The start

The private tech scene is splitting into two camps, with strong well-capitalised start-ups bulking up and zombie firms looking for a way out.

In Australia's start-up tech sector, the divide between the weak and the strong is growing. There is an increasing number of "zombie" companies staggering along, hoping their stronger peers can bring them back to life, or at least survive the tech winter, according to industry insiders.

The previously buoyant tech scene has been buffeted over the past 18 months as venture capital investors’ wallets have snapped shut, US banks have crumbled, and the tally of collapsed companies has started to rack up.

One Ventures managing partner Michelle Deaker says some of its portfolio companies can take advantage of tougher market conditions for their rivals. Louie Douvis

Leading local investors and start-up founders told The Australian Financial Review that funding sentiment had almost reached the bottom of the market, but it remained unclear how long it would stay there before kicking back to the surface.

"The bottom will come when interest rates stop being lifted, and the commentary is that this should be soon, with some criticism of the Fed's recent rate hike," says Dr Michelle Deaker, managing director and founding partner of one of Australia's largest VC funds, OneVentures.

OneVentures is on the cap tables of some of the local sector's highest rated start-ups, including $1.25 billion-valued "unicorn" Employment Hero, e-commerce shipping and fulfilment platform Shippit, digital debt collection platform Indebted, and healthcare product platform Eucalyptus.

"However, if interest rates continue to rise because inflation can't be brought into check, capital will flow away from our sector and it will become harder for companies to raise their follow-on rounds, so the bottom may flatten and it may be that we crawl out of it rather than a bounce," Deaker says.

The highest profile Australian casualty of the global tech wreck so far has been grocery delivery start-up MilkRun, which brought the shutters down in April. The company became something of a poster child for VC funding excess before the market slowdown. Having only launched in 2021, it raised $86 million from a rollcall of big name backers including Mike Cannon-Brookes, Scott Farquhar, AirTree Ventures and Tiger Global Management.

Although it had big plans to disrupt Coles and Woolworths’ local dominance, and was popular among its fast-growing customer base, the company burned cash at a rate that was almost encouraged at its inception, but had become anathema by 2023.

MilkRun's collapse was followed by celebrity chef Shane Delia's online restaurant marketplace Providoor, blockchain firm Everledger, and online alcohol operators BoozeBud and Kaddy.

In financial circles, a company is often referred to as a zombie if it can't service its debts or fund its operations out of its earnings. This describes a number of tech companies, which often favour market share growth over profits.

Michael Biercuk of Q-CTRL said there could be a number of ‘zombie’ companies staggering to their demise later this year. Jamila Toderas

But the house of cards can tumble if access to external funding suddenly disappears, as is currently the case for some firms.

Last month, to address the rising number of company insolvencies caused by the rapid increase in interest rates, Productivity Commission chairman Michael Brennan insisted that Australia's well-capitalised financial sector would not hesitate to pull the pin on impaired loans, putting companies across sectors on notice that they would have to find their own ways to survive.

"Overall, it's our view that things will remain mixed for some time to come," says Michael Biercuk, CEO and founder of Quantum Computing control software firm Q-CTRL. The firm recently secured its own position with a $US27.4 million ($39 million) funding round featuring investors ranging from Salesforce Ventures to Australian rugby legend John Eales.

Q-CTRL showed its strength in May by announcing its expansion across Europe, with new offices in Germany and the UK. In the UK it sees opportunities coming out of the AUKUS trilateral security partnership, specifically in quantum sensing.

"It's our fear that there are likely a number of zombie companies that have failed to raise in 2022 and may have six months or less of capital runway remaining," Biercuk says.

"In quantum, we’ve already seen some global start-ups go through massive lay-off rounds; if a number of them carry on without substantial capital injections, it may be quite a nasty second half of the year, with high-profile closures and bargain-basement acquisitions."

The potential for merger and acquisition activity is already playing out as stronger tech companies take advantage of their robust balance sheets to take out rivals or add new products and customers quickly.

Last month, Queensland-based corporate training online marketplace Go1 raised a funding round at an increased valuation to fund a $100 million acquisition of a popular German company called Blinkist, while highly backed restaurant ordering app Mr Yum was revealed to be in merger talks with an Australian rival Me&U.

