Increased investment in gender-balanced startups with at least one female founder, from 15% in 2022 to 25% in 2023, is a much welcomed first step for closing the venture funding gender gap. So as deals and startup growth picks up, entrepreneurs and investors have expressed optimism for the future of the startups ecosystem, which is ready to take on new challenges and embrace new ideas. 

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References

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