Are Australian investors overly conservative?

Getting venture capital for any start-up is hard work. Even in the US, the world’s biggest venture capital market and the mecca for start-ups, only two out of every hundred get funded.

It’s even more difficult in Australia where there is a smaller market. Entrepreneurs say an even bigger problem is that the venture capital firms here are conservative.

Start-up specialist Fiona Boyd, founder of RushCrowds, a social media site that sends people to music, arts and entertainment events, says Australian VCs are just timid.

“They’re not actually hunting and looking for the deals,’’ Boyd says.

“They are very vanilla. They want it all beautifully wrapped up and presented.”

“But you know what? It’s venture capital, no one really knows the future and when people are playing with new technologies, the outcomes are mainly unknown, apart from the fact that you can create great technology, test it, put it into market and build up from there.” 

Valley of death

Significantly, RushCrowds has not been able to get any interest from VCs here. But it plans to set up operations in San Francisco and has already had positive discussions with venture capital firms in Silicon Valley.

“What happens here that might be different to Silicon Valley,” she says.

“Here, everyone is very focused around their rules and their process which is good to a degree and it may lead to some degree of self protection but I think they are missing the opportunity.”

“There are a number of companies that are going straight to Silicon Valley unfunded because they know that’s where the risk money is.”

The problem, she says, is the “valley of death” for start-ups that are looking for anything less than $5 million.

“They are simply not interested. The Australian VCs will probably be doing themselves out of good deals if they don’t become more active at a lower range of one to five,’’ she says.

What makes it more difficult for start-ups now is that venture capital firms around the world are investing less.

Part of it is because of the global financial crisis, the other part is that investors are now more conservative and gun-shy.

Global dip

Brigitte Smith, managing director of GBS Venture Partners, puts it bluntly: “It’s going down fairly precipitously and that’s a global phenomenon.”

“The volume of venture capital in the United States is probably at half to a third to the level that was being raised in 2007 so there has been an extreme contraction of the industry globally and we’re seeing that also in Australia.”

Figures from the Australian Private Equity and Venture Capital Association Limited (AVCAL) show that in 2011, VCs invested $120.6 million in 76 companies, the lowest since 2007 when they invested $150 million in 68 companies.

In 2010, they invested $186.5 million in 92 companies, in 2009 it was $209.9 million in 97 companies and in 2008, they invested $201.9 million in 72 companies.

There are approximately 26 funds in Australia, but of these probably only 10 are actively investing. They most commonly invest in life sciences (45%), information and communication technologies (30%) and clean tech (5%).

Most funds are mandated to invest in Australian businesses and it is estimated that 80% of Australian venture capital goes to Australian companies.

With some 250-300 active portfolio companies, the average investment range is $4-$15 million. They are not drawn to anything less than that. Total funds under management are about $2.3 billion.

Chris Nave, a partner at Brandon Capital Partners, says the problem is particularly acute in Australia.

“While the drop in Australia has been precipitous like in the US, Australia is starting from such a lower base,” he explains.

“While the US venture industry has contracted, there are still a lot of funds under management but because we have such a low base in Australia, we are not unrealistically facing a situation in two or three years where there no venture capital will be available.”

The narrow focus of venture capital funds – life sciences, ICT and clean tech – means that many industries will not get a look in.

But Smith says the venture capital funds are struggling to keep up with even the sectors they already cover.

“We don’t have enough venture capital investments for the industries we invest in,’’ she says. “The core industries we invest in are being overlooked just to start with.”

Funding gap

Starfish Ventures co-founder Michael Panaccio concedes that some industries will be overlooked. There is a big gap between the haves and have not’s.

But he says they need to present features that would attract venture capitalists. In a sense, they say, eligible industries are self-selecting.

“Manufacturing hasn’t had the kind of support it probably warrants and most venture capitalists by their very nature are directed towards technology,’’ Panaccio says.

“So unless you have a manufacturing enterprise with some world beating technology, you’re not going to draw the interests of VCs.”

He says the three sectors of life sciences, ICT and clean tech play to Australia’s strengths.

Australia is a leading player in the medical industry; Australians have shown themselves to be great adopters of technology and Australia with its abundant sun, wind and surf is suited for clean tech.

No crazy money

Venture capital firms reject suggestions that they are conservative, that they don’t have the “crazy money” approach of Silicon Valley.

But they need returns. Entrepreneurs wanting to attract venture capital need good ideas and good business plans.

“If it’s a solid idea, there are investors in the market and they should go and meet those investors with a well thought out plan,’’ Smith says.

“If it’s a stupid and crazy thing to put your money in, then it’s not something we need.”

“We’re willing to take a risk if we think the individual is competent and they know what they’re talking about and understand what’s ahead and they put together a plan that has some possibility of being successful.”

An alternative for entrepreneurs is to use angel investors who, unlike the venture capital firms, put money into start-ups at the seed stage, often where the only tangible product is an idea in someone’s mind.

In 2009, Australian angels invested $1.4 billion in more than 5,000 companies but like the venture capitalists, they have a narrow focus.

They focus on biotechnology, IT, communications, web based software and some manufacturing.

Getting beyond the idea

Vern Bowles, the founder of Hantech, says one of the big reasons for the gap between venture capital and business is that the innovators need to map out how exactly the business will grow.

To attract venture capital, they need business savvy.

“The disconnect is that it’s often a lack of knowledge on the side of the inventor and understanding of taking a product through to where you think it needs to go,’’ he says.

“You might have a great idea but you have to develop it.”

Still, at this stage the VC industry in Australia is struggling to attract investors. One of the big issues at the moment is the inability to attract interest from superannuation funds.

Super funds are now run by fund managers who have a two to three-year investment horizon. Venture on the other hand is a 10-year game.

Another problem is that with super choice, most people are now nominating that their funds stay in cash, away from investment.

Also, Australia’s Future Fund has ignored venture capital.

AVCAL CEO Catherine Woodthorpe says: “The Future Fund is actually precluded from taking nation building into account when it makes it decisions, it has to be on purely on a financial basis and that’s unique in the world.”

“Most sovereign funds have an element of nation building in their mandate whereas with the future fund that is quite the reverse.”

The venture capital has a big job ahead of itself educating super funds and the public about the importance of developing Australian industries, something that will be there when the mining boom ends.

But at the same time, entrepreneurs will need to find ways to attract reluctant VCs, or else try their luck overseas.

This article first appeared on StartupSmart.