Survey finds founders 'more accepting of economic challenges' with earlier push to profitability

A survey of Australian founders conducted by law firm Herbert Smith Freehills (HSF) has found resilience and optimism are two prevailing themes in the national startup space, with a greater sense of preparedness amidst recognition that the funding environment continues to be challenging.

A lower proportion of founders than last year felt that current fundraising conditions were more challenging than in 2022 - at 73 per cent compared to 81 per cent - and a strong majority of 91 per cent agreed startups would need to reach profitability earlier.

HSF has pointed to one respondent's comment that "pipeline to profitability is probably the most common phrase with investors at the moment" as illustrative of the current sentiment. 

With 40 respondents, the scale and statistical significance of this survey pales in comparison to that undertaken by Cut Through Venture and Folklore Ventures which canvassed the views of 1,000 startup founders, professional startup investors and angel investors to prepare the State of Australian Startup Funding Report 2023. 

Nonetheless, the findings do offer insight into a potential change in mentality and approach to startup funding in the community. Responses were from startup founders at all stages of the journey, with around 15 per cent at the pre-seed stage and 72 per cent from series seed to pre-initial public offering (IPO).

HSF partner and co-head of venture capital in Australia, Elizabeth Henderson, says founders are now "more accepting of the economic challenges they are facing" and more are pursuing a path to profitability over growth, funded by new capital.

"For many, this pursuit of profit over growth started in early 2022, and we are now seeing a number of companies that have successfully navigated the transition and no longer need to raise as much or as frequently to pursue their scale ambitions," Henderson explains.

HSF’s survey also reflects that for many founders, the path to profitability is a higher priority than seeking an exit.

"The majority of respondents, 79 per cent, said that their company did not intend to pursue a liquidity event in the next 12 months, which likely reflects the greater focus on profitability, as well as respondents’ positive expectations in relation to future capital raising," Henderson says.

"It may also indicate that there is not yet a meeting of minds on trade sale valuations, and reflects the pause in the IPO market both in Australia and the US."

In a sign of positivity for the sector, 74 per cent of founders surveyed expect to raise capital within the next 12 months, and not just to bridge - only 38 per cent stated that their company will look at a bridging round before its next series or priced round.

Henderson's fellow co-head of venture capital in Australia, Claire Thompson, points to a significant number of bridging rounds over the past two years.

"But the data suggests that founders no longer expect their next raise to be a bridge. The majority of founders surveyed are looking to raise, and they are expecting to undertake priced rounds," Thompson says.

"This may reflect an acceptance that investors will be looking for some certainty on the cap table as these companies mature and move past the valuation uncertainty over the past two years."

While most respondents expect their next raise to be above their last post-money valuation, there was still a degree of uncertainty among the respondents when it came to valuations. More than a third of respondents stated that they were unsure about valuation or expecting a down round.

"Founders’ expectations on valuation were more measured than expectations on raising, with 61 per cent agreeing that they were confident that their company’s next raise will be above its last post-money valuation. This reflects an acceptance of 'new normal' fundraising environment," Thompson adds.

HSF partner Clayton James predicts that for founders with profitable startups, 2024 will be a year for secondaries.

"For the companies that have successfully navigated the pivot to profitability, there have been fewer opportunities for liquidity. This has resulted in a number of companies in the Australian ecosystem with early investors and employees sitting on significant positions they may wish to crystallise, and investors looking for opportunities to get in," James says.

"Accordingly, we expect to see some significant secondary transactions in the next 12 months, and recent deals involving Canva and Employment Hero have shown a clear appetite for these transactions”.

James further predicts that 2024 will see a growing pipeline of deals.

“The majority of founders we surveyed still intend to raise in the next 12 months. Anecdotally, we are seeing a busy start to the year, particularly at the seed and series A stage and in key sub-sectors including enterprise SaaS, climatetech and AI.

“Most importantly, founders remain hopeful - 62 per cent of founders in our survey feel optimistic about the long-term prospects for Australian startups.

"Overall, we continue to see a level of confidence, one that is tempered by a recognition of the new paradigm in the Australian VC ecosystem."

HSF is the pre-eminent venture capital law firm in Australia, and one of the leading VC firms in Asia Pacific, advising on more VC transactions for more clients than any other Australian law firm, including some of Australia’s most high-profile tech companies. Startups and scale-ups it has either advised directly or indirectly via investors include Linktree, Harrison.ai, Netwealth (ASX: NWL), Archistar, and numerous other high-profile names in the Australian business community.