Riding the Cybersecurity Investment Wave

The Current Economic Climate Shapes Funding Opportunities in Q1 2023 but Investors remains positive for Cyber Security.

May 08, 2023

State of the Cybersecurity Financials

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For this week, I wanted to share some perspectives and data on the investor market in 2023. Starting by putting numbers into the worldwide economic perspectives, I will then zoom on the VC Q1 2023 market and, in particular, what it means for cybersecurity companies.

A very particular worldwide economic context

The cybersecurity financial market is not immune to the overall financial market. Due to the pandemic, there is a zero-interest rate policy in place. Moreover, the war between Ukraine and Russia created a significant crisis in the energy market and reinforced the supply chain issues between Western countries and their Eastern suppliers. It is fair to say that since 2019, there has been no peaceful year.

The economic impacts of these crises are numerous :

The zero-interest rate policies of the central banks probably lasted too long. Coupled with supply chain issues, it created a significant inflation problem worldwide.
As money was free, we saw an increase in VC-backed company valuation.
Still, the growth of these companies follows a standard pattern for most of them. As a result, the ratio between enterprise value and turnover (or ARR) skyrocketed.

Cybersecurity was not immune to these phenomena. As you can see in the graphics below, provided by Finerva and SEG, the valuation of established public cybersecurity companies relative to their sales is decreasing. The ratio is coming back to the pre-pandemics balance.

The rush is over

As the market shifts, investors are more cautious about where they invest. Pitchbook, leveraging its database, reports that the mega deals - deals over 100M$ - which happened between 2020 and 2022 for excellent companies are likely to be very rare.

Cybersecurity is still a growing concern and a fast-growing market. New and innovative solutions are needed to cover the latest threats and defend against an ever-growing criminal cyber industry.

Still, it is a good thing that the valuation of companies is linked to their sales and growth. It will prevent the “gold rush” phenomena and help build a sustainable industry.

Wait, is it a new funding winter?

The question is legitimate. We are still determining what will happen as we speak (May 2023).

Many predict a significant recession in 2023 and 2024, probably reducing funding availability. This will significantly limit the large deals for later-stage startups that have built their success on inefficient, high cash-burn practices such as high salaries, big marketing budgets, and international operations without associated revenues.

Despite this downturn in the venture capital market, seed-stage funding has remained strong. Investors are optimistic about the potential of higher-quality companies, and many small funds are bolstering seed-stage activity. According to PitchBook, seed companies' median US deal size in Q1 of 2023 was $3 million, representing an increase from the $2.6 million median in 2022. Additionally, median pre-valuation for US seed-stage startups has increased, with Q1 2023 reaching $13 million compared to a median of $10.5 million in the previous year.

The following graphics highlight it.

The same trends can be observed regarding cybersecurity.

Crunbase reports alongside the above chart that although 2021 and 2022 experienced anomalous fundraising trends, the first half of last year still saw significant investment despite investor pullback.

If current trends continue, the total amount of funding raised by cybersecurity startups this year 23 will surpass the less than $10 billion raised in 2020. The market is still growing, as cybersecurity remains one of the few sectors where investors continue to invest.

Europe's cybersecurity ecosystem remains strong.

While the overall venture capital market is shifting, the cybersecurity investment market, particularly in Europe, remains strong. According to Axeleo Capital, cybersecurity is still a key topic for investment. In their latest European Cybersecurity Q1 2023 Index, they provide some interesting perspectives.

Following the trend of the last quarter of 2022, Q1-23 saw high activity in European cybersecurity investments. While the number of deals decreased slightly compared to the previous quarter, dropping from 41 to 38, the total amount of money raised was 408M€.

The table below provides a split per country of the number of deals in Q1 2023.

Mergers and acquisitions (M&A) operations also suffered setbacks.

Lastly, the mergers and acquisitions market is currently on pause. According to Crunchbase reports, there has been a decrease in M&A operations, with strategic buyers less eager to purchase cybersecurity companies.

The following chart displays this trend.

The two large deals for the quarter were:

In March, Cisco acquired Lightspin, a Kubernetes security firm based in Israel, for $200 million.
Rapid7 bought Minerva Labs, an Israel-based endpoint security startup, for approximately $38 million in cash and stock last month.

Conclusion

To summarize, the worldwide economic context has impacted the cybersecurity financial market, with valuations of established companies returning to pre-pandemic levels. However, Europe's cybersecurity ecosystem remains strong, with high investment activity in Q1 2023. There is also a shift in investor focus towards seed-stage funding, with large deals becoming rarer.

Despite recent decreases in cyber M&A and funding, the cybersecurity sector remains strong and attracts investor interest. Investors believe that more innovative solutions are needed to address the latest threats and defend against a growing criminal industry, making it a promising area for investment. Cyber Builders should remain positive, as cybersecurity is one of the few sectors that has not seen a significant drop in funding.

It remains to be seen how these trends will continue to evolve in the coming months and years. I'd like you to read more from the reference websites I used (link below).

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