venture capital in australia

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VentureCapital inAustralia

October2003

Venture Capital in Australiaa how to guide

contentsWhat is Venture Capital? .................................................... 2The Australian Market – an Overview ............................... 4Competitive Environment................................................... 7Legal Issues....................................................................... 12Market Contacts ................................................................ 13Venture Capital Definitions .............................................. 14

This document is one of a series of free information tools for exporters produced by New ZealandTrade and Enterprise. We provide a wide range of standard services and sophisticated solutionsthat assist businesses through every stage of the export process.For information or advice, ring NZTE on 0800 555 888, visit www.marketnewzealand.com, [email protected] or contact your NZTE Client Manager.

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October2003

What is Venture Capital?

Venture capital (VC) is a means of financing fast-growing private companies. Finance may berequired for business development at a number of stages in a company’s life including start-up,development or expansion, whole or partial purchase of another enterprise or the rescue of afaltering business. Venture capital is most often an investment in private companies orenterprises although the term has slightly different meanings between countries.

Growing businesses always require capital and there are a number of different ways to fundgrowth. New capital may be sourced from personal resources, family and friends, wealthyindividuals and private investors, other companies and organisations, and the professionalventure capital or private equity industry.

The venture capitalist acquires an agreed proportion of the equity of the company in return forthe required funding. When venture capitalists invest in a business they become part-owners andtypically require a seat on the company's board of directors. They tend to take a minority share inthe company and usually do not take day-to-day control. Rather, professional venture capitalistsact as mentors and aim to provide support and advice on a range of management and technicalissues to assist the company to develop its full potential.

Advantages of Venture CapitalVenture capital has a number of advantages over other forms of finance, such as:

• Finance - The venture capitalist injects long-term equity finance, which provides a solidcapital base for future growth. The venture capitalist may also be capable of providingadditional rounds of funding should it be required to finance further growth.

• Business Partner - The venture capitalist is a business partner, sharing the risks andrewards. Venture capitalists are rewarded by business success and capital gain.

• Mentoring - The venture capitalist is able to provide strategic, operational and financialadvice to the company based on past experience with other companies in similar situations.

• Alliances - The venture capitalist often has a network of contacts in many areas that can addvalue to the company, such as in recruiting key personnel, providing contacts in internationalmarkets, introductions to strategic partners and, if needed, co-investments with otherventure capital firms when additional rounds of financing are required.

• Facilitation of Exit - The venture capitalist is experienced in the process of preparing acompany for an initial public offering (IPO) and facilitating in trade sales.

Disadvantages of Venture Capital• Dilution of company ownership by previous investors

• High level of returns sought by an investor

• Professionalism – international knowledge and skills of venture capitalists may be dauntingfor companies who have had little or no experience or expertise in the international arena.

• Duration of commitment – Are investors in for a ‘quick buck’ or are they in for a more stablemedium term investment.

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• Unclear exit strategies - What impact will the strategy have on the company in the short-termand long-term. Do you have a clearly defined process to overcome such a situation?

Venture capital firms typically source most of their funding from large investment institutions suchas superannuation funds and banks. These institutions often invest in a venture capital fund for aperiod of up to ten years. Funds however can also be obtained from high net worth individualswhose expectations and motivations may differ.

To compensate for the long-term commitment and lack of security and liquidity, investmentinstitutions expect to receive very high returns on their investment. Therefore, venture capitalistsinvest in companies with high growth potential or in companies which have the ability to quicklyrepay a high level of debt - as in the case of a leveraged management buyout.

Venture capitalists typically exit the investment through the company listing on the stockexchange, selling to a trade buyer or through a management buyout. Although the venturecapitalist may receive some return through dividends, their primary return on investment comesfrom capital gain when they eventually sell their shares in the company, typically three to sevenyears after the investment. More venture companies, particularly in Singapore and the UnitedStates, are examining share retention should companies list on the stock exchange as a way tomaintain ongoing financial and business involvement in the company while receiving financialbenefit for the firm.

