How to build a sustainable venture capital industry in Australia

Everyday, there are a tonne of opinion pieces written about what is lacking from Australia’s startup ecosystem. So much so that it’s easy to be confused about what we really need. Who do we listen to? Who does government listen to? Is it broken Employee Share Ownership legislation? Is it a culture of risk-averse venture capitalists? Is it an overall lack of capital in the ecosystem? The reality is that there are a lot of things lacking — first and foremost an actual blueprint for how we can build a sustainable industry around venture capital.

The foundations

To build a venture capital industry, certain foundations need to be in place, namely a solid and supportive regulatory environment and skills. Arguably, Australia has both. We rank in the top 10 on the World Bank’s ease of doing business index despite the fact that there are some things we need to do better. Employee share schemes, for example, are seriously broken and despite the rhetoric, nothing of any substance has been done to rectify the situation. Government is also distracted with Crowdsourced Equity Funding (CSEF), which I don't believe is the right priority at this stage. Overall though, Australia is a pretty easy place to setup and manage a company.

On the skills side, we definitely have a big issue around the take up of education in STEM subjects. In a time, where one of the coolest jobs in the US is to be become a “hacker”, I'm still shocked to hear that Australian kids think technology is “nerdy” — apparently, they are immune to the Zuckerberg-effect. This one will take time, and we absolutely have to fix it, but in the meantime, we do excel in two other areas import to startups: Design and Business. We have monumental talent in these two areas and in the short-term we need to be tapping it to plug the gap. Programs like Disrupt@Scale (which is backed by Mirin Capital in partnership with BlueChilli) aim to do this, and we need more of them. Disrupt@Scale is not tailored to Technical founders. It’s tailored to first time Entrepreneurs who can go on to solve real problems if they have support on the technical side. Of course, non-technical founders can always outsource development, but it is (without a doubt) exponentially better to have a tech team that also has skin in the game.

The early stages

So we have the foundations for venture capital and the capability to create companies. That’s a good start, but these companies need a lot of support in their early stages, which comes from Mentorship and Investors. There is no shortage of startup mentors in Australia, with nearly half of Australian startups having at least one mentor according to Startup Muster. Co-working spaces in Australia have taken off and, despite the debate in Silicon Valley on their effectiveness, for Australian entrepreneurs they provide tremendous value in terms of networking, support and motivation. The support networks are in place and will only grow more efficient over time.

In terms of early stage investing, Australia also does this exceptionally well. There are lots of Angels and Seed Funds operating in Australia and if you have a solid team and are chasing a big, disruptive market with some early customer validation then you can raise a seed round relatively easily (easy by VC standards anyway). Again, we can't make sweeping statements about a shortage of venture capital without the context around which stages we are talking about.

The key issue at the early stage is not lack of capital, it’s lack of opportunities or deal flow (as we say). The problem is, it’s not exactly an efficient market and finding the right early stage investors can take time, but perseverance is a critical entrepreneurial quality. Marc Andreessen summarises this nicely in his blog post, When the VCs say “no”, which I’ll paraphrase:

• One “no” doesn’t mean anything
• Three “no’s” could be coincidence — keep trying
• Five or more “no’s” is no coincidence — something is wrong with your plan.

Investors and their capital are out there and most I know want to invest more, but are constrained by the number of high quality deals that come through their door. For now though, we are getting by and this is really something that will be fixed over time as we plug gaps in the Foundations — more high quality founding teams solving big issues adds to the deal flow funnel helping early stage capital to be more efficiently and effectively deployed.

Over the last few years, Australia has built a great early stage funding and support system for startups, which has the momentum to keep growing of it’s own accord. It’s time now to shift the focus to the next level.

Growth stages

The next layer we need to focus on is the growth stage — this is where the biggest gaps are. There are very few Series A deals from Australian VC’s and even fewer Series B/C because we don't have many funds big enough to do those rounds. To play in this space, a VC needs to have committed funds of $50-$100M for Series A and at least $200M for Series B/C/etc, but raising a fund this size needs institutional money and Australian institutions refuse to play ball. Big investors, like Superannuation funds want to see a track record before investing in VC, but by the time that comes around, they will have missed the boat. It will take us another 7–8 years before Australia’s top funds reach maturity and while I have no doubts that we will have some great results, the time to invest in the next stage of tech growth in this country is now, not in another 7–8yrs. If we wait much longer, we won't be able to keep our Growth stage companies onshore.

We have some fantastic companies around the Series A mark and VCs should be able to tell these stories to raise later stage funds. Just like an entrepreneur sells the future value of his or her company to investors, so too will VC’s need to sell the opportunity of investing in growth stage companies to institutional investors. VC is about investing in future potential, not past results and the pipeline for future potential right now is pretty strong. It really shouldn't be too hard of a sell once the stigma associated with Australian VC is overcome. In reality, these investors already play in assets with the same kind of risk profile as Series B or C startups. Private Equity, Commercial Property Trusts and publically listed Exploratory Mining Companies are not all that different from a risk perspective than a technology startup with customers and revenue looking for growth capital to scale the business. Illiquidity is also not such a huge problem at this point, as most companies are around 5yrs into their journey and hence maybe another 3–5yrs from a potential exit.

To be clear, this is where I believe we have a huge opportunity to tap into the trillions of dollars managed by Superannuation funds. I don't think the government has a role to play in this, but both industries need to be working more closely to come up with a solution. Apparently there are over 360 superannuation funds in Australia with assets over $50M, so surely some of these are willing and able to support VC — it’s just a matter of finding the right partners. On top of that, we need to tap overseas investors, especially from neighbouring Asia. All in all, this should not be an impossible task.

Exits

Exits are a huge and important part of the venture capital industry. Exits allow funds to return profits to investors, which can then be reinvested. It also gives founders the opportunity to give back to the community by having additional time to mentor other founders as well as becoming investors themselves or even starting a new company. The recycling of capital and knowledge in the ecosystem has been an important factor in the success of Silicon Valley and is something that can be replicated here under the right circumstances. The exit opportunities for Australian startups are plentiful. Foreign companies have proven that they are not averse to making cross border acquisitions and there is precedent for the listing of small and medium sized companies on the ASX. I won't focus too much on exists in this post — I’ll leave that for another day.

What next?

We have the platforms to support early stage companies and to enable lucrative exits, however we really can't capitalize on these until we fix the gaps in the Growth stage. Currently, successful Australian startups are going overseas for the their Series B rounds and beyond (some even for Series A) and there is little incentive to return. Once these companies move offshore we maintain the right to call them Australian, but we lose the right to share in their success. Foreign staff are hired, foreign investors take the lion's share of returns and foreign governments collect the company’s taxes. This is a lose-lose situation for Australia if we don’t bridge these gaps. I wholeheartedly believe that we can do this, but it'd help if we were more aligned and working closer together towards a common goal. If you have thoughts on how we can achieve this, let me know.

James McKinnon is Managing Partner of Mirin Capital — an Australian Venture Capital firm based in Sydney and Melbourne. You can reach me at jm@mirin.vc or on twitter @jrmck.

Update: This post also appears on StartupSmart: http://www.startupsmart.com.au/financing-a-business/venture-capital/how-to-build-a-sustainable-venture-capital-industry-in-australia/2015030314260.html