snowball group whitepaper - evolution of venture capital in australia

EVOLUTION OF VENTURE CAPITALIN AUSTRALIA12th Feburary, 2014

Level 3, 296 Collins StreetMelbourne Victoria 3000Phone: (613) 9005 2124Email: contact@snowballgroup.com.au

www.snowballgroup.com.au

WHITEPAPER BY SNOWBALL GROUP

“Disinterest by private

equity investors is resulting

in companies leaving

our shores in droves and

seeking private equity

investment in more liquid

markets. With them we

are losing our innovation,

our talent, our commercial

future.”

3Snowball Group - Evolution of Venture Capital in Australia

Evolution of Venture Capital in AustraliaWe take a brief look back in history at private equity

funds, venture capital funds and start-up funding in

Australia and attempt to predict what the future holds.

Compared to the USA, Europe and throughout

Asia when it comes to investing in start-up

and early stage ventures, risk averse Australian

investors show a distinct lack of interest and

a blatant distain for even bringing them up

as an alternative asset class or an investment

option. On the other hand, private equity

buyout funds and investment in large private

companies appears strong, even if Australian

institutional investors have abandoned the

private equity sector over the last couple of

decades. What does this mean for private

equity investment, and in particular the

venture capital sector’s future? We take a brief

look back in history at private equity funds,

venture capital funds and start-up funding

in Australia and attempt to predict what the

future holds.

There is no doubt the strength of the

private equity buyout sector in recent

times has been due to some of the largest

private equity firms in the world appearing

on our shores. Since mid-2008 onwards

they’ve demonstrated a genuine appetite

for some of Australia’s largest and iconic

companies. This hasn’t been without its trials

and tribulations. Nevertheless, amongst a

plethora of choice, especially coming out of

the emerging economies, in particular Asia,

they have persisted and continue to show a

genuine interest in Australian businesses.

Unfortunately, the Australian Venture Capital

(VC) sector hasn’t faired as well. In fact,

Australian start-up ventures and early stage

companies looking for capital to grow their

companies are now abandoning Australian

4 Snowball Group - Evolution of Venture Capital in Australia

investors in droves and going offshore.

We are losing our most valuable assets,

“innovation and creativity”. It’s going to

overseas investors who’re less risk averse

and more visionary. Overseas venture

capitalists and angels appear to be more

entrepreneurial and prepared to invest in

ventures with higher risk and longer-term

horizons than their Australian counterparts.

However, those that look to Australia are few

in number and constrained in what they can

allocate to ‘Down Under’ investments.

When it comes to investment in innovation

at the seed to start-up stages, irrespective

of the public rhetoric and relatively meagre

incentives offered by Government, local

investor support is abysmal. This isn’t a

swipe at those who’ve tried valiantly to

support start-ups over the last decade. No,

we have the greatest respect for those who

clearly have identified where Australia’s

future lies – and it’s not mining and riding

on the sheep’s back. It’s more of a hard

long glare at institutional investors, angel

investors, large VC and PE fund managers,

and more generally at sophisticated

investors who consistently show a

preference for risk aversion and short-

term gain, sticking with classical stocks

and property investments, without much

foresight for the future of the country.

To shed light on why this continues to occur

in Australia while the USA and Asia are in

a frenzy investing in innovative start-ups,

let’s first take a step back in time. This white

paper reviews the evolution of the venture

capital and private equity investment sector

in Australia and attempts to determine what

lies in ahead.

In the beginning...

The origin of VC funds and private equity

(PE) buy-out funds in Australia occurred

relatively recently in our short history. In the

1970’s the first VC firm was ‘International

Venture Corporation’ Pty Ltd (IVC), dedicated

to private capital transactions. Indicative

of the times, the types of early venture

capital investments IVC focused on included

aquaculture, road surfacing and concrete,

consumer finance, leasing, property services,

marine equipment manufacturing, intensive

piggeries, off-peak heater manufacturing,

Australian film production, laser equipment,

mineral exploration and pyrophyllite

extraction and processing1.

‘Enterprise Management of Australia

Corporation’ (EMA) followed IVC two years

later. EMA invested in the tourism and

leisure sector, as well as the manufacturing

1. We highly recommend you read ‘Inside Private Equity’ by Bill Ferris, which provides an insightful account of the private equity and venture capital scene in Australia. This book published in 2013 by

Allen & Unwin is a main source of many of the historical accounts in this article. In particular refer to pages 208 – 240.

“Right from the gecko Australia’s private equity and

venture capital sector faced a rocky pathway, continually stopping and starting in line with health of the financial and economic climate. “

and services sectors. IVC and EMA had mixed

results, both selling off their assets in the

1980s.

Another participant in the private capital

sector was Hambro-Grantham focusing on

small technology companies operating under

the MIC2 scheme and establishing a parallel

Other initiatives in the 1970’s included the

Australian Innovation Corporation aimed at

getting investment in early stage ventures,

and the government owned Australian

Industry Development Corporation (AIDC)

focused on major manufacturing and mining

project finance. The AIDC also invested in

small advanced-technology ventures. One

of their most notable investments was in

Optus, later going on to ultimately become

a subsidiary of the SingTel Group out of

Singapore.

Although there was evidence of moderate

success, during those early years there were

also a number of unsuccessful ventures

involved in computer equipment, telecoms

and software development. The result

was an immediate pullback by investors

from private capital investing. Just as the

momentum in private equity investment

started picking up pace, it hit a brick wall

at the first sign of trouble. This began

a continuing trend that remains today,

reflecting the risk averse nature and short-

tem perspective of Australian investors,

with little or no commitment to intrinsic

value and long-term investment. Right from

the gecko Australia’s private equity and

venture capital sector faced a rocky pathway,

continually stopping and starting in line

with health of the financial and economic

climate. As we will see, even government

support and incentives, whether or not done

politically derived, or whether considered

as ultimately ill conceived have never

been able to overcome the deep seeded

structural and cultural problems faced by

the Australian private equity sector and local

investors.

At he end of the 1970’s it was evident that

private equity financial returns weren’t

compelling enough to shift the attitudes

of large superannuation fund managers

and their investors away from risk-averse

investment. Industry funds were sufficiently

catered for from the steady and less risky

returns of the top 100 listed companies,

treasury bonds and inflation-driven property

assets. Here lies the conundrum. The

introduction of equity capital markets in

Australia has been good and bad for the

modern world, and in particular Australia

since their introduction. The ability of

publicly listed companies to trade their

shares on stock exchanges has considerable

2. Management and Investment Companies (MIC) scheme was a program introduced in 1984 to encourage investment in innovative startup technology businesses. It offered financial, strategic and

administrative assistance to venture capital investors. The government issued MIC licenses to companies who satisfied the Government’s strict criteria. By the end of 1991 the MIC program achieved

relatively good success with $225.4 million invested in 155 companies. The scheme provided upfront tax deductions. As a result the tax incentive tended to dominate investors’ motives rather than

the investment outcome itself.

benefits in the investment world. It enables

companies to raise capital through their

IPO and then later in secondary market

activity. It attracts a wider range of investors

from institutional investors, sophisticated

investors, to retail investors. It provides

greater liquidity within short time frames,

with the safety that comes from regulation,

strict compliance requirements, operating

on a transparent trading market platform.

Continuous disclosure is undoubtedly a

major plus for having public companies. It

ensures fair play and avoids the likelihood of

insider trading and ill-informed decisions by

buyers and sellers.

However for all its benefits, the antithesis

is the cultivation of an investment culture

where investors generally focus on high

turnover, short-term horizons, for market

driven gain. There is little insight or care

given to the specific machinations of a

company, its intrinsic value, and its long-

term vision. In many ways this is the

opposite of private equity where investors,

shareholders and management alike focus

on the core value proposition, the long-term

horizon, seeking reasonable yield along

the way, with a greater focus on long-term

capital growth and sizeable return when

their investment is realised. The investor

has to really buy into the vision, have faith

in the management, understand the risks

and back the core proposition right from

the start. Management and the directors can

make the hard decisions for the long-term

good, not be driven by satisfying analysts

and institutional shareholders about the

immediate impact to earnings in the next

quarter.

