Do we give our most ambitious startups enough runway?

Failure is a fact of startup life according to Startup Genome, which analyses the global startup ecosystem and has found that 90 percent of startups fail. Around 1.5 percent of startups go on to have a big exit valued at US$50 million or more.

Those are daunting odds. Statistics on startup failures in New Zealand are difficult to come by beyond the generic Stats NZ business survival figures.

‍However startup industry figures say the Startup Genome research probably holds fast here when you take into account early stage, pre-funded companies, many of which are little more than side hustles. It depends how you define a startup company,” says Lance Wiggs, co-founder of the $100 million Punakaiki Fund, and a partner of the Climate VC Fund.

Punakaiki bid farewell to one of its investments this year, Melon Health, which sold its operating assets to Christchurch-based Pegasus Health and appointed liquidators in March. Wiggs described another company in the 17-strong Punakaiki stable as being “quietly in zombie mode”.

“Our valuations were flat this year, but we will take the win because the average listed investment company is down 15 percent in the last 12 months,” says Wiggs.

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Economic headwinds hit startup funding

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Last year was particularly tough as global startup funding dropped by 34 percent. The faltering economy hit investor confidence, and inflation and rising interest rates made investment capital more expensive to secure. According to survey data on startup failures in 2022 from CB Insights and invoicing software maker Skynova, a lack of financing/investors, closely followed by running out of cash, were the two key reasons cited for startup failure.

Grocery startup Supie went into liquidation in November with debts of $2.1 million, and founder Sarah Balle’s dreams of making a dent in the grocery duopoly held by Foodstuffs and Woolworths have gone unrealised. Despite the daunting statistics, many in the business community took the failure hard, disheartened that a talented entrepreneur with a worthy goal had fallen after a promising start.

While Supie attracted investment from Icehouse Ventures, it is understood prospective angel investor Kirsty Reynolds pulled the plug on doing so in late October after she was informed that Supie had negative net assets of $1.7 million. 

She assessed that there wasn’t sufficient appetite among investors to refinance the company given that Supie’s margins were in negative territory and only 3,500 of its members were now active subscribers. This suggested any new funders would have to wear sustained losses in a bid to turn things around. Questions linger around whether Supie was ever sufficiently capitalised to undertake its mammoth task of going up against two entrenched incumbents. 

In early December space startup Argo Navis also went into liquidation after having raised over $2 million in seed money. The company was developing upper stage rocket engines for use by rocket launch providers and appears to have run out of cash.

There are no official figures available in New Zealand on how many startups are likely to struggle with the capital runway they have left but some have given guesstimates.

Rob Vickery, founder of Hillfarrance Venture Capital, posted on LinkedIn this week that based on his stats and observations of the local startup market, he estimates around half of seed-stage companies in New Zealand will be out of money and attempting to raise new rounds in the second and third quarters of 2024.

He says too many companies raised too much capital at too high a valuation and didn't use the money raised to build sustainable foundations.

"The splurge of startup venture capital from 2020 to mid-2022, coupled with first-time fund managers who deployed too early without reserves, is a dangerous cocktail starting to create a hangover," he says.

"With an increasing risk-adverse VC and angel community, if a startup hasn't hit high six-figure revenue levels generated from triple-digit month-on-month growth, funding will be hard to come by."

His advice to startup founders is to get your accountants and investors to agree on a sustainable but reduced cash burn, plan initiatives to retain and grow your sales, engage your cap table regularly and challenge your investors for connections and ideas. He also says Kiwis have to get comfortable with failure.

"I know New Zealand culture makes this hard, but doing the right thing might be starting again, especially if you have done everything in your power to try and fix it."

Wiggs says many startups can weather tough funding environments if they are still able to demonstrate customer and revenue growth. 

“Xero raised money in good times and bad times, but the growth rate just kept on going, which gave them a war chest to get them through,” he says.

