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Nick Hac

Repost: The state of Australian VC ( as seen by an VC funded Aussie in Silicon Valley)

Update & repost

I deleted the below post about 3 weeks ago. When i initially posted this analysis i was new to medium and didn’t realise the power medium had as a social content distribution tool — i naively thought it was just another cool blogging platform like blogger which i have used for over a decade.

I had lots of great feedback and shares of this post from people i respect like Mike Cannon-Brookes of Atlassian and Daniel Petre of Airtree as well as many other community members in VC from Australia.

The reason i deleted the post was mostly to avoid any syndication into mainstream media, as last time i had an opinion on something on social media it accidentally escalated to the front page of the DailyMail.co.uk as a “Rant”. That combined with distaste of people who just talk online and never do anything — i am not one of those people, i am actively running a global technology company. I also didn’t really want to kick sand in the face of every Australian VC — many of whom are people i know and respect.

After numerous emails from people i know i am happy to repost my original analysis and would add that over $1BN of VC is in the pipeline of ESVCLP approval which will make it easier for Australian companies to get funded. That said, even if this new $1BN of financing becomes available in the next year, given VC fund lifecycles it will likely only add an additional $100–300M of additional financing annually, still well short of the estimated $3BN+ that Australia should need annually to match the USA (or $7BN+ to match Israel).

There was some criticism of my post that good Australian companies still get funded, and that selling software in Australia isn’t hard. But i still strongly disagree and will cover this in a future post. As a short synopsis in my view Australian businesses are conservative in buying local B2B tech. To add insult to injury many companies operating in Australia are really just Sales & Marketing subsidiaries of US companies that use all their parent companies software and tech infrastructure providing no ability to sell software to them as you get pushed back to global HQ for decision. I’ll talk more about this later.

Anyways, if anyone cares, here is the post i deleted a few weeks ago back online.

Original Post

There has been a bunch of discussion around whether Australia is doing enough for startups started by Jon Westenberg and Rick Baker

Much of this questions if the AU Government has been creating policies that encourage startup investment. To me this is a private market problem, but the government is certainly making Australia a less attractive place to run companies.

  • Universities produce half the engineers they did a decade ago
  • Taxation on gains from startups have no material discount to reflect the massive level of risk (other than a few $10m ESVCLP funds), whilst mature investment categories that do not generate export revenue like real estate have negative gearing and first home buyer bonuses and easy access to capital.
  • Government programs designed to assist startups (R&D rebates, EMDG, Commercialisation Australia) end up mostly being used by established companies to increase their margins. The companies that need these most, can’t spend the time or the money on the advisors/accountants/lawyers needed to get the business into shape to complete these assistance programs.
  • The ATO aggressively reviews early stage companies that are loss making over non-material errors in compliance, causing massive distraction and costs for startups that are so fragile it’s a miracle they are in business at all, let alone deal with Tax compliance. No entrepreneur can comply with thousands of unknown rules as they are most likely a young passionate software engineer or designer that is fighting tooth and nail to create something of great value. You don’t even know if your product will work, or can you find an ideal target customer that repeatedly uses your product and doesn’t leave 6 weeks after signing up, and you need to understand why they want to buy and find a large enough market of other similar customers but you probably won’t and will have to find another 35 niche markets to test. You are fighting just to be alive — you have no idea if you can get to profitability before you run out of money and anything you model in excel always turns out to be way more or way less than you think — no model actually turn out to be true. And then the ATO rocks up and can burn weeks of your life and the rest of you very limited cash in bank on tax accountants and lawyers… It’s like they want to kill innovation on purpose.

Even the poster-child of Australian technology company success “Atlassian” — moved their corporate entity to be headquartered in the UK before they listed on the USA based NASDAQ. A UK company listing on the NASDAQ isn’t exactly a great showcase for Australia’s best, and shows even if you succeed in this game in Australia that is stacked so heavily against you — all you want to do is leave your money out of the country.