Over the years Government has stepped in to stimulate private equity investment

In the 1980’s, as a consequence of a

government review3 a report was released

identifying the problem facing early stage

high-technology enterprises in Australia.

Apart from the lack of quality management

operating these companies, the biggest

problem (as alluded to above) was a

poor attitude toward high-risk, long-term

investment. As a consequence the report

concluded there was a lack of technological

development due to a lack of capital

allocated to it. Investors opted for short-

term, risk-averse investment opportunities.

As a consequence of these findings the MIC

scheme and subsequent programs were

commenced.

Although assistance in promoting

investment in innovation should be

perceived as an admirable initiative, a

3. The Espie Committee was established in 1981 and chaired by Frank Epsie. The findings were released in a report in 1983. As a result the MIC scheme was born.

“The fact government assistance is needed, or in fact is the main

driver for investment in start up and early stage technology investment is an indictment on investors in the Australian market. Elsewhere, notably Silicon Valley, private investors have thrived on

high risk and high returns of long-term investment opportunities in the technology space. It appears investors in Australia are stuck in the risk averse psyche of investing in old faithfuls, old world stocks. “

good thing, it also highlights the inherent

problem facing growth and development of

private equity in this country. Please don’t

get me wrong any help is warmly received.

The fact government assistance is needed,

or in fact is the main driver for investment

in start up and early stage technology

investment is an indictment on investors in

the Australian market.

Elsewhere, notably Silicon Valley, private

investors have thrived on high risk and

high returns of long-term investment

opportunities in the technology space. It

appears investors in Australia are stuck in

the risk averse psyche of investing in old

faithfuls, old world stocks. The truth is the

world has moved on and these traditional

investment selections are now proving to

demonstrate inherent high risk.

More than ever these traditional stock

selections are becoming very sensitive to

the continuing negative influences of an

uncertain global political and economic

environment. Australian investors are still

focused on local banking and finance

companies, property, mining, resources,

energy and utilities, and to a lesser extent

infrastructure investments.

In fact, Australia’s reliance on cyclical

investments such as high-risk mining

stocks is indicative of investors’ short-term

investment horizons. But in the long-term

it presents limited foresight to Australia’s

continuing prosperity. They are now fairly

high risk, rising and falling due to effects of

global economic crises, the high Australian

dollar, and commodity price fluctuations.

The new emerging economies including

China are able to influence world commodity

pricing, placing Australia in a vulnerable

position.

The amount of infrastructure spend needed

is both prohibitive to the Government as it is

to private financiers and investors, including

the miners themselves. Yet investors persist,

relying on non-renewable export products,

ignoring the less riskier and more valuable

resource we have in information technology,

engineering and life sciences.

We astound the world with our high degree

of invention and innovation, but instead of

the private sector harvesting this asset and

encouraging it, meagre funding via

“We astound the world with our high degree of invention and innovation, but instead of the private sector harvesting this asset and encouraging it, meagre funding via government grants and subsidies, and a lack of participation by private investors has seen steady erosion of our precious resource to offshore markets. Optimism about our future won’t overcome the problem that has permeated our history. The reality is overseas investors value what we have and we do not.“

government grants and subsidies, and a lack

of participation by private investors has

seen steady erosion of our precious resource

to offshore markets. Optimism about our

future won’t overcome the problem that has

permeated our history. The reality is overseas

investors value what we have and we do not.

The pattern has repeated itself throughout

the evolution of venture capital and private

equity in Australia. If we go back around

the mid-1980’s, investment in private equity

began to take hold due to tax incentives

from programs like the MIC scheme. The

owners of private companies also began to

use secondary boards as a great platform

to raise equity capital, or realise their

investments.

It involved less complexity and cost

compared to listed public companies. In

fact around $1.4 billion of capital raising

occurred through secondary boards in

Australia leading up to 1987, with a market

capitalisation of $3.8 billion. However,

with the 1987 financial market crash,

the momentum gained in private equity

investment came to a sudden halt as

investors withdrew and returned to risk-

averse investments, drying up the activity on

secondary boards.

At the end of the decade we saw a range of

activities aimed at encouraging investment.

This included R&D concession schemes

to encourage exporting and investment

in research and development, especially

technology, engineering and life sciences.

The R&D tax concession scheme provides a

tax deduction of up to 125% (since 2011) of

expenditure incurred on R&D activities4.

Another initiative was the Grants for

Industry Research & Development (GIRD)

scheme, aimed at encouraging a focus on

new emerging technologies. These schemes

tend to come and go with the rise and fall

of new Governments, usually with a political

agenda attached.

At the end of the 1980’s other sources of

funds and incentives became prominent.

These proved to be catalysts to the evolving

activity in venture capital and private equity

investment. The MIC scheme

4. R&D tax concession entitlement commenced in 1985, initially as a 150% tax deduction on R&D expenditure. In 1986 this was changed to 125% tax deduction. In 2001 two new elements were

introduced

Post 2011 the R&D Tax Incentive provides eligible companies with a 45% refundable tax offset (equivalent to 150% tax deduction) for R&D entities with a turnover of less than $20 million per

annum. It also provides a non-refundable 40% tax offset (equivalent to 133% deduction) for all other eligible R&D entities.

“Whether it’s due to the tyranny of distance, necessity, or inherently part of our culture, Australia possesses something the rest of the world admires and actively seeks, our inventiveness and ability to innovate. “

was subsequently replaced by the ‘Pooled

Development Fund’ (PDF) program. Unlike

the MIC, PDFs focused on providing tax

incentives when investments were realised;

providing exemption to capital gains tax

and having greater flexibility than the MIC

scheme. PDFs offered greater incentive to

institutional investors. The government also

introduced additional programs, important to

the commercialisation of research work.

The advent of Cooperative Research Centres

(CRCs) in the 1990’s was an important

development in the private equity sector for

several reasons. The aim was to provide the

right incentive to support and commercialise

important scientific research residing in

Australian universities. At the time, and the

reasoning still remains, it was realised that

Australia’s heavy reliance on its primary

source of export, namely minerals, coal,

gas and agriculture was unsustainable.

As mentioned above, these sectors are

cyclical by nature and face increasing global

competitive and price pressures, especially

when the Australian dollar is high against

the US dollar. There was a realisation by

the Government in the 1990’s, and the

same is true today, we needed to harvest

our valuable know-how residing in our

universities and look to commercialise them

to the rest of the world.

Whether it’s due to the tyranny of distance,

necessity, or inherently part of our culture,

Australia possesses something the rest of

the world admires and actively seeks, our

inventiveness and ability to innovate. Over

time, for a country with a relatively short

history and a small population, Australians

have continually been responsible for

some of the world’s most important

break throughs. Today is no different. The

introduction of CRC programs in 1991 was

aimed at enhancing Australia’s economic

growth through fostering collaboration

between government, universities and

private companies. CRC programs look

to facilitate research initiatives and

reap the benefits of cooperation by

encouraging outcomes in adoption and

commercialisation.

Since commencing many CRC programs

have been established in the areas of

manufacturing technology, information

and communication technology, mining

and energy, agriculture, the environment,

and most notably medical science and

technology. Examples of CRC successes

include the ‘Hearing CRC’ producing the

“The point being made is that CRC’s

have proven and will continue to prove invaluable in fostering research, innovation and

commercialisation, providing fertile ground for venture capital markets well into the future. CRCs also identify an important ingredient in fostering commercialisation of technology; you can’t do with just having government support alone, private investors and corporate venturing has to be there in a big way.“

Cochlear hybrid system restoring hearing

to the hearing impaired across the world,

the Australian Biosecurity CRC Program

producing a genetic diagnostic test used for

equine flu, and the Australian Photonics CRC

which brought together the universities of

NSW, Sydney and Melbourne, the ANU, Telstra

and Siemens.

