Interest rate hikes, inflation and war in Europe are driving innovation funding trends worldwide. The Ukraine/Russia battlefront, China’s factories and the United States Federal Reserve are thousands of miles away. But globalisation means Australian innovators, and the funding they need, are not immune to the macroeconomic impacts these geopolitical shockwaves are creating.
Global drivers
Innovation funding trends don’t develop autonomously or exist in a vacuum. So let’s consider the factors behind them, and what they may portend for innovation businesses.
Rising interest rates
The Reserve Bank’s (RBA) September decision lifted Australia’s official cash rate for the fifth month running. The move has taken interest rates to levels not seen since 2015, and demonstrate that the RBA is in lockstep with other central banks around the world.[1] Borrowing costs are increasing at a pace not seen for more than three decades. And with more rate rises in the offing, the days of cheap money are well and truly in the rearview mirror.
Key takeaway no.1
Higher interest rates equal higher borrowing costs on new and existing debt for start-ups, scale-ups and everyone else, including Venture Capitalists (VC). With the cost of money heading north, equity investors have less money to invest because capital is tending to flow towards lower-risk investments such as bonds and public equity, rather than start-ups.[2]
Inflation
Central banks are pumping up interest rates to put the brakes on inflation, which is rising globally at speeds not seen since 2001. In Australia, the inflation rate is on track to hit 8% by the end of the year. It normally sits at around 2-3%. And the RBA wants to send it back there.
Key takeaway no.2
Higher inflation means everything costs more, including finance. Overall, inflation creates uncertainty and means there is less money available to investors, so the value of the capital they can bring to your start-up or scale-up is lower. However, the flipside to rising costs is that money is worth less. So any debt your start-up has is also deflating.
War
The war in Ukraine is reshaping the global capital and commodity markets because both Russia and Ukraine are key suppliers. The rouble, Russian commodities and Russian-owned assets, businesses and oligarchs have been blackballed by western economies, while Ukrainian goods and commodities face logistical obstacles getting to market. The result is higher oil and energy costs worldwide (so more inflation) and a risk to grain supplies which has stoked food price hikes.
Key takeaway no.3
War in Europe involving a nuclear power is creating a new level of uncertainty. No one knows whether the conflict will escalate or fizzle out. No one likes high-stakes uncertainty less than investors. And they’re responding by seeking safe havens for their capital. So riskier investments such as start-ups and scale-ups have fewer investors with fewer dollars to court right now. On the debt capital side, the war is fanning the flames of global inflation as energy and food shortages continue to bite.
Tensions east and west
The recent spat between the US and China is the latest in a sustained souring of relations between the world’s largest economies. And the latest escalation follows bans and swingeing tariffs on many Australian exports to China. Even before the pandemic, Chinese investment in western infrastructure was being questioned and curtailed. Then the pandemic arrived and exposed the world’s near total reliance on China for manufactured goods. This, together with the frosty relations, have driven the reshoring trend for Australian manufacturing and other western economies as well as policy changes on sovereign capability.
Key takeaway no.4
One door closes and another one opens. Concerns about China are fuelling a manufacturing renaissance. And this spells opportunity for start-ups and scale-ups, especially if their innovation is in one of the Federal Government’s National Manufacturing Priorities of resources technology & critical minerals processing; food & beverage; medical products; recycling & clean energy; defence; and space. When the Government is providing certainty around funding and policy direction, it lowers the perceived risks for investors and lenders, making it easier for start-ups and scale-ups to access debt and investor capital.
Supply chain disruption
Almost every economy, apart from China, is now following a ‘living with COVID’ policy. As a result, it’s becoming increasingly difficult for China to maintain its COVID-zero status. So lockdowns and temporary factory closures have been on the rise. China’s position as a world-leading manufacturer means this is exacerbating existing supply issues and shortages.
Key takeaway no.5
Short-term, if you’ve outsourced or are planning to outsource manufacturing for your innovation to China, your start-up or scale-up is exposed to supply chain risks. This could make investors (existing and future) reluctant to back your venture. The reason is it may lengthen your time to market and let your competitors gain the first-mover advantage. However, you can pursue opportunities for your business to re-shore your manufacturing and potentially access government grants.