Venture capitalists are therefore in the business of promoting growth in the companies theyinvest in and managing the associated risk to protect and enhance their investors' capital.

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The Australian Market – an Overview

Number of Firms 179

Total Capital AUD$8.828 billion minimum

Invested Capital AUD$4.560 billion minimum

Available Capital AUD$4.358 billion minimum

Total number of Investments 1,308

Current Portfolio 880

Completed Divestments 428

Professional Staff 614

VCs may only provide investment opportunities to companies within specific stages of businessdevelopment. The preferences by stage of capital of VC firms break down as follows:

• Seed 59

• Start up 69

• Early expansion 93

• Expansion 101

• Management buyout 73

• Management buyin 61

• Turnaround 42

Information technology and communications have traditionally been high areas of investment.Following is a breakdown of number of new investments by industry from 2000 / 2001 financialyear.

• Internet specific 26

• Computer software 18

• Consumer related 16

• Biotechnology 15

• Financial services 15

• Communications and media 11

• Business services 10

• Medical/Health 9

• Industrial/Energy 8

• Manufacturing 8

• Agriculture/Forestry/Fishing 7

• Computer Hardware 7

• Semiconductors/other Electrical 5

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• Utilities 2

• Construction 1

• Transportation 1

• Other 1

Growth RateThe Australian VC sector has experienced rapid growth since the mid 1990s, both in terms ofmanaged total capital and the number of venture capital firms operating in the market.

Key drivers include:

• Institutional investor awareness of venture capital as a separate asset class

• Increased awareness and participation of private investors

• Government programmes to encourage participation in the sector

• Building on Information technology (BITS) Program

• Innovation Investment Funds (IIF) Program

• Pooled Development Funds (PDF) Program Industry growth

• Increased interest in technology investment

In October 2001, the Australian Government reformed Commonwealth legislation changing theway private equity (venture capital) funds may choose to operate. New legislation has providedfor tax concessions for investors from outside Australia making it more attractive to allocate aportion of their global portfolio (funds) to Australian venture capital partners.

Through the establishment of the venture capital limited partnership (VCLP), the Australianventure capital industry will be brought into line with the structure operating in most othercountries. International investors who fall within the criteria of the legislation will be tax exemptfrom capital gains on their investments in Australian VCLP’s. VCLP criteria states however thatthese investors must be resident within a ‘designated country’ which at the moment only includesthe United States, UK, Japan, Germany, France and Canada. There are plans to further extendthis list.

In addition, changes have been made to rules covering other investors ie. Individuals orinstitutions. Any investor who invests less than 10% of a VCLP’s (Australian coy) capital will alsodo so without incurring capital gains tax. There are no country restrictions with this clause.

There are however criteria that Australian companies must meet to be classified as a VCLP.These are:

• Limit its investments to unlisted companies or trusts, or listed companies in the process ofdelisting

• Invest only in companies when the value of the assets of the company is less than $250million

• Not invest in property development

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• Limit its investments to businesses that are primarily based in Australia at the time of theinitial investment

• Not invest more than 30% of its committed capital in any single investment

• Structure its partnership so that it does not own more than 30% of the VCLP

• Structure its fund within the investment time horizon of 5 – 15 years.

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Competitive Environment

Major Players in the MarketThere are 131 companies operating within the Australian VC market offering a total minimum ofAUD$8.828 billion. The largest companies based on total capital available are:

1. CVC Asia Pacific US$10+ billion

2. Advent International Australia US$ 5 billion

3. DB Capital Partners AUD$1.6 billion

4. Castle Harlan Australian Mezzanine Partners AUD$550 million

5. Pacific Equity Partners Pty Ltd AUD$500 million

6. AMP Henderson AUD$406.8 million

7. Macquarie Direct Investment AUD$395 million

8. Catalyst Investment Managers AUD$350 million

9. RMB Ventures AUD$300 million

10. GS Private Equity AUD$295 million

Selecting the Venture Capitalist InvestorThe Australian Venture Capital Association represents most venture capital organisations inAustralia. The AVCAL Directory of Members provides basic information about each member'sinvestment preferences and is available from the association via its website atwww.avcal.com.au. The Australian Venture Capital Guide, published by Pollitecon Publications,provides information on venture capital as well as listing companies who offer businessintroduction services, product development funding and infrastructure equity.