There is large number of CRC programs

operating in Australia today including a

Polymer CRC for the automotive industry,

a CRC for Enterprise Distributed Systems

Technology, a CRC for Cotton Catchment

Communities and a CRC for Innovative Dairy

Products, an Environmental Biotechnology

CRC, and a CRC for Mental Health.

The point being made is that CRC’s have

proven and will continue to prove invaluable

in fostering research, innovation and

commercialisation, providing fertile ground

for venture capital markets well into the

future. CRCs also identify an important

ingredient in fostering commercialisation

of technology; you can’t do with just having

government support alone, private investors

and corporate venturing has to be there in a

big way.

Innovation Investment Fund (IIF) program

Another major initiative by the Government

continuing to have an enormous impact

on investment in early stage innovative

ventures is the ‘Innovation Investment

Fund’ (IIF) program. The IIF supports ten-

year innovation funds, managed by licensed

venture capital fund managers. These funds

are aimed at helping develop Australian

companies to become globally competitive

by commercialising outcomes of Australia’s

strong research capability. The IIF program

has been operating since 19985.

5. Over the three rounds the program has licensed16 fund managers and supported 100 new companies. In Rounds 1 & 2 nine fund managers were licensed and invested $221 million, matched with

a total funding of $354 million. For Round 3 and 4 the Australian Government committed up to $100 million to be equally matched by private sector capital.

In the latest round6 fund managers

appointed included Carnegie Venture Capital,

GBS Venture Partners and Innovation Capital

Associates. The Carnegie Innovation Fund

No.2, Limited Partnership is focused on

providing capital and support to a portfolio

of investments in seed, start-up and early

stage companies7.

The fund is building upon a successful track

record of investing in Australian companies

that drive innovation in life sciences,

information technology and internet-

enabled sectors, clean technology and other

industries.

The GBS BioVentures V IIF fund is an

Australian life science specialist fund. The

fund invests in companies commercialising

Australian biomedical innovation to

create new medicines and medical devices

to treat unmet global medical needs8.

Innovation Capital Associates has a general

fund investing in Australian technology

companies with global potential. Potential

portfolio companies will operate in the

service and high margin manufacturing

sectors9.

The IIF program and IIF follow-on funding

(IIFF) contribute heavily to commercially

develop targeted firms and to develop a

self-sustaining early stage venture capital

industry in Australia. Notable success

stories include Looksmart supported by IIF

fund manager AMWIN Management who

invested $2.2 million and gained a return of

$245 million. Seek, the online job website

received venture capital by IIF fund manager

AMWIN Management, seeing the company

successfully list for a market capitalisation

of $600 million in 2005. Biotech QRxPharma

was formed in 2002 with Four Hats Capital’s

IIF Innovation Fund providing $4 million

as the founding investor, together with

Innovation Capital Associates (registered

as a PDF) and University of Melbourne’s

Uniseed.

In 2007 the company raised $50 million in

an IPO. Other successes include the drug

discovery company Pharmaxis focusing on

autoimmune diseases and supported by

IIF fund manager GBS Venture Partners,

and biotechnology company Alchemia who

received venture capital from four IIF fund

managers including Start-up Australia, GBS

Venture Partners, AMWIN Management, and

Coates Myer and Company.

5. Over the three rounds the program has licensed16 fund managers and supported 100 new companies. In Rounds 1 & 2 nine fund managers were licensed and invested $221 million, matched with

a total funding of $354 million. For Round 3 and 4 the Australian Government committed up to $100 million to be equally matched by private sector capital.

6. Round 3,Tranche 4

7. The Carnegie Innovation Fund No.2, LP received a matching grant of $40 million in April 2013. It’s reported total greater than $80 million, instead totaling $120 million

8. The GBS BioVentures V IIF Fund received a matching grant of $30 million in April 2013, totaling $60 million.

9. Innovation Capital Associates received a matching grant of $30 million in April 2013. Total fund size is $60 million.

A rocky road for Private Equity buy-out funds over the last decade

As we entered the new millennium from

2000 and onwards we witnessed rapid

growth in private equity leveraged buy-outs

by private equity funds, mainly to support

expansion capital activity. This occurred

at the time when venture capital activity

and the performance of their funds were

levelling out. However, by the end of the

decade growth in the private equity buy-out

segment started to dramatically dissipate.

Coinciding with the beginning of the GFC

and continuing on to today, large Australian

superannuation funds began withdrawing

from investing in private equity. Participation

is now less than one per cent of their

cumulative assets. They refuse to even even

look at early stage venture capital.

On the other hand, around ten years ago

we saw the first signs of interest from

international private equity funds, replacing

the Australian super funds and investing in

Australian private equity. It initially included

an abundance of large private equity fund

managers such as The Blackstone Group10,

Kohlberg Kravis Roberts (KKR)11, CVC

Capital Partners12, TPG Capital13, and The

Carlyle Group14. Even so, international PE

funds right from the start have found the

going fairly tough. There were a number of

failed attempts along the way at some of

Australia’s largest iconic companies, as well

as less than impressive outcomes for those

transactions that did proceed. Notably, KKR

had a run at Coles for a year before bailing

out in 2007, with Coles eventually being

bought out by Wesfarmers. Other failures

included TPG’s early tilt and spectacular

failed bid of Qantas. This was balanced out

with the buy-out and successful IPO float

of Myers Retail. In 2006 and 2007 there

was CVC’s buyout of Channel 9 at an over-

inflated price, incurring an eventual loss. In

2006, KKR failed in its bid for PBL Media,

subsequently investing in Seven West Media

including Channel 7. KKR exited in 2013.

The attraction of private equity buy-outs

by some of the largest private equity funds

in the world was best demonstrated in

2010 with the takeover battle for private

hospital operator and pathology provider

Healthscope. TPG and The Carlyle Group

hotly contested with KKR with a near $2.7

billion offer.

International PE buy-out funds are no doubt

here to stay. They sit comfortably with the

few large Australian PE funds including

Pacific Equity Partners (PEP), Quadrant,

CHAMP, and Archer Capital. Collectively

10. The Blackstone Group L.P. is an American multinational private equity, investment banking, alternative asset management and financial services corporation based in New York City

11. KKR & Co. L.P. is an American multinational private equity firm, specializing in leveraged buyouts, headquartered in New York. The firm sponsors and manages private equity investment funds.

12. CVC Capital Partners is a private equity firm with approximately US$46 billion in funds focused on management buyouts. Since 1981, CVC has completed over 250 investments across a wide

range of industries and countries

13. Formerly Texas Pacific Group (TPG). TPG Capital is one of the largest private equity global investment firms focused on leveraged buy-outs, growth capital and venture capital. Total assets are

around $US48 billion

14. The Carlyle Group is an American-based global asset management firm, specializing in private equity, based in Washington, D.C. Total assets $US31.6 billion

“What is evident is that innovative start-up ventures

can’t rely and depend wholly on non-government sources of funding to support future innovation in Australia. This is a sad indictment on the foresight and long-term vision of Australian investors and why our talent, intellectual property, our creativity and ability to innovate are progressively being transferred overseas. “

they’ve provided the catalyst and continuing

commitment to private equity investment

in Australia; replacing participation by risk

averse industry funds and large Australian

superannuation funds who have kept away

since the onset of the GFC.

Essential for PE buy-outs is the leverage

required from major Australian banks and

highly liquid offshore Asian banks, whether

as a syndicate or as a club, whether having

a local or offshore presence. PE buy-out

funds rely on leverage to drive returns to

equity. There’s no doubt prior to the GFC

we witnessed banks unrealistically exposed

to risk with respect to private equity buy-

outs. This has moderated compared to 2008

where debt was 8 to 10 times cash flows.

Nowadays, you’re more likely to get 50%

debt and 50% equity. That is, if the equity is

valued at 6 times annual cashflow, then debt

may be 3 times the cashflow.

Even though banks are seen as majorly risk

averse, especially in the light of prudential

regulations and liquidity restrictions due

to Basel III, the truth is they still like the

margins they can earn from private equity

leveraged buy-outs and mezzanine funding.