Climate change
It’s official. The Bureau of Meteorology has declared a La Niña for Australia for the third year in a row. A triple La Niña will likely bring with it flood disasters across Australia. The threat of climate change will be front of mind, as will potential solutions to fix it.
Key takeaway no.6
If your start-up or scale-up has innovative solutions that fix or mitigate climate change or simply boost our resilience to and recovery from climate-driven catastrophes, you’re in the box seat. Your venture will be more likely to access government grants and attract equity investment.
For a deeper dive into the geopolitical and macroeconomic forces shaping the innovation funding landscape, read our article, Innovation funding in FY23: what it means for your R&D.
Debt financing: what are your options?
So how are the current key trends shaping innovation funding impacting what’s available in terms of debt financing products for Australian start-ups and scale-ups?
Traditional finance
When we think of debt financing, bank loans, business overdrafts and credit cards spring to mind. These traditional types of funds can be fiendishly hard to obtain for new ventures and businesses with innovation. New companies don’t usually have a financial track-record such as bank statements and full-year accounts to support their loan or credit applications. Early-stage innovation businesses often don’t generate revenue which is a complicating factor. And whether a start-up has assets, such as plant and equipment, that it could use as loan collateral, will depend on its industry sector.
Even if your venture has been able to lasso some bank funding, rising interest rates are making your finance more costly to service right now, and for the foreseeable future.
Alternative finance
Alternative finance has grown and become more mainstream, fuelled in part by the pandemic. In general, it has been a boon for innovation-focused businesses, with options available for start-ups and scale-ups at every stage and from every sector.
Peer-to-peer
Peer-to-peer lending platforms can offer innovative businesses access to debt financing that’s crowd-based. It can provide your business with secured or unsecured loans. The interest rates are lower than those typically offered by banks and approvals are usually faster too. Prospa is a homegrown peer-to-peer lender. It offers businesses unsecured loans of up to $150,000, and amounts of up to half-a-million dollars on a secured, fixed-rate, fixed-term basis to companies that can meet its lending criteria.
Buy Now Pay Later
Then, there are the Buy Now Pay Later (BNPL) financiers. Over the past 10 years, BNPL has exploded worldwide, enjoying a meteoric rise to become a $350 billion global industry. This has happened because its offerings and business models resonated with Millennial and Gen Z consumers. Crucially, the industry successfully dodged regulation and drew in subprime borrowers like moths to a flame. With rising interest rates and inflation, the chickens have been coming to roost with many BNPL companies chalking up huge losses.
Australian BNPL operator Zip offers unsecured business loans of up to $500,000 and hasn’t escaped unscathed. The fintech posted an eye-watering $1 billion loss and closed its United Kingdom division last month. In Australia, regulation is on the cards for the sector within the next 12 months. Despite its recent troubles, many industry commentators see a bright future for this form of alternative finance once the current line-up of providers has undergone a period of increased competition and consolidation.[3]
Revenue-based
Revenue-based financing, such as that offered by Tractor Ventures, is another avenue worth exploring. It offers non-dilutive funding of between $50,000 and $1 million to businesses in Australia and New Zealand that are generating regular monthly revenues of $15,000 and upwards. Revenue-based financing is a great option if you’re generating regular revenue at a certain level. Early-stage innovation ventures that are non-revenue or have lumpy feast or famine revenue streams can explore R&D financing instead.
R&D finance
R&D financing, such as the Radium Advance, is available to both non-revenue and revenue-generating businesses that can claim the R&D Tax Incentive (R&DTI) refund from the Australian Tax Office (ATO). The funding is non-dilutionary and typically secured against your company’s expected R&DTI refund. You can access as much as 80% of your tax refund early at a fixed interest rate. And there are no capital and interest payments or fees until your refund arrives from the ATO and pays off your loan, ensuring it is a cash-flow friendly option for businesses.
Always check the fine print
Whether you’re dealing with a high-street bank or a platform-based fintech, always read the terms and conditions for your finance. Pay close attention to a loan’s security requirements, break clauses and additional fees you may have to pay if your business circumstances change.
What’s happening with investor capital?
As we’ve already noted, capital markets are tightened for investors such as VCs. So there is less money to go around. And that means investors are turning over every penny twice before they sink it into start-ups and scale-ups.
