New normal for early funding in infotech is actually the old normal

With interest rates high and investors averse to risk, the post-pandemic boom in funding for tech startups is officially over.

Early-stage funding for information technology companies in the US and Canada raised $850.0 million in the third quarter, according to S&P Global Market Intelligence data, marking the first time in more than two years that quarterly funding fell below the 10-figure mark.

Not only was the amount raised down, but so were the number of transactions. The number of early-stage funding transactions in the sector involving private equity or venture capital firms stood at 202 in the quarter ended Sept. 30, down from 228 in the second quarter.

There are a number of factors at play. Perhaps most importantly, the pandemic created demand for technology companies that could help consumers, businesses and enterprises adapt to the new work- and learn-from-home environment. On top of this, interest rates at the time were still low, allowing investors to flood the marketplace with cheap money.

"Many tech companies simply do not need to raise money after the fundraising spree of 2021 and 2022," S&P Global Market Intelligence tech M&A analyst Samantha Tomaszczyk said.

Now that interest rates are higher and the post-pandemic frenzy has waned, investors have taken off their rose-tinted glasses and returned to eyeing early-stage startups more critically.

This has resulted in some nascent companies being "scared off by the prospect of down rounds," Tomaszczyk said, referring to when a startup raises a subsequent round of funding at a lower pre-money valuation than its previous fundraise.

"Plummeting valuations and a lack of fresh capital left startups in the fintech and software segments, in particular, more vulnerable to takeover," she said.

While the $850.0 million raised in the third quarter is low compared with the same quarter a year ago or even two years ago, the figure is actually up from pre-pandemic levels, when quarterly totals were consistently below the $1 billion mark.

Tomaszczyk also noted that early-stage funding has been hit harder than funding in later stages. In particular, she said private equity and venture capital firms have pursued "safer bets," with older and more profitable companies experiencing a less severe drop in investment.

Looking at various funding types within the early stage, the tech sector raised $805.5 million from seed funding during the third quarter, with pre-seed funding contributing $39.0 million, and accelerator funding totaling $3.3 million. Angel funding accounted for just $2.4 million of the total, while crowdfunding did not contribute to the amount raised during the quarter.

As to which startups were able to attract investment, Upwind Security Inc. raised the highest amount of early-stage funding in the third quarter. The cloud software company received $50.0 million by selling 4,577,102 series seed-1 preferred stock at about $10.92 each.

Upwind was founded by the team that built Spot.io, which was ultimately acquired by cloud data services company NetApp Inc. in 2020 for $450 million. The fact that Upwind's leadership team was able to build a cloud infrastructure business and sell it was a major factor in attracting investors.

Year-to-date, Poolside, an AI company specializing in software and code development, secured the highest early-stage investment among IT companies. The company secured total gross proceeds of $126.0 million from a consortium of private equity investors.

Passwordless authentication startup Descope Inc. ranked second, having raised $53.0 million in a round of funding in February.