In Australia we’ve seen the disappearance of

many international investment banks from

Australian shores, less in-house resources

devoted to private equity investment, and

much less risk appetite. Yet the anticipation

of greater M&A activity this year as a

result of an estimated $4 billion of unused

committed investor funds will no doubt see

the banks heavily involved. There’s also an

expectation by market analysts there’ll be

quite a few IPO exits in 2014 as funds seek

to realise long awaited returns. You can

be sure the banks will be there front and

centre.

In the 2009 fiscal year, VC and PE funds were

severely affected by the GFC. In Australia,

the total funds raised fell to $1.54 billion,

similar to FY2004 levels. Investments

involved the supply of capital to existing

investees for follow-on investments

and capital restructures. VC funds in

Australia mainly invested in life sciences,

computer and computer electronics and

communication. PE funds invested mainly in

business and industrial products. VC funds

fundraising efforts fell by 19% to only $263

million. This reflected how difficult

the fundraising environment was. There was

no commitment for seed investments. Most

of the $180 million investments made in

FY2009 concentrated on start-up to early

stage with only 7% in seed and 26% in later

stage expansion/growth.

The significance of what occurred in 2009

is that it highlights a recurring theme;

as soon as there is any sign of adverse

conditions in the global economy, funding in

innovation initiatives is negatively impacted.

The decrease in committed VC funds was

swift and dramatic, demonstrating investors’

sensitivity to risk. What is evident is that

innovative start-up ventures can’t rely and

depend wholly on non-government sources

of funding to support future innovation in

Australia. This is a sad indictment on the

foresight and long-term vision of Australian

investors and why our talent, intellectual

property, our creativity and ability to

innovate are progressively being transferred

overseas. Perhaps rather than the headline

concerns over foreign ownership of large

iconic businesses and mining resources that

are old world assets we can’t rely on in the

future for our economic prosperity anyway,

we should be more worried more about the

insidious loss of our new world assets. If

nothing else FY2009, the peak of the GFC,

highlighted this ongoing problem we still

see today.

Is there a place for Private Equity investment and Venture Capital funds In Australia?

From a global perspective the past three

years15 has seen a lethargic and flat period

for the private equity buy-out market. This

coincides with problems faced by global

capital markets post-GFC and due to the

ongoing sovereign debt crisis and USA’s

economic woes. Locally, Australia faired

better with a relatively well performing

economy and growth rate, buoyed by the

mining boom and China’s demand for

exports from Australia.

201016

After a period of consolidation the 2010

fiscal year showed signs of gradual

improvement. The Australian private equity

and venture capital funds saw more invested

companies than funds raised. After 2008

and 2009, in an environment where capital

was hard to get, this was very welcome.

Nevertheless, post-GFC and in the light of

the tax treatment17 of private equity firms,

investors remained very cautious during this

15. This white paper was written at the end of CY2013 and start of CY 2014.

16. Refer to ‘The Australian Private Equity & Venture Capital Association’s 2010 Yearbook, released in October 2010.

17. In Australia moves were made to change the ‘Thin Capitalisation’ rules to reduce the safe harbor debt-to-equity ratio from 3:1 to 1.5:1 for non-financial entities. This limits interest deductions on

shareholder debt for Australian investments. This will be put into effect on 1 July 2014. This will have impact on overseas PE funds and their continued investment in private equity in Australia. This

is coupled with future possible tax reforms seeking to address instances of double non-taxation i.e. when exit gains aren’t taxable in Australia due to protection under a double tax treaty and are

also exempt in the vendor’s residing jurisdiction. The issue was raised in 2009 with TPG’s tax-free disposal of Myer Retail and the ATO’s pursuit through the courts to recover tax realised by TPG from

the sale.

time, reflected in less new commitments in

fundraising activity. This was highlighted

in the case of VC firms throughout the

world where they were only able to raise

half of the previous year’s commitments. In

Australia, what VC funds did raise basically

came in conjunction with the release of

Round 3 of the Innovation Investment

Fund program and IIF follow-on fund.

The IIF matching fund for the appointed

VCs was critical to ensure innovation was

not killed off during this time. The whole

aim of the IIF was to address the lack of

capital available to promising innovative

companies post the GFC. In 2010, of the 14

VC funds that raised new capital, nine were

funded under the IIFF program and two

raised matching commitments as part of

the IIF co-investment program. The IIF and

IIFF represented 82% of new VC funding

commitments in FY2010.

Investment by private equity firms was up

on the previous year, while VC funds were

slightly down. Most of it was follow-on

investment not new deals, demonstrating

the industry ‘s steady line of support for

existing investee companies. Interestingly,

PE fund managers significantly increased

their focus on listed companies such as

PEP’s investment in Energy Developments

(ASX:ENE), Investec Wentworth Private Equity

minority equity stake in ClearView Wealth

(ASX:CVW) and Navis Capital’s acquisition of

remaining shares in Peoplebank, (formerly

ASX:PBA).

The general exit environment showed a

gradual improvement with a number of

divestments. Divestments were up on the

previous year with trade sales dominating,

and public offerings reappearing with 3 IPOs

and 7 sales of quoted equity.

201118

In FY2011, the combined effort of the

Australian PE and VC industry improved

across the board in fundraising, investments

and divestments. However, there was a

demonstrable trend towards a higher

concentration of fundraising and investment.

There were a smaller number of funds and

completed deals. Although we witnessed

improvement in the sector it wasn’t a

bounce. This was even though the Australian

economy had a strong performance

compared to the rest of the world. With

the global economic volatility continuing,

a persistently strong Australian dollar, and

unresolved tax issues lingering, any strong

rebound in PE and VC activity was severely

constrained.

Although fundraising was significantly up

on the previous year, the environment for

fundraising remained challenging with most

General Partners (GPs) deferring or shelving

fundraising plans. The number of funds with

new commitments decreased 39% from the

previous year. It should be said that half of

those came from overseas investors and

40% from funds-of-funds.

18. Refer to AVCAL’s 2011 Yearbook, released in November 2011.

New funding commitments to Australian VCs

continued to decline with three VC funds

raising $120 million, down 24% on the

previous year. Similar to the previous year,

they mainly involved IIF programs. In the PE

space $2.2 billion was raised, up 84% on the

previous year mainly due to Champ III and

the Quadrant PE Fund 3 final closings. Very

little was in new commitments but rather

reinvested gains from older funds, or 2010

and older vintage years, demonstrating the

longer fundraising periods faced by GPs.

Investments were up with the top 10

deals representing three-quarters of the

investment amount. However the number of

companies receiving investments declined

with most being follow-on investments. PE

investments grew by 50% from the previous

year to $3.5 billion. This was mainly due to

the Healthscope transaction19, representing

43%. The fall in VC fundraising on the other

hand reflected an uncertain fundraising

outlook and an aging profile of existing

funds. Around 75% invested was from funds

with vintage years of 2008, and 16% from

funds 9 years and older.

In FY2011, we saw increased investment

activity among international VCs and

investors for high growth Australian

technology companies. Notable was

Accel Partners’ investment in software

development platform provider Atlassian,

crowdsource website 99Designs, and online

FOREX service provider, OzForex along with

The Carlyle Group.

Divestments were up on 2010 with trade

sales still remaining the most popular

method of exit. Interestingly, secondary sales

to PE firms represented 11% of divestments,

and there were no full exits in PE funds

through IPOs. VC funds generally performed

well and had higher net proceeds from

divestments compared to the previous 2

years.

At the end of FY2011, Australian PE and

VC investment in Australian companies

over the previous 4 years outweighed any

fundraising by Australian GPs. This reflected

the difficultly in the local fundraising

climate and at the same time highlighted

the importance of continuing private equity

investment in Australian companies.

201220

Unlike the rest of the world private equity

in FY2012 was quite buoyant in Australia.

We saw a large increase in fundraising and

investment activity, continuing into FY2013

and H1 FY2014.