“Overall, New Zealand companies get it. They're not super spendy and the conversations we have, I suspect, are a lot more mature than the ones they’ve been having over the last year in the States, where companies may have been used to spending millions a month and suddenly have, say, two months of runway left.”

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Big brand play, big capital needs

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The funding runway available, timelines, and the advice given by directors and investors as the worm began to turn on Supie will no doubt receive attention in due course. But Suse Reynolds, an investor in numerous startups and executive chair at the Angel Association New Zealand, warns against drawing any conclusions from the Supie failure about our startup ecosystem in general.

“I know some of the players well enough to know that they gave it every fibre of their being,” says Reynolds, who is no relation to Supie’s angel backer Kirsty Reynolds.

Business to consumer startups like Supie – big brand plays that can require a relatively high level of working capital – are not the norm for our startup ecosystem. 

Reynolds says startup investors are realistic about how much funding runway a business needs to get off the ground, but that we just don’t have deep enough pockets to back some ambitious ventures in a small market. 

“Expectations are a little misaligned with the degree of wealth and capacity we have to invest in things like infrastructure and startups,” she points out.

“We have a lovely lifestyle, but we are not a wealthy country. It's safe to say that New Zealand startups are in the main undercapitalised for that reason, because we're not wealthy.”

The recent Upstart Nation report from the Startup Council, which Reynolds deputy chairs, pointed out these structural and capital challenges. Among the report’s recommendations were contributing a further $500 million in capital to the Government's NZGCP Elevate programme to stimulate venture investment, and introducing tax incentives to promote investment in ‘UpStarts’ and venture funds.

There are no firm signs that the new National-led coalition government is committed to either, but we certainly have a new administration considered more friendly to business and the startup community than its predecessor.  

“We are also still relatively new to this whole gig,” says Reynolds. “We are around 15 years into building a startup ecosystem and it takes time to build the flywheel in terms of recycled capital, recycled talent, all of that kind of stuff – probably closer to 30 years.”

It means that startups learn to be “super efficient” with the capital they do lay their hands on, which has served the ecosystem well, adds Reynolds.

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Fear of failure

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While startup failure is normal and even healthy, it's also tougher in a small country where we are so tightly networked.

“When you bump into somebody who's put $50,000 into your startup and it didn't fire and for whatever reason, it still stings, it still hurts,” says Reynolds.

“I do think there is an obligation on all of us in this space to be a bit more realistic, particularly in a New Zealand context, about how long these things are going to take to get to liquidity, to get to that value inflection point.”

The conventional wisdom is that 90 percent of an early-stage investor's returns come from 10 percent of their investments - implicit in that is a swathe of failure.

"The other oft-stated wisdom is that in any portfolio of ten investments, half will fail completely, another three or four will return your money (and hopefully a bit more), and one will be the home run … 10-30x your money back or an IRR (internal rate of return) of north of 25%," Reynolds says.

"Angels and venture investors are looking for outsized value creation and returns, otherwise the endeavor is not sustainable and doesn’t make sense. Given the degree of risk, the returns have to be big. Typically about half of an angel’s investments will make it to sustainability."

Incumbent challengers here – like internet and phone service providers CallPlus and ihug that went up against Telecom’s monopoly in the late 1990s – have typically carved out a tenuous toehold, stayed lean and funded growth off revenue. It led, in both those cases, to sizeable exits, but after a decade or more of hard slog. Regulatory concessions were crucial to giving them access to Telecom’s network at sustainable prices.

“Customer revenue is the cheapest form of capital you can access,” says Reynolds. “So Kiwi startups are pretty mesmerised by generating that kind of value as quickly as they can.”

If consumer-oriented businesses are hard going, it can be even more intense in the world of deeptech. It’s currently the fastest-growing sector for early-stage investment, but one associated with high risk and significant capital requirements. 

Outset Ventures partner Angus Blair this year led a $10 million seed investment in what is arguably the country’s most ambitious startup, OpenStar Technologies, which is developing a nuclear fusion reactor with the aim of creating perpetual, clean energy.