I certainly think there are more challenges for entrepreneurs in Australia than in the USA, and can speak with at least a little more authority than most commenters throwing popcorn from the nosebleeds. I have started 2 venture backed technology companies in Australia (one of which was successfully acquired BuzzNumbers → Sentia Media in 2012). I was so disenfranchised by how hard it was to start and run an early stage technology company in Australia that i started my 3rd VC backed company Lucy.ai in the USA with the help of Australia’s premier accelerator StartMate (which the Economist.com ranked as the 3rd best accelerator in the world after yCombinator and TechStars).

Entrepreneurship is less sexy than the media makes it out to be

Being an early stage technology entrepreneur is an immensely difficult thing regardless of what country you start your company in. If you are purely interested in financial gain, there are much easier ways (build a consulting firm, or a real estate brokerage or car dealership or pretty much anything that involves things that already exist).

Good reasons for becoming a technology entrepreneur include loving doing hard things, enjoying complex challenges, a desire to grow significantly both personally and commercially extremely rapidly, an irrational passion to fix a problem that really pisses you off, a hatred of an inefficiency that allows stupid people to own markets and profit by behaving unethically or by controlling access to information in an unfair way.

The best entrepreneurs i know are trying to right a wrong in the world, that is what enables them to push through all the stress and immense risks and ongoing existential threat.

Unfortunately as an entrepreneur, your chances of success are statistically so low you would think any sane person wouldn’t do it. You will undoubtedly face massive obstacles around fundraising, hiring staff with the right skills, building software that actually works, acquiring customers in a highly competitive space against not only the large well funded incumbents of the last generation of companies, but also competing with the new tech giants that have billions of cash in bank and can squash you in a second. You also have to retrain yourself from managing code to managing people, and if you are the CEO, you likely find yourself immensely isolated solving business problems you have never solved before and no one can advise you as you are building something that no one has ever built before. The Struggle comes to mind

Analysis of Venture Capital Sizing by Country

According to the numbers in 2014, Australia Invested $200M in VC and the US invested $50BN. When you adjust for population, if Australia invested at the same level as the USA, we would have needed to invest around $3.4BN more than we did in VC to match the USA on a per capita basis.

Only Israel stands higher than the USA as the world leader in Venture investment to the best of my knowledge — and their track record for driving export revenue from technology and IP proves this is a very valuable thing to do [source needed].

Source: Google

Why Australia lacks the $3.4BN in VC it would need to match the USA

Australian business is largely run by Oligopolies, making it very difficult to break through for startups.

From supermarkets to banking to insurance to automotive to fast food, in almost every industry we have approximately 5 large companies that own 90% of the market. This makes it very difficult for startups to get anywhere near the critical mass to get the price efficiencies they need to compete with the incumbents. By contrast, as an example: in the USA there are over 350 retail banks for citizens to choose from. Adjusted for population, Australia should have around 26 banks. This means consumers in the USA are more willing to try new vendors if they have an offer which seems better. In Australia there is subconscious distrust of anyone who isn’t an incumbent. This broader set of companies in each sector delivers significantly more options for customers and much greater ability for new market entrants to compete equally and beat underperforming old companies.

Australians think they are early technology adopters, but that is not wholly true.

Australians are certainly new technology creators with an impressive resume of inventing WiFi, PaceMakers, the first Fridge, Black box flight recorders, Google Maps, Cochlear implants, Polymer Bank Notes, Electric Drill, Ultrasound, HPV Vaccines, Medical Penicillin and many more.

Australians consumers are certainly early adopters of successful US technology companies products like the iPhone and PC and FaceBook.

But Australian consumers are fairly resistant to new technologies that are not proven in the US first, and Australian businesses are typically skeptical of homegrown business technology — the “you can’t get fired for buying IBM” mentality is alive and well.

When we try and point to the exceptions like Atlassian, Freelancer, PCTools and 99Designs — we quickly find that these companies mostly succeeded because of a largely USA customer base.

As a uncorrelated data point, my first computer as a kid when i was around 8 years old was a MicroBee, which at the time owned 80% of the Australian PC market in the 1980’s. By 1990 they discontinued the business and went to 0% market share as the commoditised IBM compatible PC’s designed and marketed from the USA and made in Asia destroyed the australian market based on price.