Like the previous year, there was a

continuing trend in FY2012 in regards to a

concentration of a smaller number of GPs

successfully raising funds. Nevertheless,

there was an increase in committed funds

compared to the previous year. On the other

hand investments and divestments remained

cautious due to the predicted slowing down

of China’s GDP growth rate, global economic

uncertainty, a continued high

19. Public to private takeover of Healthscope by TPG Capital and The Carlyle Group.

20. Refer to AVCAL’s 2012 Yearbook, released in November 2012.

Australian dollar, as well as challenging

M&A and IPO market conditions.

The increase in fundraising was around

59% up on FY2011, totalling $3.34 billion,

the highest since the GFC21. This positive

result was tempered by a plethora of

deferred fundraising commitments and a

concentration of fewer new PE managers

being successful in their fundraising

commitments. Most of the funds committed

to were from overseas investors, reflecting

the continued subdued sentiment by local

participants.

Australian VC funds had a major increase on

the previous years. Most of this was under

the Government’s Renewable Energy Venture

Capital Fund co-investment program. This

amounted to $200 million out of the $240

million total funds raised. The Government

backed programs remained the main source

of new commitments for VC funds, as

fundraising remained difficult for VCs.

A continuing trend in FY2012 was most

VC and PE commitments were raised

from overseas Limited Partnerships (LP),

representing 36% of total new commitments.

Almost no funding was raised from the

domestic private sector by Australian VC

funds.

As mentioned above, investments by PE and

VCs fell during the period. This reflected the

subdued climate as a result of continuing

investor worries and uncertainty concerning

the global economic crisis. It was also a

product of easing of growth in the Chinese

economy and the predicted negative impact

it would have on the performance of the

heavily relied on Australian export mining

industry. These factors greatly reduced

business, consumer and investor confidence.

Three main deals dominated, representing

41% of PE fund investments. They included

Bain Capital’s acquisition of MYOB from

Archer Capital, Affinity Equity Partners

purchase of Primo Smallgoods, Champ

Private Equity’s acquisition of oOh! Media,

and the acquisition of SGA Hygiene by

PEP. With respect to VC funds, investments

remained steady with 42 investments in

new companies and 45 in existing investee

companies. Competition for VC funds

remained tight with only 12 VCs investing.

What came to the fore was the depth of

start-up and early stage ventures competing

for scarce local funding. Foreign VCs were

active, seeing Australia as an attractive

market for technology start-ups with global

VC heavyweights such as Khoshla Ventures,

Index Ventures and General Catalyst Partners

attracted to invest in start-ups such as

Kaggle and Big Commerce.

21. Archer Capital Fund 5 raised half of the FY2012 PE committed funds.

201322

In the 2013 fiscal year, there was moderate

activity overall in the PE and VC sector,

slightly down from 2012. However, there

were promising signs for improvement for

2014 as we witnessed improved business

confidence and a fairly buoyant IPO market.

Fundraising by Australian PE and VC funds

fell to $867 million in FY2013, reversing the

upward trend in FY2012. Most fundraising

was from PE funds, raising $711 million.

This was a sharp decline from the $3 billion

raised in the previous year. Anchorage

Capital Partners Fund II, Advent 6 and

Anacacia Fund II were the largest domestic

funds, raising 80% of all fundraising

commitment to PE funds.

VC funds raised $155 million, 35% lower

than FY2012. This came from just three

funds. Notable VC funds included the

IIF Carnegie Innovation Fund No. 2 and

Bioscience Manager’s Asia Pacific Healthcare

Fund II, mentioned above.

Investments were slightly down, reflecting

an overall softening of M&A activity.

Investments by PE funds were 7% down

on the previous year. Notable investments

by PE funds included the private to public

takeover of Spotless by PEP, KKR’s buyout of

GensisCare from Advent Private Capital and

TPG’s acquisition of Inghams Enterprises. The

turnaround deal of Dick Smith by Anchorage

Capital who acquired them from Woolworths

featured prominently in in September 2012.

This was followed up with a listing in

December 2013.

Investment by VC funds fell 20% to $111

million. However corporate VCs like Telstra

Ventures, super angels, and funds backed

by successful business founders were active

in backing early stage companies. This

included start-up online graphic design tool

provider Canva (Blackbird Ventures) with

$3 million seed capital, asset management

solution provider Assetic (M.H. Carnegie &

Co.) and SaaS provider Whispir involved in

communication management systems who

have been funded by Telstra Ventures.

Exits from PE funds continued to be

dominated by trade sales including Exego

sale by Unitas Capital to Genuine Parts in

the USA and the sale of Southern Cross

Venture partner’s Virsto Software to VMware.

However there were some good signs for

exits via IPOs with the listing of Virtus

Health by Quadrant Private Equity. We also

saw some major write-offs by PE funds,

notably Nine Entertainment.

Even though FY2013 was fairly benign,

we did see some positive signs with an

indication that PE and VC funds will look to

clear a backlog of exits to make room for a

new cycle of fundraising and investment.

22. Refer to AVCAL’s 2013 Yearbook, released in December 2013.

Today and Tomorrow, what’s in store?

With a steady return to business confidence

and strong demand by institutional

investors, buoyed by the success of the

Virtus Health listing, some large and notable

IPOs occurred in the first half of FY2014.

This included the breathtaking floats of

Freelancer23 and Indoor Skydiving Centre.

PE funds had a few notable IPOs during the

same period who’ve continued to perform

well post listing. These included credit-

checking company Veda Group24 and online

foreign currency company Ozforex25.

However, even with the success of

Freelancer, Veda and Ozforex, there have also

been some equally disappointing results and

share performance after their IPOs. Take the

rocky start for electronic goods retail chain

Dick Smith Holdings26. It opened as high as

5.5% above the IPO share price of $2.20 but

then fell flat by the end of the day to $2.16.

It’s now trading around par but fell below

$2 in late December before recovering.

Turnaround PE firm Anchorage acquired Dick

Smith in November 2012 from Woolworths

for $94 million. At the IPO it was valued at

$520.3 million.

Disappointing listings included the Cover-

More Group owned by PE firm Crescent

Capital Partners, Nine Entertainment

Co., and packaging business Pact Group,

all demonstrating lack lustre results

since their floats late December 2013.

This has signalled mix messages to the

market regarding the much-heralded list

of upcoming floats around February and

March 2014. This includes the listing of

Healthscope by PE funds TPG and The

Carlyle Group for around $4 billion. It also

possibly includes Medibank Private, fleet

management company SG Fleet (owned by

Super Group and Champ Ventures), the large

retirement home operator RetireAustralia

tipped to IPO at $400 million, and a quick

turnaround by PEP with the return of the

catering and cleaning company Spotless27

to the ASX through an IPO. This is predicted

to be worth $1.5 to $2 billion. In addition

other IPOs mooted for FY2014 include

Smartgroup’s Smartsalary ($200 million)

and Sterling Education ($200 million). All in

all the market anticipates a busy time with

around $7 to $8 billion worth of IPOs.

This renewed activity is a result of growing

business and investor confidence. Even

though global economic and political

concerns persist, institutional investors

in Australia are showing some sign of

investment appetite, albeit with ‘under-

23. ASX:FLN) The online job outsourcing platform Freelancer’s successful listing in November 2013 surprised the market. It was of the few stocks that have continued to be strongly supported by

investors post listing. On January 8, 2014 FLN demonstrated a gain since its IPO of 170%.

24. (ASX:VED) The Veda Group is a credit reporting and data services company and returned to ASX after 6 years away. VED listed on 5 December 2013 at 50 cents per share. As at 7 February 2014

share price is $1.90.

