Big superannuation funds and investment houses have trillions of dollars to invest on behalf of Australians, but the money is not going to startups.
That means Australia lacks innovative companies like Apple, Amazon and Google, which drive the US sharemarket and create jobs for a new generation of workers in the industries of tomorrow.
Getting the venture capital thing right is really important.
The chart below tells the story of companies that have come into existence through venture capital funding rounds and have since moved into the $100 million valuation category.
Many are recognisable names that make products we all use. Some, like MYOB and Aconex, did it all in Australia.
Others, like Zoox and Afterpay, attracted funding rounds in the US as well.
But none would have got going without first-stage funding from Australian venture capital funds.
Investment in the wrong place
Overall financial investment is jumping, with the superannuation sector now worth $2.8 trillion and acting as a major force in capital formation.
But funds available for the vital first stage in venture capital (VC) startups is shrinking.
Dr Geoff Waring, partner with $4 million VC fund Stoic Venture Capital, said Australian startups were being held back by the investment strategies of super funds.
“Superannuation funds have been increasing their allocation to exchange-traded funds [ETFs] as they are easy to invest in,” Dr Waring said.
That means small Australian companies “are losing billions of dollars of potential investment to large capitalisation and overseas companies”.
“Superannuation funds could be earning more through longer-term venture capital investment than compared with today’s short-term public equity markets,” Dr Waring said.
Even money that is going into the VC space is moving towards big deals for companies that are already up and running.
“Since I came into the industry in 2013, funding support for stage-one raisings that need between $500,000 to $1 million has fallen away, particularly since 2017,” said Paul Naphtali, CEO of venture group Rampersand.
Last year about $3.8 million went into VC early stage funding deals compared to about $7.2 million in 2017, according to Rampersand.
Deals valued between $1 million and $10 million also fell dramatically.
Conversely, overall VC investment is growing strongly. It topped $75 million last year and, despite the pandemic, reached roughly $65 million over the year to June 2020.
“The VC market has been distorted, with early-stage development lagging as the big private equity and super funds move in and the weight of money flows towards big pools,” said Ron Finkel, managing director of VC firm Momentum.
“They need deals valued at between $3 million and $10 million to justify the time and effort involved in researching a potential investment.”
As a result, the big funds are incapable of making the small investments that groups like Rampersand ($36 million) and Momentum ($32 million) can put together.
“Many companies aren’t looking for big dollars – it might be $200,000 to $500,000 but they need experience as well as money and all that adds up to wisdom,” Mr Finkel said.
With the big funds unable to provide that, the pipeline of new companies building employment is not what it should be.
As the above chart from the OECD shows, Australia only just makes it into the top 10 in global startups.
Comparable countries like Israel, Canada and Sweden are doing far better, highlighting the need to channel more money into stage-one funding.
It’s looking up
But while Australia might be lagging, the situation has improved in recent years.
“The change is massive,” said Yasser El-Ansary, CEO of the Australian Investment Council.
“There was very little venture capital available five or six years ago, but now there is a lot more capital available for later funding rounds. But there is still a significant amount for seed and early funding rounds.”
However, even the largest dedicated Australian VC funds are too big to focus on really small deals.
“As funds grow they tend to pull back from early-stage financing because they aren’t suited to what is essentially a cottage industry,” Mr Naphtali said.
Little local interest
Geoff Dolphin, chief financial officer with Telstra Ventures, said his fund invests very little in Australia at all.
“Our fund has a global outlook with about 70 per cent invested in the US, 10 to 15 per cent in China and a little in Australia,” Mr Dolphin said.
Which is worrying, as ensuring we have a growing pipeline of new firms in evolving areas will help build national prosperity.
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