“We had a very ambitious milestone to hit within 12 months, and 18 months cash in the bank, but also a really supportive cohort of investors in that syndicate as well,” says Blair.

Icehouse Ventures and Blackbird also contributed to the seed funding round.

“The most ambitious companies also have the most capital formation risk. That's why I spend a large amount of my time supporting the company.”

Blair says that in VC investing, experience in the well-established US market shows that a third to half of a portfolio of companies are expected to return less than 1x the sum invested.

“If I was to guess, New Zealand isn’t fast enough to fail on venture/angel-backed companies because my sense is certainly that it’s a much lower shut-down rate,” he says. 

“It’s also more normal to ‘put a company into hibernation’ rather than liquidation if it’s being managed appropriately and there’s a vision for either a ‘phoenix' or an intellectual property sale. 

Outset has one company in that position, with a $0 valuation on the firm’s books and with founders continuing to work on it around their day jobs.

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18 months’ runway

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Blair says he typically won’t invest in a business unless there’s sufficient capital available to give it an 18-month runway. He also doesn’t factor in any grant money the startup is expecting to receive.

“Then I’m working to a plan where the value inflection is going to happen in 12 months. That’s a 12-month R&D plan with 18 months of cash; that's basically your minimum round that you can get away with,” he says.

Companies attracting a lot of interest may be lucky enough to secure a 24-month deal, but in the current constrained funding environment, Blair has seen startups “pivot their approach”, extending their runway from 18 to 24 months in the process, usually by reducing the size of the team.

Blair says deeptech has been less susceptible to the “poor pricing discipline” that plagued the SaaS sector when cash was cheap and hype was high. It’s always been a tough path when fundamental physics or chemistry are involved and “Mother Nature can say no”, he points out.

“Funds are getting away, but they're just not getting away at the large sizes that they did a couple of years ago, so that will decrease appetite in New Zealand,” adds Blair.

“I feel like the bottom is in, it's just a matter of how long we're going to drag along the seafloor. It’s still really hard to survive. The average seed fund in the US that’s going from fund one to fund two has a 70 percent death rate.” 

Angus Blair’s five funding tips for founders 

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1. How much is enough? Be very clear with prospective funders (and yourself) about how much capital you think you need to reach the milestones that will allow you to attract further funding. 

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“The mistake you can make is when you can't raise that amount of capital right now, but you agree to take some anyway and it's not enough,” says Blair. “If the price is too high and the capital requirements too high, the company is not going to get its investment. That might mean you shouldn't do the company.”

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2. Understand your customer. Scaling an engineering- or science-based startup is challenging and might require more capital than originally envisaged, but you should be constantly learning about your customers along the way.

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“If you're halfway through your runway and you don't have an idea about how you're going to reduce the technical risk on your project, then you haven't been doing enough work understanding your customer well enough.”

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3. Take advice from your investors. Whether you have angels or a VC firm investing, they’ve likely done this before. Draw on their knowledge to finetune your estimates for capital requirements. “Part of a sophisticated investor’s job is to assess the use of funds and determine how realistic it is and how much buffer there needs to be.”

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4. Streamline if required. Progress towards technical and business goals can be uneven, with inevitable setbacks. The key is to constantly evaluate progress and adjust as necessary. “If you're 18 months in and you're not making progress, that’s a real problem. What you can and should do ahead of time is streamline the team and refocus.”

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“If you do need to go forward with a smaller team, it's better to do that earlier rather than later. The earlier you do it, the longer your runway gets extended.”

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5. Seek helping hands. Establish whether your funders have the capacity to help out financially if unforeseen events put a temporary strain on finances. Bridging finance and SAFE notes are potential avenues to explore with funders. “If you've got existing shareholders that are able to provide bridging capital, that can be an important part of managing risk.”

Failure is a fact of startup life according to the Startup Genome, which analyses the global startup ecosystem and has found that 90 percent of startups fail. Around 1.5 percent of startups go on to have a big exit valued at US$50 million or more.