25. (ASX:OFX) The online foreign currency and international payment services company listed on 11 October 2013 for $2 per share for a $480M float. It’s currently trading at $3 per share 7 February

26. (ASX:DSH)

27. PE Fund, Pacific Equity Partners (PEP) acquired Spotless for $723M in August 2012.

“It has become a structural change in

the way business will be conducted in the future, or more to the point, how it’s

being conducted now.“

“Coupled with the enormous activity by technology based companies and investments being made, one only has to see the amount of sustained activity by US private equity & venture capital funds, as well as angel investors and syndicated angel investor groups over the last two years to know where the world is heading. To support this it’s worth noting in 2013 US private equity fundraising totalled around US$193.7 billion.28“

whelming exuberance’. Still there is appetite

to invest in private equity that’s exiting

via public markets. With more sensible

valuations and hard fought book-builds, PE

firms have been keen to exit investments

they’ve been holding longer than they

normally would, to make room for new

committed funds and new investments.

However, investor interest in start-up and

early stage companies still remains low. Even

with the success of Freelancer and Atlassian

(supported by overseas VC fund, Accel

Partners), mainstream investors in Australia

stay sceptical and risk averse. They remain

stuck on resources, banks, property and

infrastructure, retail and manufacturing. That

is, “old world” businesses who’re struggling

themselves to survive in a brave new global

world that arrived years ago. This is in the

face of the great innovative successes we are

witnessing around the world such as Google,

Facebook, Twitter and now a plethora

of SaaS platforms, cloud technologies,

proliferation of API plug-ins, online enabling

platforms, eCommerce platforms, interactive

ecosystems, big data and analytics, and the

list goes on. Coupled with the enormous

activity by technology based companies

and investments being made, one only has

to see the amount of sustained activity by

US private equity & venture capital funds,

as well as angel investors and syndicated

angel investor groups over the last two

years to know where the world is heading.

To support this it’s worth noting in 2013 US

private equity fundraising totalled around

US$193.7 billion28. Although there were 12

funds there were in excess of US$5 billion,

the average was around US$100 million,

accounting for 32% of the fundraising. VC

funds in 2013 raised less in aggregate than

2012, preferring to focus on smaller vehicles

where capital raised flowed into smaller

early stage funds with the likelihood of

greater gains. There is plenty of dry powder

for later stage

23. Pitchbook Data Inc. 1H 2014 U.S. PE & VC Fundraising and Capital Overhang Report p3

“If it wasn’t evident before it is now, start-up ventures are leaving our shores in droves to find sources of funds and gain access to dynamic and global markets.“

investment with a PE capital overhang of

around US$465.5 billion.

In the case of early stage investments, more

is being spent than is being raised and as

a result the capital overhang is declining

each year, currently at US$57.9 billion. This

is occurring in light of VC deal-making

occurring at break neck speed as many start-

up companies come out of their seed, pre-

series A phases. The ‘series A crunch’ as it’s

come to be known is a product of a rapidly

changing investment environment and is a

sustained trend. It’s unlike the previous dot

com boom experienced between 1995 and

2000. It has become a structural change in

the way business will be conducted in the

future, or more to the point, how it’s being

conducted now.

In Australia, unlike in the USA and Asia, PE

& VC fund managers continue to be risk

averse, even in light of the success of tech

businesses such as Freelancer and Atlassian.

Ask any start-up company, whether it’s a

cloud-based software as a solution, an

online eCommerce venture, mobile device

app, or a scientific technological solution

in health, communications, or engineering

needing to be commercialised. Getting

funding locally is close to impossible. Local

investors will want the start-up to first have

market traction and be making profit before

they’ll consider it. They’ll want a sizeable

chunk of the company, want to be in control

in regards to the business strategies and

commercial decision making, while imposing

onerous conditions on the founders. They

will spend a ridiculous amount of time to do

their ‘due diligence’ and commit to meagre

funding.

This approach by Australian investors is at

odds with the rest of the world. More to the

point it has badly frustrated and stifled our

progress as a nation of smart innovators

over the last decade, and continues to do so.

Many of the bright minds in the information

technology sector are now taking their

destiny into their own hands, and looking to

greener pastures where getting funding is

easier, and the environment is conducive to

being successful. If it wasn’t evident before

it is now, start-up ventures are leaving our

shores in droves to find sources of funds and

gain access to dynamic and global markets.

“Here lies the real difference; you can start-up quickly, with limited seed funding required. You can do it cheaply and with less risk exposure. The mantra is if you’re going to fail, fail quickly and move on. “

The world has changed, but no one has told Australian investors...

In a poignant special report on tech start-

ups in The Economist29, it’s argued that we

have reached a “Cambrian moment”. It has

taken the last couple of decades and a few

false starts to form, but the framework and

platform has arrived and the planets are

all aligned. To the risk averse, and you hear

this constantly from Australian investors,

they argue its all too risky and similar to

the dot com bubble a decade ago. To the

ignorant, I guess a simplistic and uneducated

conclusion like that could be reached.

However I’m surprised (or may be I shouldn’t

be), I would have thought that a little more

thought and understanding, and foresight

would be put into making investment

decisions. Evidently not!

In the special report, it points out a number

of things that have changed the game and

indicate a lasting and permanent trend.

It’s different to last time for a couple of

reasons. A decade ago it was early days

in the commercial use of the Internet

and the web. There wasn’t such a general

acceptance of the web as there is today. The

technologies and tools were in their embryo

stage. They were limited and predominately

only accessible by techies with commercial

acumen. In addition, there weren’t iPhones

and iPads with wireless connectivity and

infrastructure to support highly efficient

data communication and data storage. In

this limited environment start-ups had to

first come with a product and business

model, raise money and hope for traction.

So what’s different? Start-ups are now being

built on solid foundations enabling them

to get to market with lower costs, faster

and with lower funding requirements. The

Internet is fast, universal, and wireless. Major

infrastructure around the globe has been

created to make it affordable and ubiquitous.

Not only for start-ups, but those that will

consume their products and services. For

start-ups all the building blocks now exist

and are easily accessible. It includes easy-

to-learn programming frameworks, available

online platforms to find and gain access

to developers, the ability to easily share

code, or even outsource testing usability. A

major advancement has been the creation

of a large volume of APIs, multiplying and

growing in number as we speak, allowing

one service to use another. Probably the

most important difference is the arrival of

platform services including affordable cloud-

based hosting infrastructure with virtual

servers. You can now basically rent

29. Refer to an article titled ‘A Cambrian Moment’, 18 January 2014, The Economist, Tech Start-ups. It refers to the beginning of life forms beginning to multiply in an explosion leading a wide variety

of animals on earth around 540 million years ago. This used as an analogy of what is occurring in the entrepreneurial space and digital realm today. A major shift, permanently changing the world as

we know it today.

on-demand and pay-as-you-go, enabling

start-ups to avoid large upfront capital

expenditure on development environments,

allowing them to move quickly to

commercialisation. There are platforms

enabling start-ups to quickly distribute their

products and services to market, eCommerce

enabled with plug-in billing and payment

systems integrated to online fulfilment

systems and accounting platforms. Marketing

has become so much easier with the

advent of social media and a high degree

of interactivity happening on a global basis.

The world has never been so connected.

Here lies the real difference; you can

start-up quickly, with limited seed funding

required. You can do it cheaply and with less

risk exposure. The mantra is if you’re going

to fail, fail quickly and move on. Terms like

“MVP” and “Pivot” coined in the ‘The Lean

Start-up’ by Eric Ries30.

The proliferation of start-ups at seed stage

and their speed to early stage funding

is the reason for the series A funding

crunch. The framework and environment

enables start-ups to take a much different

approach. Start-ups can spend their time

‘tinkering’ to develop a good idea, working

in interconnected ecosystems. Once found

they can then look for a business model to

allow for fast profitable growth. This is the

opposite of the dot com bubble a decade

before where investors and entrepreneurs

alike made their bet on a business plan and

then tried to execute it.

Let’s be clear, the explosion of start-up

technology ventures using the building

blocks outlined above has created a major

shift in the way business is done now and

in the future. It’s structurally, socially, and

culturally changing the way we do business,

replacing traditional structures of doing

business for good. The Economist in its

article points this out by giving examples

such as the social network LinkedIn

fundamentally changing the recruitment

business, Airbnb disrupting the traditional

hotel business, and Uber connecting would-

be passengers with drivers – changing the

taxi business. This is just the tip of the

iceberg and why investors in Australia need

to change the way they think.