The most important thing before even considering a VC partner is to get one’s company“investment ready” – most VCs are inundated with proposals from companies that are not readyfor a VC investment.

Before selecting a venture capital partner, companies should study the particular investmentpreferences set down by the venture capital firm. Often venture capitalists have preferences forparticular stages of investment, industry sectors, geographical location and amount ofinvestment.

Once a short list of potential venture capitalists has been drawn up, it is often a good idea tocontact the venture capital firm and request a copy of their publications, or look on their website,to clarify the type of investments they favour.

An investment in an unlisted company has a long-term horizon, typically four to six years. It isvital to select venture capitalists with whom it is possible to have a good working relationship asthese individuals will be closely tied to the company’s success.

http://www.avcal.com.au/

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October2003

Often businesses do not meet their cash flow forecasts and require additional funds, so aninvestor's ability to invest further funds if required is also important.

Finally, when choosing a venture capitalist, companies should consider not just the amount andterms of investment, but also the additional value that the venture capitalist can bring to thecompany. These skills may include industry knowledge, fundraising, financial and strategicplanning, recruitment of key personnel, mergers and acquisitions, and access to internationalmarkets and technology.

Surveys in the US consistently rate management support as the most important contribution of aventure capital firm. There are many sources of capital, but only a venture capitalist can provideexperienced management input gained by helping many other companies successfully conquerthe inevitable problems and growing pains.

What does a Venture Capitalist look for?Venture capitalists are higher risk investors and, in accepting these higher risks, they desire ahigher return on their investment. Venture capitalists have differing operating approaches. Thesedifferences may relate to the location of the business, the size of the investment, the stage of thecompany, industry specialisation, structure of the investment and involvement of the venturecapitalists in the company's activities.

Companies should not be discouraged if one venture capitalist does not wish to proceed with aninvestment in the company. The rejection may not be a reflection of the quality of the business,but rather a matter of the business not fitting with the venture capitalist's particular investmentcriteria.

Venture capital is not suitable for all businesses. A venture capitalist typically seeks:

Superior Businesses

Venture capitalists look for companies with superior products or services targeted at fast-growingor untapped markets with a defensible strategic position. Alternatively, for leveragedmanagement buyouts, they are seeking companies with high borrowing capacity, stability ofearnings and an ability to generate surplus cash to quickly repay debt.

Quality and Depth of Management

Venture capitalists must be confident that the firm has the quality and depth in the managementteam to achieve its aspirations. Venture capitalists seldom seek managerial control; rather, theywant to add value to the investment where they have particular skills including fundraising,mergers and acquisitions, international marketing and networks.

Corporate Governance and Structure

In many ways the introduction of a venture capitalist is preparatory to a public listing. The venturecapitalist will want to ensure that the company has the willingness to adopt modern corporategovernance standards, such as non-executive directors, including a representative of the venturecapitalist.

Venture capitalists are put off by complex corporate structures and where personal and businessassets are merged.

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Appropriate Investment Structure

As well as the requirement of being an attractive business opportunity, the venture capitalist willalso be seeking to structure a satisfactory deal to produce the anticipated financial returns toinvestors.

An Exit Plan

Lastly, venture capitalists look for clear exit routes for their investment such as public listing or athird-party acquisition of the company.

Marketing StrategiesOnce a short list of appropriate venture capitalists has been selected, an approach can be made.The venture capital firm will ask prospective investee companies for information concerning theproduct or service, the market analysis, how the company operates, the investment required andhow it is to be used, financial projections and, importantly questions about the managementteam.