MicroBee was my first PC as an 8yo — i learned Chess and Basic and a bunch of games like Prince of Persia- i always wondered what would happen if i plugged the phone cable into the port that fitted the phone cord, but i didn’t know anyone who could tell me how to connect to the internet, or that the internet even existed. This was before telstra bigpond, AOL, netscape or the world wide web.

Australia has a 2o+ year track record of VC firms underperforming CPI or even savings accounts at the big 4 banks. The reason LP’s invest in VC is to seek outsized returns for the risk of a small part of their portfolio — and Aussie VC’s largely don’t deliver.

Australian Venture Funds have performed terribly for over 2 decades. I won’t name funds as the information i have is word of mouth, and the data is not public as far as i know (VC’s are not required to disclose returns to the public as they are private investment vehicles for their private sophisticated investors {mostly superannuation, credit unions and high net worth families}). But from what i have heard pretty much every VC fund in Australia has delivered negative returns or returns that are sub CPI CAGR.

This has in-turn created a compounding problem for VC firms in AU where VC’s in Australia need to invest in what they see as safe bets from their increasingly small investment pool. This means Aussie VC’s can’t make the kind of high risk bets that deliver the outsized returns they need to actually deliver a result, as they fear having to explain their losses to their upstream investors. This means they deliver poor results, which shrinks their fund sizes even more.

What is surprising to hear over here in Silicon Valley is that some of the VC’s investors (LP’s) over here are Australian Super Funds, Credit Unions and High Net Worth Families. Australian Investors are taking their funds to Silicon Valley not to Australian VC funds.

A high profile case in point is Telstra Ventures, that PR’d they were there to invest in seed stage investment in Australia when they launched. However, their last 2 investment last month in Jan 2016 were $45M into Palo Alto based Instart Logic and $100M into Shanghai based Qiniu. Australia’s largest telco who owns all the infrastructure that runs all australia’s copper internet invested the equivalent of 75% of total Annual VC investment in Australia in the first month of the year in 2 deals both foreign. I don’t have a problem with this, Telstra is free to do what is in the best interests of their shareholders, and they probably couldn’t allocate this in australia if they wanted to anyway. But if Telstra invested in this rate in AU companies across the whole year, it would fix 50% of the 3.4BN VC deficit in Australia.

How could the Govt incentivise Telstra Ventures and 20 other companies like them to focus all this investment in AU? It could 40x the $200M Annual VC spend and make Australia on par with the USA in terms of capital availability and turn Australia into a world class technology nation with a massive depth of future export income that would be built to get our country unhooked from the toxic cash of destroying the most pristine continent on the planet.

Australian funds and corporates are heavily investing in VC, just not in Australia.

The Great Australian Brain Drain

As it is both hard to breakthrough in the Australian market, and hard to raise capital in Australia, and hard to get paying Enterprise customers, the best Australian entrepreneurs typically leave Australia as they don’t really have any choice.

USA delivers a better return for Australian Entrepreneurs

Becoming an entrepreneur means leaving a stable income behind, taking on huge amounts of risk both personally, socially, professionally and financially. You get paid about half your market income, you work 2x as much and have 10x the stress. You need to make sure the pay-off is worth it, especially given that getting a pay off with a successful acquisition is improbable in the first place given the failure rate of startups. Given both the valuations of startups, the challenges in acquiring customers and the very few number of potential acquirers in Australia, it just doesn’t economic sense to take on so much personal and financial risk and stress for such a low chance of such a small return in Australia.

As an example, the average seed investment for a startup in Australia requires the entrepreneur to have significant revenue traction to raise a modest $250k on a typical $1M to $2M pre-money valuation. By contrast, in Silicon Valley it is not uncommon to raise $1–3M in seed financing on a $6–8M pre money valuation.

For australian internet entrepreneurs, it is not hard to quickly find out online that it is both easier to raise money (at 3–8x better valuation in the USA) and is much easier to acquire customers from less skeptical US marketplace that welcomes new entrants. It is also very clear from the Tech Media (techcrunch etc) that US technology companies often get acquired at significantly better valuations than Australia.