Mr Yum's co-founder and chief operating officer, Adrian Osman, says he thinks it is an impossible task to pick the exact bottom of markets, and that even as inflation eases and interest rates stop climbing, it is unlikely that money will become cheap again any time soon.

"We’re seeing tech companies self-organise into two cohorts: those that can be ‘default alive’ or don't require external capital to be profitable, and those that cannot," he says.

"While it is harder and may become increasingly difficult for start-ups and VCs to raise funds, it will mean a shorter road to death for those that would have likely otherwise failed anyway."

— Andrea Gardiner, Jelix Ventures.

"In the coming 12 months, we’ll see the first cohort making the most of bad times; scaling more creatively and efficiently than ever, raising capital – albeit at more humble valuation multiples – and potentially making strategic acquisitions."

Biercuk says this divide between strong and weak start-ups and scale-ups will provide governments with a difficult conundrum when considering any measures to support the sector.

The Australian government is in the early stages of deploying a $1 billion portion of the $15 billion National Reconstruction Fund to support the growth of critical technologies in Australia. Quantum computing has already been called out as an area of focus by Industry and Science Minister Ed Husic, who unveiled a new national quantum computing strategy in May.

Biercuk, however, says the government needs to exercise caution when faced with the potential of high-profile "critical technology" start-ups running out of cash.

"Governments should be cautious to ensure that they don't throw good money after bad," Biercuk says.

"They will be wise to target business support for those suffering under global macroeconomic conditions, but otherwise delivering high-impact technology at a rapid pace. Start-ups with years of heavy marketing and capital expenditure and little to show for it shouldn't be the beneficiaries of the sunk-cost fallacy.

"In our view, it's a time for careful and considered investment in key areas that maximise returns and ensure true business growth. The strong [and careful] will survive, and our sector will likely be better off for it."

Deaker says it is already clear that there are many small companies in the Australian market that will not be able to raise fresh capital, and that this is presenting opportunities for other companies, including in her portfolio.

Andrea Gardiner of Jelix Ventures says investment in early stage start-ups should continue during tough market conditions. Dominic Lorrimer

"This is an opportunity for those cashed up and at a slightly later stage. For example, one of our portfolio companies is looking at one small acquisition to bring in a new product and two hires," she says.

Although this may sound gloomy for aspiring entrepreneurs contemplating the beginning of their start-up journey, investors at the very early stage say there will still be capital available for aspirational companies.

The risk in writing smaller cheques to help kickstart a company that could come into its own by the time the markets pick back up again, remains a tantalising prospect for seed stage and some investors.

Last month, US-based venture studio Atomic closed on $US320 million to start building up to 60 new start-ups from scratch, and European early-stage investor Seedcamp closed a €166 million ($270 million) fund.

Meanwhile, in Australia, seed stage investors including RealVC and Jelix Ventures have kept the cheques flowing, despite the broader market gloom.

"I am not sure that there is a tech cycle, there are certainly economic cycles and high interest rates have been pushing asset values down … [but] at Jelix, our investment cadence has not faltered, as we know that some of the best investments are made in economic downturns," Jelix Ventures’ founder and CEO Andrea Gardiner says.

"I am unconvinced that we have hit the bottom of the economic cycle. I hope it will be a softer landing than the GFC for example, but I would not be at all surprised if it is not. However, as an investor, I think this represents an opportunity," she says.

She says there is definitely consternation in VC firms that backed later stage start-ups or scale-ups around 2021. The concern is about falling valuations and the risk to their eventual returns to investors.

She says the local venture capital industry was taught a valuable lesson about throwing too much cash at rapid market share expansion during periods of low interest rates, and had adjusted its sights to exercise more caution.

"In some respects, the tougher market is good for the start-up sector," Gardiner says.

"While it is harder and may become increasingly difficult for start-ups and VCs to raise funds, it will mean a shorter road to death for those that would have likely otherwise failed anyway, so less cost.

"Investments are being made with more discipline, so hopefully that means they are more likely to generate returns for investors to encourage them to keep investing in our start-up sector. And that is a good thing because it is critical for economic growth and the future for our kids."

Follow the topics, people and companies that matter to you.

Fetching latest articles