Australian startups need growth capital funding to thrive: FSI interim report

Medium and small businesses, including startups, need better access to growth capital funding, including venture capital and private equity, the Financial System Inquiry interim report has found.

The report, which was released Tuesday morning, says Australian venture capital funds have not provided investors with adequate compensation for associated risks.

Australian venture capital funds formed between 1985 and 2007 had a pooled internal rate of return -1.4%.

It says barriers to generating significant investor interest include the aforementioned underperformance of VC funds, as well as the fee structures of VC and private equity funds, the tax treatment of venture capital limited partnerships, and scale.

“The Australian market may be too small for some ventures to be viable, particularly when it comes to commercialising a product,” the report says.

“In addition, certain cultures, particularly relating to risk, and extensive networks need to be developed to facilitate a thriving venture capital industry.”

The inquiry notes it received submissions suggesting superannuation funds should be encouraged to invest in securitised SME loans and venture capital funds.

“A mandate requiring superannuation funds to do so may also involve an implicit guarantee by the Government, which the enquiry does not consider to be appropriate,” it says.

“Superannuation funds could consider investing in venture capital funds as part of a broader approach to diversifying their asset portfolios.”

It says changing the research and development tax credit system to a quarterly basis for new ventures, which VC funds argue would help alleviate cash flow constraints, is an issue that should be considered as part of the Tax White Paper process.

In a statement, Australian Private Equity and Venture Capital Association chief executive Yasser El-Ansary says if those barriers are removed, private equity and VC funds could play a more significant role in supporting startups.

“Australian venture capital funds are currently invested in around only 200 startups and early stage ventures,” El-Ansary says.

“There is substantial scope for the industry to play a greater role in building Australian businesses and creating new employment opportunities – especially in new high innovation industries of the future – if the enquiry makes recommendations for changes to some existing policies and regulations later in the year.”

Technology and the financial system

The report also highlights the role technology is playing in opening up the financial sector to non-traditional players.

“Incumbents in the Australian payments industry are facing competitive challenges from new market entrants, such as PayPal, POLi, PayMate and Stripe,” it says.

“Closed-loop pre-paid systems operated by companies outside the financial sector outside the financial sector, such as Apple, Skype and Starbucks, are holding growing amounts of customers’ funds.

“Apple has also recently signalled its interest in mobile payments more broadly and recently developed fingerprint biometric authentication for its phones.”

The inquiry received a number of submissions highlighting the potential risks virtual or crypto-currencies like bitcoin present to the current financial system.

Those risks include the safety of the funds stored in such a way, which it says are at risk of system collapse or fraud, the highly speculative nature of virtual currencies which could lead to investor protection issues, their pseudonymity and the money laundering potential that comes with it, and their cross-jurisdictional nature.

“Whether new entrants should be brought within a regulatory perimeter depends on the nature and scale of the risk they present, and who bears the risk,” the report says.

“Government needs to strike a balance that allows the benefits of innovation to flow through the financial system, while maintaining stability.”

The report concludes that government and regulators should take a flexible and technologically neutral approach to regulation, which is not currently the case as some federal and state regulations require the use of certain forms of technology.