Home Articles 12 months on from Commercial Ready axing, Australian companies are hurting

12 months on from Commercial Ready axing, Australian companies are hurting

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Nearly 12 months after the Federal Government’s surprise decision to axe the popular Commercial Ready Grant Scheme, Nick McNaughton embarked on a mission – to plot the impact of its closure on Australian innovation. In his first report, McNaughton heads to the coal-face, seeking feedback from those most affected by the cut – technology developers and members of the early-stage investment community.


May 2009 brings the first anniversary of the axing of the popular Commercial Ready Grant program run by AusIndustry. The termination of the program surprised many at the time, particularly those involved in the development and funding of new technologies, who predicted that the consequences would have a significant impact on Australian innovation.

Twelve months on, while much of the negative sentiment hasn’t changed, a number of positive suggestions have emerged.

A BRIEF HISTORY

The Commercial Ready program was once AusIndustry’s flagship innovation grants product, providing $200 million a year to small and medium enterprises. The program aimed to encourage the creation and growth of Australian companies by fostering R&D, proof-of-concept and early-stage commercialisation at the grass-roots level. The program also promoted collaboration between industry and research institutions.

Historically, this program had bi-partisan support. During the 1980s, the then Federal Labor Government introduced Grants for Industrial R&D (GIRD), which were designed to assist companies that were not yet profitable and, therefore, unable to access the R&D tax concession (the same principle as its successor, Commercial Ready). The Howard Government replaced GIRD with the R&D Start program in the mid-1990s. This program morphed into Commercial Ready (CR).

Commercial Ready was largely supported by the industries and organisations it was designed to support. It provided a business viability process that forced applicants to crystallise and communicate their business plan and provided incentive for them to secure external funding on a like-for-like basis. CR supported the successful commercialisation of many Australian innovations, leading to the emergence of substantial companies such as ResMed and Unwired and other less prominent but nevertheless highly successful companies.

The CR program was abruptly terminated in mid 2008. In justifying the decision, much was made of a comment The Productivity Commission made in its 2007 report into Public Support for Science and Innovation:

There is robust evidence indicating that the Commercial Ready program supports too many projects that would have proceeded without public funding assistance.

Past and current participants in the program were quick to question this comment. Early-stage, high-risk, high-growth enterprises were not distinguished from larger firms, which were accused of receiving “industry welfare”. The implication in the report is that some funding was too large, even when capped at $5 million. (Of the 454 grants, only two were at this cap: Intellection, a CSIRO spin-out, and BluGlass Limited, spun out of Macquarie University.)

The Productivity Commission did not argue that the program should be discarded, but that a stronger filter should apply to grants.

A National Innovation Review, lead by respected innovation veteran Dr Terry Cutler, was commissioned by the Federal Government as part of the portfolio of its new Minister for Innovation, Senator Kim Carr MP. The outcomes were produced in a report titled Venturous Australia.

STRANDED

When the axe fell, over 70 companies were caught in the application queue. The last 12 months have been challenging for many of these applicants.

Entrepreneurs have been faced with a perfect storm of bad news: the Global Financial Crisis, the bank crisis (tightening up credit markets), the stock market meltdown (turning high net-worth individuals into cautious, cash-conscious investors) and the retail slowdown raising the bar on new business procurement.

Technology venture Audinate had previously secured VC investment and had an application for $1.6m in the CR pipeline.

Since the axing of CR it has pursued far less aggressive development plans and more conservative growth. The business may now need to raise money this year rather than late 2010, as originally planned.

“The demise of the Commercial Ready scheme could not have been more badly timed, followed as it was by the global economic crisis…. Start-ups who were anticipating using the scheme to underpin their R&D budgets and provide a longer runway to achieve commercial success may now be finding themselves having to try to raise additional venture funding sooner than they otherwise would, and in a very poor financial climate.”
David Myers, Chief Operating Officer for Audinate.