In reality, all of the above questions should be answered in the business plan. Assuming theventure capitalist expresses interest in the investment opportunity, a good business plan is aprerequisite

The Business Plan

Venture capitalists view hundreds of business plans every year. The business plan musttherefore convince the venture capitalist that the company and the management team have theability to achieve the goals of the company within the specified time. New Zealand Trade andEnterprise has provided general comment on the types of information that should covered withinan investment business plan. More detailed information, however, is available on the AVCALwebsite.

The business plan should explain the nature of the company's business, what it wants to achieveand how it is going to do it. The company's management should prepare the plan and should setchallenging but achievable goals.

The length of the business plan depends on the particular circumstances but, as a general rule, itshould be no longer than 10 pages. It is important to use plain English - especially if you areexplaining technical detail and avoid jargon and general position statements.

Executive Summary

This is the most important section and is often best written last. It summarises your business planand is placed at the front of the document. It is vital to give this summary significant thought andtime, as it may well determine the amount of consideration the venture capital investor will give toyour detailed proposal.

It should be clearly written and powerfully persuasive, yet balance "sales talk" with realism inorder to be convincing. It should be limited to no more than two pages and include the keyelements of the business plan.

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Background on the company

Provide a summary of the fundamental nature of the company and its activities, a brief history ofthe company and an outline of the company's objectives.

The product or service

Explain the company's product or service in plain English. This is especially important if theproduct or service is technically orientated. A non-specialist must be able to understand the plan.

Market analysis

You need to convince the venture capital firm that there is a real commercial opportunity for thebusiness and its products and services. Offer the reader a combination of clear description andanalysis, including a realistic "SWOT" (strengths, weaknesses, opportunities and threats)analysis.

Marketing

Having defined the relevant market and its opportunities, it is necessary to address how theprospective business will exploit these opportunities.

Business operations

Explain how your business operates.

The management team

Demonstrate that the company has the quality of management to be able to turn the businessplan into reality.

Financial projections

Consider using an external accountant to verify and act as "devil's advocate" for this part of theplan. AVCAL has a range of national and regional corporate members who could help you withthis.

Relevant historical financial performance should also be presented. The company's historicalachievements can help give meaning, context and credibility to future projections.

Amount and use of finance required and exit opportunities

State how much finance is required by your business and from what sources (i.e. management,venture capital, banks and others) and explain the purpose for which it will be applied. Outlinethe capital structure and ownership before and after financing.

Consider how the venture capital investors will exit the investment and make a return. Possibleexit strategies for the investors may include floating the company on a stock exchange or sellingthe company to a trade buyer.

Investment ProcessThe investment process begins with the venture capitalist conducting an initial review of theproposal to determine if it fits with the firm's investment criteria. If so, a meeting will be arrangedwith companies/management team to discuss the business plan.

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Preliminary Screening

The initial meeting provides an opportunity for the venture capitalist to meet companies and keymembers of the management team to review the business plan and conduct initial due diligenceon the project. It is an important time for the management team to demonstrate theirunderstanding of their business and ability to achieve the strategies outlined in the plan. Theventure capitalist will look carefully at the team's skills and backgrounds.

Negotiating Investment

This involves an agreement between the venture capitalist and management of the terms of thememorandum of understanding. The venture capitalist will then study the viability of the market toestimate its potential. Often they use market forecasts that have been independently prepared byindustry experts who specialise in estimating the size and growth rates of markets and marketsegments.

The venture capitalist also studies the industry carefully to obtain information about competitors,entry barriers, the potential to exploit substantial niches, product life cycles, distribution channelsand possible export potential. The due diligence continues with reports from accountants andother consultants.

Approvals and Investment Completed

The process involves exhaustive due diligence and disclosure of all relevant businessinformation. Final terms can then be negotiated and an investment proposal submitted to theboard of directors. If approved, legal documents are prepared.

A shareholders' agreement is prepared containing the rights and obligations of each party. Thiscould include, for example, veto rights by the investor on remuneration and loans to executives,acquisition or sale of assets, audit, listing of the company, rights of co-sale and warrantiesrelating to the accuracy of information enclosed.