Early stage
Before the current economic woes, less than 1% of businesses seeking VC backing were successful. Now, the odds are getting longer. According to financial data and software company PitchBook, a market correction is underway for early-stage start-ups seeking VC for Series A and seed funding rounds. Over recent months, seed and Series A deal valuations have dropped significantly. Early-stage investors are becoming more selective, shifting their focus to nascent businesses that can achieve higher revenue targets. Valuations are plunging and many analysts say this is a healthy correction. So if you’re a start-up founder seeking a VC backer, expect to give away more of your equity in return for less capital.[4]
Later stage
If you’re limbering up to scale your start-up, remember the higher the dollar number you’re seeking, the higher the stakes are for would-be investors. Late-stage start-ups and scale-up investors tend to be more cognisant of risk in general and now in particular. So do your homework, have a polished pitch ready to go and accept it’s probably going to take you longer to reel in an investor than it would have done 12 months ago.
But if your company was founded more than five years ago and has already attracted investors, experts are warning that raising new capital will be an issue. This is because these businesses may now be seen as overvalued, and there is simply less capital around.[5]
Indeed, in the US, start-ups with less than 12 months of runway are being encouraged to sell to strategic buyers as the days of the abundant and accessible investor capital that kept them afloat are numbered.[6]
Regardless of how the financial and investor markets are shaking out for your business, it’s crucial to have as diverse a capital stack as possible. Having a variety of funding sources helps you avoid cash flow shortfalls and ensures your innovation and growth stay on track. Read our article How to build the best R&D capital stack for your business to find out more.
Sector-specific trends
It’s crucial to remember that the trends in investor capital are general. There can be surprising variations in the funding landscape depending on what sector you’re in, or what type of founder you are. Data from Crunchbase has revealed that venture investment in foodtech, which includes plant-based and lab-grown meat, reached a record $12.8 billion globally in 2021, which is double that of 2020. According to Pitchbook, private equity investors are flocking to invest in cyber security start-ups and scale-ups. And in the US, investment in innovation businesses with female founders is growing at its fastest rate ever. You can expect this trend to make its way to Australian shores in the not too distant future. So drill down into the specific undercurrents in your industry sector and area of innovation, and adapt your investor strategy accordingly.
Consistent capital you can count on
If you’re eligible for the R&DTI refund, Radium Capital can let you access it early with an affordable, fixed interest rate R&D loan. So why not add a Radium Advance to your capital stack? We can approve loan applications in just two business days, and your funding will be in your account a few days after you sign your loan documents. Connect with one of our R&D finance experts today and get your application started.
[1] World Economic Forum. 2022. This chart shows how central bank interest rates have changed. [ONLINE] Available at: https://www.weforum.org/agenda/2022/08/central-banks-hike-interest-rates-inflation-pressures/.
[2] Forbes. 2022. What The High Interest Rates Mean For Startup Founders. [ONLINE] Available at: https://www.forbes.com/sites/forbestechcouncil/2022/05/04/what-the-high-interest-rates-mean-for-startup-founders/?sh=6186a9066691.
[3] Eddy Sunarto. 2022. Buy-now-pay-later faces day of reckoning, but some stocks may survive and even thrive – Stockhead. [ONLINE] Available at: https://stockhead.com.au/tech/buy-now-pay-later-faces-day-of-reckoning-but-some-stocks-may-survive-and-even-thrive/.
[4] ‘Put up the for-sale sign,’ more VCs tell founders as market sours | PitchBook. 2022. [ONLINE] Available at: https://pitchbook.com/news/articles/mergers-acquisitions-vc-startups-sale-falling-valuations.
[5] Forbes. 2022. What The High Interest Rates Mean For Startup Founders. [ONLINE] Available at: https://www.forbes.com/sites/forbestechcouncil/2022/05/04/what-the-high-interest-rates-mean-for-startup-founders/?sh=6186a9066691.
[6] ‘Put up the for-sale sign,’ more VCs tell founders as market sours | PitchBook. 2022. [ONLINE] Available at: https://pitchbook.com/news/articles/mergers-acquisitions-vc-startups-sale-falling-valuations.