Seasoned Australian entrepreneurs expressed similarly strong views about the CR axing. Brand Hoff, who founded Tower Software in 1985 and sold the globally successful company to HP in 2008, made the following observation.

“I believe that scrapping the Commercialisation Ready grant scheme was one of the most short-sighted decisions ever made by any Federal Government… The Government might as well cancel all sorts of R&D concessions and close down University R&D, because the next delicate stage in the commercialisation process has been cancelled. Just watch as our most promising entrepreneurs and researchers leave Australia to find a better commercialisation climate. Goodbye innovation, just when we need it!”
Brand Hoff, Founder, Tower Software

Hoff is now the Director of a number of early-stage, high-tech companies.

Scarcity of funding options for early-stage ventures in Australia was a common concern for those affected.

AVCAL made a number of recommendations to the National Innovation System Review (below).

“In conjunction with the difficulties in raising funds that have since beset the VC industry, it has proved hugely detrimental to the commercialisation of IP in Australia. This, in turn, will lead to a hiatus in economic growth in the broad technology sectors that might take years to recover from.”
Dr Katherine Woodthorpe, CEO of AVCAL (the Australian Private Equity & Venture Capital Association Limited).

But the most common concern related to product delays and the impact that reduced R&D funds can have on an innovation’s speed to market.

“The loss of the $250k CR Grant has been a huge blow and has resulted in time delays for our rollout in Japan and China…. This has also delayed export income from those countries.”
Graham Kelly, CEO of MyStaff

“We were negotiating with Venture Capital at the time (of the axing of CR) and looking to match the VC money with the CR. When CR fell through, so did our negotiations with the VC. This put the company back a good six to 12 months.”
Gayle Clarke, MD of Neuro Vision Technology.

“Early stage companies need to create global barriers to entry, which in turn support sustainable competitive advantage…. To do this, they must be properly capitalised at the early stages, because that’s when they get their patent priority dates and where they get their leading edge. Australian companies are insufficiently capitalised in their early stages and, therefore, their barriers to competitors are not sufficiently water-tight.”
Dr Roslyn Brandon, MD & CEO of Athlomics

To illustrate the point, Dr Brandon provided the diagram below.

market-failure-slide_580w

Brandon continues: “VCs are unlikely to fund a company in the very early stages because it is still too risky. Therefore, the CR scheme was vital to get small companies off the ground and to help to decrease their risk profile and to make them VC-ready.”

WHEN THE MONEY’S IN THE BANK

The news and views from companies who successfully closed their CR applications prior to the axe dropping is different.

Victor Skladnev, the CEO of AiMedics, which gained a $2.75m grant in June 2007 to accelerate the commercial development of its life-saving diabetes HypoMon® product, had nothing but praise for the grant.

“CR has made a huge difference. The support has given the company that extra boost to go ahead and achieve commercialisation…. There is no doubt that companies who have received CR funding are perceived to be partly qualified by the rest of the investment community.”
Victor Skladnev, CEO, AiMedics

AiMedics secured a significant VC investment, with the grant application doubling the commercialisation runway. Skladnev believes, “the scrapping of CR will have a huge downstream negative and regretful impact on R&D in Australia. A form of CR needs to be in place.”

Simmersion Holdings secured a $836,000 CR Grant in July 2007 to build a high definition Virtual Worlds platform.

“We used the funding to build this platform, which we shipped last month. Without the Commercial Ready Grant, Simmersion could not have undertaken this R&D.”
Bob Quodling, CEO, Simmersion Holdings

The company leveraged the grant to secure venture investment domestically and from Japan.

“At the peak of this R&D activity, our monthly average R&D head-count expenditure exceeded $80,000,” said Quodling. Simmersion Holdings’ CR Grant concluded at the end of June 2008.

“Had the Commercial Ready program continued, we would have submitted a follow on application for grant funding for this R&D through to at least the end of 2009,” said Quodling. “Obviously, this $60k+ R&D expenditure has a serious impact on cashflow.”

WHAT ABOUT THE TAX CREDITS AND OTHER GRANTS?