Who’s feeding the start-ups?

Start-ups nowadays don’t just rely on family,

friends and maxed out credit cards to get

started. If they did, “tinkering” wouldn’t

be an option. In the US, a movement has

gained momentum due to the efforts of past

entrepreneurs, universities, some corporate

venturers, and a few VCs with foresight.

30. The lean Startup Book by Eric Ries, published by Crown Publishing Group October 2011. “MVP” stands for Minimal Viable Product to prove up an idea and get to market. It’s a core component of

Lean Start-up methodology in the build-measure-learn feedback loop. “Pivot” is the term used to describe the iterative nature of start-ups nowadays where one foot is planted while the other may

have to shift stay still to preserve.

We are now witnessing an explosion in start-

ups due to a growing list of accelerators,

co-working spaces, and studio like holding

operations. These start-up schools have also

attracted angel investors, syndicated angel

investors, and early stage VC funds, which

actively seek to invest in start-ups.

The formation of these start-up schools

has spawned an interconnected global

ecosystem. Accelerators alone throughout

the world total in excess of 2,000 and

growing. In addition there are a raft of

platforms that service the start-ups in these

accelerators.

In the past technology incubators were

formed to foster young entrepreneurs.

The idea came out of SOHO in New York

and was more about increasing the price

of property by housing dot coms. They

provided entrepreneurs with a workspace

and business facilities, the ability to mix

with other entrepreneurs and share their

experiences, receive mentoring from

commercial professionals on how to get

grants, commercialise and pitch for funding.

Although they had some merit they had

limited success. The reality was small teams

of developers tended to work in isolation,

gaining free rent and access to technology

allowing them to continue coding. Once in

the incubator it was hard to move them on

and difficult to commercialise them.

Accelerators may be considered the

antecedents of the early incubators but

in fact they are structured very differently.

Accelerators are known as “schools for

start-ups”. One of the first seed accelerators

to start back in 2005 was Y Combinator.

This was set-up by Paul Graham, a former

software entrepreneur and angel investor.

If you have a good idea you want to move

to a product you can apply to Y Combinator.

If successful you’ll receive seed funding of

around US$20,000 and relocate to their

facilities in Silicon Valley for 3 months.

During this time you’ll work intensely to

get your small start-up in shape to pitch

to investors, culminating in a Demo Day of

specially selected investors. In return the

start-ups provide Y Combinator with around

8% of their companies. Y Combinator has

had notable successes such as Dropbox

and Airbnb. Other well-known accelerators

include TechStars and Startupbootcamp

who’ve set up international networks.

Accelerators are now operating

independently around the world, but in many

cases remain inter-connected.

As well as accelerators, another development

is the proliferation of co-working spaces.

These facilities host entrepreneurs and

start-ups in one location. They get all the

essential facilities such as high speed

internet, a desk and chair, printing services,

board rooms and meeting rooms. They also

get the opportunity to collaborate with

other start-ups, gain access to mentors and

advisors, and in regular intervals, investors.

This is all for a small monthly fee.

Another option available to start-ups, where

entrepreneurs have turned investor, is

the studio-like holding operations. These

technology studios provide an opportunity

for rapid experimentation and company

development. Technology studios have

sprung up such as ‘Betaworks’, ‘Obvious Corp.’,

‘Monkey Inferno’, ‘Lightbank’ and ‘HVF’. Each

has a slightly different model. Generally

studio creators provide the facilities and

usually take large chunks of equity and

co-founder status. They actively participate,

creating and incubating ideas in-house. They

may provide seed-stage funding but most of

all provide their entrepreneurial expertise

and resources to help generate and build

companies at scale. Start-ups within the

technology studios are able to leverage

functions such as sales and marketing,

hiring, and legal advice. This is ‘parallel

entrepreneurship’ where experienced

entrepreneurs can work in tandem with

talent in-house and help new entrepreneurs

turn ideas into actual businesses. It

effectively leverages repeatable services

across the studio’s start-ups, enabling them

to scale quickly with less capital required.

Of course the latest trend is crowd funding.

At this stage and to this writer it sounds a

lot like promoting and getting discounted

pre-sales. It’s a great way to raise some

seed money and get traction. Noticeably, the

best results come if you’ve got a really cool

gadget, something tangible like what Ninja

Blocks has created. To be successful, you

have to first form a team who’re willing to

develop a concept for free. Then you have

to get lots of followers through your social

network, get hold of some initial seed money

(albeit a small amount) to get your product

offering (or concept) and website up and

running. Then if it’s something the crowd

likes, money will come in with the promise

of some type of reward such as discounted

pre-sold product if it eventuates. There’s

no doubt there has be some really sizeable

successes. In the US the JOBS Act is opening

up the way for donators to become retail

based investors in the company and gain

equity. There’s similar pressure in Australia

to make changes to restrictive rules

pertaining to retail investors. The belief

is by offering equity it will stimulate a lot

more seed funding for start-up ventures and

ratchet up crowd funding investments.

Support for technology start-ups in Australia.

A large Silicon Valley VC firm with $7.5

billion under management, Technology

Crossover Ventures (TCV) who’ve invested

considerable funds into growth stage media

and technology companies such as Netflix,

Facebook, Groupon and recently Spotify,

injected $30 million into an Australian

online hotel distribution platform SiteMinder

in January 2014. This is significant in itself

but what is more interesting is what TCV had

to say about Australia’s wealth of pragmatic

entrepreneurs who they see as global market

players with compelling products.

These aren’t isolated views. The rest of the

world admires the innovation and creativity

by small start-ups in Australia. Apart from

the level of innovation, they possess strong

development and commercial disciplines

seldom seen in start-ups. It makes them

an attractive proposition for VCs and angel

investors. The fact that they sit in the Asian

region makes them even more attractive

to US investors. The problem is many start-

ups toil for many years without receiving

funding. Finally, through fatigue and

necessity they give up. This is due to a lack

of he capital needed to survive and to take it

to the next level.

Little help has been offered by the

Government to date and this could soon

become even less as the current Australian

Federal Government promotes small

government and greater reliance on private

market forces. Given the unchanging nature

of risk averse Australian private equity

investors as history has shown, this could

spell disaster. At the very least it will force

even greater numbers of tech start-ups to

go offshore, taking the potential for jobs and

Australia’s economic future.

However, in recent times we’re starting to

see renewed hope. Not from traditional

funding sources, but from entrepreneurs

who’ve enjoyed previous success and are

willing to not only invest in tech start-

ups, but will offer their time to mentor

those with good ideas. In a short while,

throughout Australia we have seen the rise

of co-working spaces such as ‘Fishburners’

in Sydney, ‘Inspire9’ based in Melbourne and

home to ‘AngelCube’ accelerator, ‘York Butter

Factory’ also in Melbourne is home to 50

companies, over 200 start-up events a year

and is helped by VC firm Adventure Capital,

and ‘HUB’ based in Melbourne, Sydney and

Adelaide. In addition there is ‘Sync Labs’, and

‘Space Cubed’ in Perth.

Accelerators have also started to pop up

throughout Australia. ‘Startmate’ is a group

of start-up executives who offer mentorship

and seed financing to founders of Internet

and software businesses. This is a five-month

program of where each start-up receives

$50,000 investment. At the conclusion of

the program founders pitch to early stage

investors at demo days (one in Sydney and

one in Silicon Valley). Other accelerators for

start-up tech companies include the Founder

Institute, Slingshot, Ignition Labs, Pollenizer,

PushStart, Blue Chilli, ATP Innovations,

AngelCube as mentioned above, and the

Telstra backed Muru-D.