After i sold my last company BuzzNumbers, i subsequently found out that the price similar revenue size companies to us in the USA were receiving 10–40x larger multiples than we sold at. I don’t blame Australia or us or our acquirer. It is just that the strategic value of a technology company to an acquirer is based on the size of its customer base that it can distribute your technology to. If the USA has 13x larger customer base, and leaders in the USA industry may have 30–40x the number of customers the the leaders in the AU industry, it makes complete sense that they can value their acquisitions at much higher values.

What is the solution?

Honestly i don’t know. It certainly isn’t something that can be solved in a few months. It took us 20 years to drive the problem to this level, it will probably take 10 years to fix it. Given governments are in office for 4 years, no one will use the political capital required to risk likely unpopular policies needed that make it easier for smart people to get rich regardless of how much value they create for the Australian economy. The Tall Poppy Syndrome will kill the politician who tries this.

Australia needs to transform very rapidly into an economy that has a large amount of export revenue from Intellectual Property to offset the decline in demand and prices from export minerals.

The amount of dirt we can dig up and optimise and sell to china/india will continue to decrease year on year over the next decade and our currency will drop down to 0.5 AUD:1 USD which is around the historical norm.

The immediate solution for confident Australian technology entrepreneurs is to leave Australia for the USA (or increasingly Asia). But this exacerbates the problem even further where it is hard for Aussie VC’s to find good investments that generate outsize returns, which in turn makes it hard for capital to be allocated to VC’s, which makes it hard for Aussie Entrepreneurs to raise money in Australia. There is a negative feedback loop here, and i don’t think it will be fixed as no one is big enough to fix it.

The only solution i would want to explore would be the example i mentioned earlier. Telstra Ventures Invested $145M in Jan 2016, annualised at $1.7BN in VC. If we could create a tax incentive for the ASX 200 to invest in Australian startups, and a negative tax impetus to invest in foreign early stage investments, this could re-route the likely $5BN of VC investment that leaves Australia back into Australian startups. As a parallel, the ATO is estimated to lose $5BN of Tax inputs as a result of Negative gearing on real estate.

But i am not an economist, so i am sure using tax levers like this would have all sorts of unintended consequences.

In finding a solution outside of the crudely proposed Tax changes above, we need to find creative ways to fix the below issues (directly or indirectly)

  • Ensure raising capital in Australia is on par with US valuations
  • Make it easier to sell to Australian businesses as customers, or create an incentive for Australian companies to buy Australian technology products (this should be easy via Tax mechanisms as everyone is aware that when Aussie companies buy from Apple, Microsoft, Google etc that almost none of the gains ever get paid back to the ATO)
  • Make it easy for foreign companies to acquire Australian companies
  • Ensure entrepreneurs who actually succeed here don’t get absolutely nailed by the ATO. Almost every entrepreneur i know in Australia who has had a win and against all odds and with all the risk and stress, ends up spending another 3–5 years dealing with the ATO creating a nightmare for them. By contrast, in the USA, capital gains tax is 15% and the IRS is much easier to deal with than ASIC and the ATO. The IRS seems to understand that compliance is really hard for young companies who don’t have the budget for legal and accounting teams to fill out every form correctly and are negotiable and understand no-harm no -foul and that forgetting to file a form isn’t worth a $200k fine which would kill the business if it was issued. The ATO doesn’t seem to care if you are $5ook revenues of BHP, they want to make you comply with everything, even if it is immaterial and there is no harm
  • Significantly increase the number of engineering graduates from Universities. The number of software engineers graduating universities has halved in the last decade. Given we all use 10x more software than we did 10 years ago (iphone apps, web apps for business, games, tax etc) we have 1/20th the number of engineers we need. Maybe we should make software engineering degrees free. Just like when my Dad got an engineering degree at Sydney University in the 70's.

I look forward to hearing everyone’s suggestions around this discussion, and i am sorry for being negative around this. There are great VC funds in Australia like Blackbird and OneVentures (likely because they are started by successful entrepreneurs and not just bankers), and there is ongoing awareness of the value in solving this problem (new export revenue, more engineering graduates, increased employment, greater GDP etc etc).

But again, this is a 10 year problem to solve, and i don’t have any faith that any 4 year government will spend the political capital they require to fix it given the scope of all the other issues faced in Australia today.