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Aussie VC Supply & Demand vs. Interest Rates

Writer's picture: Warwick DonaldsonWarwick Donaldson

Updated: Jan 16

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.

Australian "Venture Capital" Google Search Trend Data
Australian "Venture Capital" Google Search Trend Data

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 year 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.

Australian "Venture Capital" Google Search Trend Data vs 10 yr US Treasury Yield
Australian "Venture Capital" Google Search Trend Data vs 10 yr US Treasury Yield

The relationship is more subdued with Aussie 10 yr Govt yields (r = 0.25).


Australian "Venture Capital" Google Search Trend Data vs 10 yr Aus Govt Yield
Australian "Venture Capital" Google Search Trend Data vs 10 yr Aus Govt Yield

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%.

Australia vs. U.S "Venture Capital" Google Search Trend Data
Australia vs. U.S "Venture Capital" Google Search Trend Data

And this is what U.S VC demand, Aus VC demand and U.S 10 yr yields look like.

Australia vs. U.S "Venture Capital" Google Search Trend Data vs. 10 yrs US Treasuries
Australia vs. U.S "Venture Capital" Google Search Trend Data vs. 10 yrs US Treasuries

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.

Aus vs. US vs. 10 yr Treasuries
Aus vs. US vs. 10 yr Treasuries

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.


Australian VC Supply vs. 10yr US Treasury (Source: AIC Yearbook 2022)
Australian VC Supply vs. 10yr US Treasury (Source: AIC Yearbook 2022)

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.


 

A massive thanks to those who generously proof read and offered feedback on this article.

 

Disclaimer: Excentricity Pty Ltd, trading as CapXcentric (ABN 42 679 978 959, AFS Representative No. 001311296) is a Corporate Authorised Representative of True Oak Investments Pty Ltd (ABN 81 002558 956, AFSL 238184). The information provided in this article is intended for companies and startups and is not directed towards investors. Any statements or representations are general information only and do not take into account your personal objectives, financial situation or needs. Readers are advised to have regard to their own circumstances and consider seeking specific advice from a professional adviser before making any business decisions. No representations are made as to the accuracy, completeness, or reliability of any information provided in this article. Readers use the information provided at their own risk.

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Excentricity Pty Ltd, trading as CapXcentric (ABN 42 679 978 959, AFS Representative No. 001311296) is a Corporate Authorised Representative of True Oak Investments Pty Ltd (ABN 81 002558 956, AFSL 238184). Any information about the financial products and financial services available from or through CapXcentric on this website is general information only and does not take into account your personal objectives, financial situation or needs. Please have regard to your own circumstances and consider seeking specific advice from your professional advisers. 

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