Aussie VC Supply & Demand vs. Interest Rates
Volatility is impacting VC supply and demand globally
**2024 Update: I now publish Aussie capital raising content on Substack here **
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TL;DR — As interest rates continue to rise on the back of global volatility, it is likely to get more difficult for founders and VCs to raise funding. Hopefully, this isn’t a surprise to anyone!
It’s no secret that the tech capital markets have had it rough lately. I can’t remember the last time I saw a large tech IPO and we all know that early-stage venture capital is off from its 2021 peak.
However, VCs are still raising new funds. A rough count puts fresh Aussie VC fund commitments at about $2b calendar year-to-date (vs. $2.7b in 2020 and $500m in 2021). But interest rates are soaring. This doesn’t make sense.
This got me thinking, what is the relationship between interest rates and venture capital supply and demand?!
As it turns out, there appears to be a few relationships worth talking about.
VC Supply & Demand vs. Interest Rates
In researching this topic, I discovered a paper by Cristiano Bellavitis and Natalia Matanova (2017) titled “Do Interest Rates Affect VC Fundraising and Investment?”.
This is what they discovered:
- As interest rates rise, debt (personal + commercial) becomes relatively more expensive thus resulting in greater demand for venture capital (founders wanting VC) as it is relatively cheaper. A 1% increase in interest rates results in a 2.5% increase in VC demand.
- As interest rates rise, venture capital supply decreases as LPs (VC’s investors) place a larger proportion of their capital elsewhere. A 1% increase in interest rates results in a drop of 3.2% in VC supply.
So, if this finding is correct, there will be less VC funding available in the coming years whilst more companies will seek it out. This will likely have a negative impact on the terms that companies are able to negotiate with investors relative to previous years.
Now, let’s take a look at VC demand.
VC Demand
Due to a lack of internal VC pitch volume data, I’ve had to find a way to approximate VC demand. The previously referenced paper used an interesting methodology to approximate VC demand (VCs wanting venture capital to fund their business), the authors used Google Search Trends for the term “Venture Capital”.
So, I decided to investigate what “Venture Capital” G Search data looks like for Australia, as you can see in the chart below. As predicted, it appears that VC demand is indeed picking up as interest rates rise.
For context, VC demand since Feb-22 is sitting about 27% above the 4 week moving average of the past 5 years.
VC Demand vs. Interest Rates
Off the back of charting VC demand, I had a look to see what relationship it has with the market’s view on interest rates. I used the 10 yr U.S Treasury yield and 10 yr Aus Govt yield as proxies.
Why 10 yr rates?
- 10 years is equivalent to the standard VC fund lock-up period
- 10 year government yields are also a key indicator of investor confidence, the health of the economy and future interest rates.
Surprisingly, the U.S 10 yr tracks remarkably closely to VC demand (r = 0.41), as can be seen below. The U.S 10 yr yield is sitting at around 3.888% at the time of writing this article which is a far cry from the 0.536% in 2020.
The relationship is more subdued with Aussie 10 yr Govt yields (r = 0.25).
U.S VC Demand vs. Australia
So, how does Australia compare with the U.S?
This is what U.S vs. Australian Google Search Trend data for “Venture Capital” looks like. U.S VC demand is sitting 39% higher than its average vs. Australia’s 27%.
And this is what U.S VC demand, Aus VC demand and U.S 10 yr yields look like.
As you can see, Aussie VC demand appears to be relatively lower than the U.S. Without more analysis, it is incredibly difficult to speculate as to why.
Above you can see the difference of change between 10 year Australian and U.S government bond yields over the past 5 years.
VC Supply
Now to VC supply. I define VC supply as fresh LP commitments to new venture funds.
It’s no secret that interest rates heavily influence LPs portfolio allocation, but it is nevertheless interesting to see how closely the two have tracked since 2010 in Australia.
Prior to 2022, the correlation coefficient between the two was -0.66. However, 2022 seems to have challenged previous year’s relationship as we can see that both have risen in tandem which has reduced the correlation coefficient down to -0.43.
2022’s data makes me wonder what influence inflation has and will continue to have on VC supply going forward. I suspect high yielding assets are still important to investors to counter high inflation, but I’ve heard it’s getting harder to raise new funds.
To note — I’m not particularly satisfied with this section’s findings as a few large funds raise in cycles every 2–3 years which I believe may be obfuscating true LP demand/VC supply. In addition, Super funds FUM are constantly growing, and their alts allocations appear to also be increasing. This warrants further research and if time allows, I may write an article on just VC supply as it is a deep topic with plentiful data.
To Wrap Up
The coming years will likely be volatile for both VCs and companies raising capital as this unusual high inflationary and geo-political cocktail plays out.
If this data and findings are correct, then founders will likely see less favourable terms when raising a round compared to previous years and VCs will likely find it harder to raise fresh capital.
I’m the Aussie Startup Capital Nerd… My name is Warwick Donaldson and I specialise in Australian DeepTech and FinTech Seed and Series A capital raisings. To date I’ve worked on over 150 Pre-seed, Seed, and Series A fundraises. Hit me up if you’d like to chat.
A massive thanks to those who generously proof read and offered feedback on this article.
- Albert Patajo who writes about “ deep analysis on startups, venture capital and investing” through the Rare Candy newsletter
- Fred Yu who writes about “investing, analytics to career building” via Seeking Asymmetry blog. Check out this article titled “The Statistcal Nature of Start-up Investing”
- Nick Bishop of Bishop & Fang an independant capital advisory firm in Sydney.