The investment process can take up to three months, and sometimes longer. It is important,therefore, not to expect a speedy response. It is advisable to plan the business financial needsearly on to allow appropriate time to secure the required funding.

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Legal Issues

Confidentiality IssuesAll venture capitalists that are members of AVCAL are bound by the AVCAL code of conduct andwill respect confidential information supplied to them by companies looking for venture capital.

The AVCAL confidentiality agreement can be used to ensure that information given to investorsis provided on the basis that the investor will maintain its confidentiality. This document can beobtained from the AVCAL website at www.avcal.com.au Resource Centre > Industry Tools.

Legal TermsIt is likely that a shareholders' agreement would be prepared containing the rights and obligationsof each party. This could include:

• Amount and terms of investment.

• Dividend policy.

• Composition of the board of directors.

• Reporting - management reports, monthly accounts, annual budgets.

• Liquidity (exit) plans.

• Rights of co-sale.

• Warranties.

• Matters requiring venture capitalist approval (such as auditors, employment contracts, majorasset purchases, major debt obligations and significant variations of plans).

It is important that companies are fully informed and are aware of the legal responsibilities andrestrictions placed upon them under any investment agreement. New Zealand Trade andEnterprise recommends that companies seek legal council from venture capital / investmentexperts prior to confirmation of any deal. New Zealand Trade and Enterprise can provide detailsof such companies should they be required.


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Market Contacts

Investment New Zealand

Level 10 GPO Box 54

55 Hunter Street Sydney NSW 2001

Sydney NSW 200

Australia

Ph: 61 2 9234 2700 Email: [email protected]

Fx: 61 2 9234 2701 Web: www.investmentnz.govt.nz

New Zealand Trade and Enterprise

Level 10 GPO Box 54

55 Hunter Street Sydney NSW 2001

Sydney NSW 200

Australia


Fx: 61 2 9234 2701 Web: www.nzte.govt.nz

Contact: John Nicholson – Senior Trade Commissioner

Australian Venture Capital Association Limited (AVCAL)

Level 5

88 Phillip Street

Sydney NSW 2000

Australia


Fax: 61 2 9251 3808 Web: www.avcal.com.au

Contact: Andrew Green – Chief Executive

Pollitecon Publications

PO Box 324

Five Dock NSW 2046

Australia


Fax: 61 2 9713 1004 Web: www.jvjournal.com.au


http://www.investmentnz.govt.nz/


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http://www.jvjournal.com.au/

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Venture Capital Definitions

Early Expansion Growth funding for a relatively new business

Expansion / Development Growth funding for an established business

Initial Public Offering When a company offers shares to the public and lists on theStock Exchange

Leveraged Buyout (LBO) Buyout that is funded with both equity and debt. LBO’s includebut need not be MBO’s or MBI’s

Management Buy in (MBI) Funding to enable a new management team to buy into abusiness

Management Buyout (MBO) Funding to enable a current management team to buy into abusiness

Pre-listing Where a company plans to list on the Stock Exchange, usuallywithin a period of a few months

Replacement / Secondary Purchase of existing shares rather than new equity

Seed Funding to develop, test and ready a product for production, aservice for commencement and other pre-first-sales activitiessuch as company formation

Start Up Funding to commence commercial business operations ie. Whena business starts taking and fulfilling commercial orders

Turnaround Funding to enable an established (faltering) business to berescued

Information sourced from:

Australian Venture Capital Association Limited, www.avcal.com.au

Australian Venture Capital Guide 2002, Bivell (ed), Pollitecon Publications, Five Dock,Australia, pp9 – 23.

Australian Venture Capital Association Limited 2001 Yearbook, Thomson Financial/VentureEconomics, AVCAL, pp17-19, p41.

Disclaimer:While New Zealand Trade and Enterprise has verified the

information in this document, we make no representation as tothe completeness, correctness, currency, accuracy or fitness for

any purpose of the information. New Zealand Trade andEnterprise will not be responsible for any damage or loss

suffered by any person arising from the information contained inthis document, whether, that damage or loss arises from

negligence or otherwise.


venture capital in australia

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