Why aren’t there more Startup Studios in Australia?
We recently published a Startup Studio 101 post for those interested in learning more about the Startup Studio model.
In that post we outlined a number of reasons why Studios are a growing and successful model of startup incubation.
But if Startup Studios are so awesome, and the model has been around for longer than the seed accelerator model, why are there so few of them in Australia?
Below are 3 reasons we believe have had a material impact on the lack of sustainable Studio formation in Australia, noting that there have been many orgs that have played with the model but very few that remain.
I’m keeping the description of these issues short as our goal for these posts, at least for now, is to introduce the Studio model. Later on we’ll dig deeper and try to tackle what are in some cases quite complex issues.
PROBLEM 1: Lack of experienced founders to run Studios.
Successful studios are typically run by experienced founders who have had success with multiple startups and, quite simply, there aren’t many of those in Australia at the moment.
Multiple successes matter because they suggest a way of thinking and processes for building tech companies that transcend specific industries, problem sets or moments in time — a perfect match for the Studio approach.
Part of the reason there is a lack of serial successful founders is that we’re relatively early in the startup industry cycle so there simply hasn’t been time to produce many of these rare founders.
Another reason is that it’s hard to build one successful company, let alone more than one. For instance, 25Fifteen co-founder Luke Carruthers had 5 startup exits under his belt (the largest, Inter Touch, which sold to NTT Docomo for ~$100M) before we started 25Fifteen. He also had a bunch of failed businesses and the associated learnings to draw from. How many founders are there in AU with a similar track record — or even a track record of being deeply involved in the building of more than one successful business alongside multiple failures?
PROBLEM 2: Lack of funding options.
While both Studios and VCs are looking to build a portfolio of successful businesses, the Studio model doesn’t align well with the traditional VC model of 2% management fee and 20% carry.
The primary reason is that the costs of being deeply operationally involved in building businesses typically far exceed the 2% management fee.
Another reason is that traditional funds (VC or earlier stage) seek exposure to a large portfolio of potentially large winners, each with the ability to return most, or all of, the fund. As you start to build out the size of the portfolio to create the diversity needed to provide those venture returns, you lose the ability to stay deeply involved in the building of those businesses.
As such, Studios have sought different ways to fund their activities until they achieve enough returns from exits to cover costs long-term.
Some Studios (typically formed out of agencies) have tried generating operational cashflow through services and using that income to fund internal teams that experiment with new businesses. This rarely works though. Service and product businesses require different skillsets, and the allure of regular revenue today, as opposed to lumpy (possible) returns in 3–10 years, often ends up starving the Studio business of the attention it needs.
A far more common approach is for Studios to demonstrate some success then have funds attached so that they can both build and invest in businesses. To get to that point they often start by taking investment directly into the Studio then covering operating and investment costs off the balance sheet.
Unfortunately, that hasn’t really been an option in Australia.
Core to this is that there is still a relatively small pool of capital as a % of GDP, and a large concentration of funds in a few firms. This results in a typical long-tail distribution. The graphs below show this in pictures:
NB: Both Brandon Capital and GBS Venture Partners are life sciences focused funds which can be reasonably excluded for the purposes of this post.
The net effect of the relatively small amount of competition for larger institutional investors is that investors stick with familiar investment approaches — existing high growth, proven founders, international from day one — rather than having to explore less common models for unique deal flow. It’s hard to blame them for that, and I’m sure investors in more mature startup markets would love to have that dynamic. For now though, it’s generally how things are in Australia.
To be fair, investing in a Studio presents some issues for traditional venture economics. Returns would come as dividends from successful portfolio exits as opposed to an ROI on the investment into the Studio itself (I can’t think of an example of a venture funded Studio that was acquired which might provide some sort of social proof of goodness of fit for the direct-investment approach — though there may be one I’m unaware of).
Sometimes a way around that is the creation of a fund attached to the Studio, deployed by the Studio itself. Having other investors invest in that fund, rather than Studio itself raising the fund, is problematic though. Almost all local VCs are unable to invest into other funds due to restrictions imposed by the tax-effective ESVCLP fund structure which dominates in Australia.
There are work-arounds, and it’s refreshing that we’re starting to have conversations with investors about how those work-arounds might supplement their investment models e.g. by giving them access to options to invest at a later stage.
There’s also the possibility that some of the money recently announced to be coming out of accelerators and other early stage incubation models might go into Studios — though we’d rather see the funding pool increase than a zero sum game of take from this model to give to that one.
Either way, the funding problem for Studios will remain until there’s increased awareness of the model and the ways that Studios and venture funds can complement each other.
PROBLEM 3: Lack of a sophisticated and active tech M&A market in Australia.
Tech M&A activity matters to Studios. That’s not because we want to build companies that focus only on the Australian market and Australian exits, but because there’s leverage available in being able to recycle capital, staff, and learnings. This is especially true when you don’t have management fees to sustain you as you do across the 10-year lifetime of the average fund. Early on, that leverage relies on smaller, more frequent exits, typically through trade sales.
Below is an overview of the Tech M&A activity in Australia over the past 12 months, based on data from BDO’s quarterly Technology M&A reports.
- Total Australian Tech M&A Deals: 54
- Total with publicly available information: 16
Of those 16, 6 aren’t relevant to the startup M&A conversation:
- 2 (MYOB & PEXA) were PE deals — 12.5%
- 4 were tech-related services businesses — 25%
Of the remaining 10
- 6 exited for between $5 and $40M — 37.5%
- 4 exited for over $40M (the highest $339M) — 25%
I’ve created that demarcation at $40M to try and distinguish between growth stage startups and those that have scaled — as growth stage businesses tend to provide Studios with earlier exits they seek in some cases and there are typically other exit options for scale stage startups.
Assuming that $40M demarcation is good for now, and using the known numbers to try and estimate the total number of M&A deals relevant to Studios we can guesstimate that:
There were approximately 20 growth stage tech M&A exits in Australia over the past 12 months from the pool of thousands of operating startups.
This needs to improve if the local ecosystem is going to sustain more Studios in the future
The above are brief explanations of just 3 reasons why Studios aren’t more prevalent in AU. They aren’t insurmountable and with more time and more education the hope is that we can overcome these in the near future.
In a future post we’ll talk about ways that we might be able to do that.