“The rest of the world admires the innovation and creativity by

small start-ups in Australia. Apart from the level of innovation, they possess strong development and commercial disciplines seldom seen in start-ups. It makes them an attractive proposition for VCs and angel investors. “

We’re also seeing the rise of Australian VC

funds that focus on global Internet start-

ups in Australia. One such firm is ‘Blackbird

Ventures’ with a $30 million fund. The

company is made up of successful start-up

founders in Australia including the founders

of Atlassian, Campaign Monitor and Aconex.

It also has some of Silicon Valley’s top

investors (Bill Tai and 500 Startups chief

Dave McClure) and access to a network of

investors in Silicon Valley. They provide

equity capital for all stages from seed, to

early stage to growth capital. To date they’ve

invested in Canva, Shoes of Prey, Ninja

Blocks, and Coinjar.

Another Australian VC Fund is ‘Adventure

Capital’ focused on advancing digital and

online technology ecosystems built by

Australian talent and their IP in innovation

and entrepreneurship. Adventure Capital’s

current fund, the ‘Digital Accelerator LP’ with

committed funds of $20 million is a super-

angel style venture fund focused on finding

and guiding early-stage tech companies that

are highly capital efficient and have global

ambition and scope. They are seeking to

increase the fund’s size to $100 million.

‘Square Peg Capital’ was recently formed

by a group of successful entrepreneurs

and technology investors. It came about

through the merger of two funds31 and

was orchestrated by Paul Bassat (Seek

co-founder), former banker Tony Holt, and

Justin Liberman. They’ve invested their own

money as well as money from James Packer

to set up a sizeable fund to invest in early

stage to growth stage technology companies.

A recent new Australian VC firm is the

‘Snowball Group’ situated in Melbourne.

Two veterans in the sector, John Dowell

and Anoosh Manzoori, head Snowball

Group. They directly invest and co-invest

in technology start-ups to early stage

companies in the Asia Pacific region.

Snowball Group has strict investment criteria

focusing on the core proposition of the

start-up business, the quality of the people,

and the risk and reward of the venture. In

particular they have a penchant for online

businesses with large ecosystems, conducive

to Big Data and analytic technologies.

Snowball Group sources their VC funds

from the USA and Asia. They’re currently

establishing a $30-$50 million VC fund for

pre series A tech companies operating in

Australia and Asia.

31. The merger was between Square Peg Ventures and Victoria Capital to form Square Peg Capital in 2013.

‘Southern Cross Venture Partners’ was

launched in 2006 by targeting early stage

technology companies with the potential for

exceptional growth and market leadership.

Their team has a strong record of utilizing

their start-up and management experience,

industry knowledge, network of business/

customer relationships, and recruiting skills

to assist in building significant shareholder

value. They prefer to act as lead or co-lead

in the early stages where they have the

experience to build value rapidly. A typical

initial investment is $2 million to $5 million

with an ability to invest more money in

later rounds. A notable success has been the

recent sale of Virsto to VMware.

‘Starfish Ventures’ is an experienced

venture capital manager seeding, building

and managing high growth technology

companies from an Australian base. Their

investment focus includes high growth

information technology, life sciences, and

clean technology companies. The team

has invested in over 60 companies to

date with 14 trade sales and IPOs. Recent

investments include Audinate32, Nitro33 and

DesignCrowd34.

Another active PE firm investing in

Australian businesses is ‘Blue Sky Private

Equity’, the only listed VC fund manager

in Australia. Blue Sky invests in private

companies taking significant but non-

controlling stakes in its investees. They

focus on long-term investment in real

estate, industrials, hedge funding activity

and water utilities. They’ve also extended

their portfolio recently to biomedical and

pharmaceutical companies. In September

2013 the company launched a $10 million

VC fund for start-up and early stage

investments. They’re not targeting specific

industries with the fund, but see many

opportunities coming from healthcare and

digital sectors. It also is looking at resources

and agriculture sectors.

‘Blue Chilli’ is a software development

company creating online web applications.

It invests in online start-ups by contributing

software development. They call this

‘Venture Technology’. They’re also an

accelerator, or rather a studio-like operation.

Last year they announced a $10 million fund

to invest in early stage tech companies. The

fund will match any angel investment over

$100,000 made by three or more investors

to a Blue Chilli company.

‘OneVentures’ has been operating for some

years, investing in emerging Australian

technology companies with differentiated

technology and compelling business models.

They focus on clean technology, information

technology and life sciences. OneVentures

invests in small high tech companies at the

seed, start up and early expansion stages. As

mentioned previously, OneVentures manages

an IIF fund of $40 million.

Led by Mark Carnegie of the Carnegie Wylie

fame, ‘M.H.Carnegie & Co.’ is a venture

capital, private equity and alternative asset

32. Audinate is a media networking solution enabling the transport of high quality media over standard IT networks.

33. Nitro develops PDF software and cloud collaboration tools.

34. DesignCrowd is an online marketplace providing logo, website, print and graphic design services by providing access to freelance graphic designers and design studios around the world. Design-

Crowd has recently acquired US based BrandStack and launched BrandCrowd, a marketplace for ready-made brands and logos.

manager in Sydney. They manage over $200

million worth of committed funds from

institutional, wholesale and HNW individuals

over several funds. Of interest, they’ve been

granted $40 million in the latest round of

the IIF program. Due to having to match the

Government’s contribution as part of the IIF

program requirement, this totals $80 million.

In September 2013 this was reported to be

a lot more, totalling $120 million. They’re

also collaborating with Vivant, an Australian

user interface and digital marketing

firm, creating an incubation facility.

The collaboration is aimed at fostering

innovative technology providing a launching

pad for those that pass their development

and commercialisation process.

Conclusion

There’s no doubt investment in private

equity in Australia has had an up and down

history. What’s evident is throughout its

evolution there’s been a lack of support due

to the risk averse nature of institutional

investors. When private equity investment

has gained some momentum, it’s been

quickly dashed, caught up in the roller

coaster ride as each economic cycle comes

around. Investment in innovation and start-

up companies has faired far worse. There has

been some recognition of the importance of

supporting innovative start-up companies

in Australia. There is a general consensus of

the need to generate ‘new world’ industries

to support the job market in Australia as

old world industries disappear. The rhetoric

in the press is great, but that’s all it is. To

date, the Government has in reality only

contributed limited funding to support

information technology, life sciences and

renewable energy companies. The lack of

commitment by Government, coupled with

the continuing disinterest by private equity

investors is resulting in companies leaving

our shores in droves and seeking private

equity investment in more liquid markets.

With them we are losing our innovation,

our talent, our commercial future. There is

no doubt Australian companies are capable

of being successful on the global stage.

Unfortunately overseas investor recognise

this more than risk averse Australian

investors.

The efforts of the few, made up of

entrepreneurs and investors who’ve

forged their past successes in spite of the

limitations they faced in gaining adequate

funding are out their fighting the good fight.

The appearance of local VC funds supporting

start-up tech companies, the proliferation of

accelerators, co-working spaces, and studio

operations connected to global ecosystems

provides hope. Whether it’s enough only time

will tell. For Australia sitting at the edge of

the Asian frontier, there’s a lot at stake.

This document is provided by Snowball Group Pty Ltd for general guidance only, and does not constitute the provision of legal advice, accounting services, investment advice, written tax advice under Circular 230 or professional advice of any kind. The information provided herein should not be used as a substitute for consultation with qualified technology specialists, professional financial and investment adviors, professional tax, accounting, legal, or other competent

advisors. Before making any decision or taking any action, you should consult with a professional advisor who has been provided with all pertinent facts relevant to your particular situation. The information is provided ‘as is’ with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties or performance, merchantability and fitness for a particular purpose.

Author:

John Dowell

Executive Director and Co-founder at Snowball Group

John Dowell has over 30 years of experience in corporate finance, venture capital and the ICT

sector. He’s a leader in areas of e-commerce, IT infrastructure, and business intelligence. He has

had extensive experience leading top global technology companies.

Level 3, 296 Collins StreetMelbourne Victoria 3000

Phone: (613) 9005 2124Email: contact@snowballgroup.com.au

www.snowballgroup.com.au

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