Inflation recently reached 6.1 per cent (for the year to end-June) in Australia, the highest rate in 19 years, and it is likely to get worse. Inflation is bad news for many businesses. Rising raw material and wage costs means profit margins often shrink. Borrowed capital becomes more expensive as interest rates rise. The real value of investors’ assets declines, as the money they are paid back in the future has less value.
University deeptech start-ups are immune to most of these pressures.
Deeptech startups are typically all-equity funded, so interest rate increases do not directly increase their costs. They raise funds at a low valuation until their technical uncertainty is resolved at scale. At that point they become an industrial business, with a monopoly because of their patented technology, the valuation suddenly rises dramatically. This unique position means they can then readily pass on cost increases to customers at this point. In addition, they are R&D heavy, intellectual property-based businesses, with low commodity-input intensities. As such, the input costs embodied in their cost of goods sold may not change greatly with inflation.
Stoic Asset Management and its venture capital partner (Stoic Venture Capital) have a portfolio of companies that is entirely university spinouts. None are significantly affected by the recent rapid increase in inflation and interest rates. Their valuations have remained low over the medium term, as they gradually progress through technical uncertainty milestones, and these valuations have not fallen dramatically like the later stage software companies such as Canva and Klarna who have been in the press lately.
Deeptech is often perceived as being on the riskier side of investing options because of the complex technologies that can fail even at later stages of development. However, deeptech is less risky in other ways, such as the impact of macroeconomic factors like inflation. Low technical risk companies, for instance in fintech sectors such as Buy Now, Pay Later, have seen valuations sink on the fear of rising default rates from recession and high interest rates (eg Sezzle and Zip), deeptech start-ups are not affected by these macro factors.
Deeptech venture capital funds should be part of a balanced portfolio. Deeptech investment is a long-term play, but it is resilient to macroeconomic factors. This is in addition to the diversification and superior returns of the top venture capital fund managers.