While those who missed out on CR were often invited to apply for tax credits, many considered this solution flawed, as the tax credits are retrospective and real costs are incurred as much as 14 months prior to the rebate being applied.

“In the CR program, there was no significant leakage of public funds. Once the company received the grant, it paid 30 percent tax (as grants are counted as income). The money was then spent by the company, largely on salaries and wages, where the government immediately recovered another 25-47 percent in PAYG payments. The net result is a significant proportion gets returned to government coffers in the short term anyway.”
Roslyn Hughes, MD of Origin Ventures

Luceille Outhred, CEO of Digislide, had this to say about the suggestion that Digislide apply for alternative grants:

“The Commercial Ready program was an absolutely fantastic program, I believe that by reducing the focus to Climate Ready there is a very real danger of some great emerging technologies being overlooked, or falling over, or being sold offshore for minimal early-stage patent value – with Australia missing out on the employment opportunities, the commercial synergies, the tax benefits and the value add that comes from keeping your development of technology within Australia.”
Luceille Outhred, CEO of Digislide

EYE ON THE HORIZON

So what is the way forward? It was the unanimous view of all participants and commentators polled for this article that some form of new Commercial Ready should be immediately re-introduced. Many recommended an expansion of the program.

The two main groups that provide the co-investment funds for early-stage companies (Angels and Venture Capitalists) have been most vocal in their government lobbying.

“The AAAI has recommended the formation of a government-funded early-stage co-investment fund…. This is a more effective and relevant model than the IIF and pre-seed fund. Of particular interest to Angel investors is a funding scheme that can support a larger volume of entrepreneurs than the 20 per year supported by VC alone.”
Jordan Green, Deputy Chairman of the Australian Association of Angel Investors (AAAI).

AAAI research shows Angels (or high net-worth individuals as they are also known) fund over 5,000 deals per year in Australia.

Roger Price, General Partner at Innovation Capital, recommends diverting some of the IIF money to create a fund for co-investment with established VCs.

“Now is not the time to try and create new fund managers, but to consolidate around the experienced. It is hard enough to develop the skills and experience to be a successful VC without creating an environment that promotes the dilution of this pool by creating more sub-economic managers.”
Roger Price, General Partner at Innovation Capital

AVCAL made a number of recommendations to the National Innovation System Review. These included:

1. Retain and bolster the highly successful Commercial Ready and Commercial Ready Plus programs. These programs have played a critical role in assisting early-stage companies through to viability. They noted the emergence of Cleantech as a new sector, but suggested that it should be retained as a competitive program within the suite of Commercial Ready programs

2. Change the time at which a tax event occurs on shares and options held by entrepreneurs and their employees to the time when actual capital gains are crystallised. We believe this will remove a major and long-standing financial disincentive to attracting talent to commercialise innovation.

3. Double the Government commitment to an individual licence within the Innovation Investment Fund (IIF) Program, even if this reduces the overall number of licences. We believe this modification to the application of critical Government funds will enhance the performance of new VC operators to better support national innovation.

In its additional submission to the National Innovation Review, AVCAL provided a two-part solution.

“In the absence of a Commercial Ready program, AVCAL is proposing a loan scheme as an alternative to a grant scheme to fill the commercialisation gap. It should employ an infrastructure similar to that which allowed Commercial Ready to be such a success. Such features would include the competitive nature of the former grants and the use of independent committees to evaluate the applications to the scheme. Their second proposal centres around the R&D Tax Offset for small companies with the limit on R&D expenditure eligible for the offset being lifted, ideally to $3m.”
AVCAL

WHAT NEXT?

At the time of CR’s closure it was reasonably contemplated by many that the cut would allow the Innovation Review some flexibility in recommending a replacement program. It is now nearly one year since the axing was announced, with no word on a replacement or expansion.

The damage caused during this lost year is multiplied by the impact of having to start a new funding program with new staff managing it. From an investor’s point of view, the CR Grants gave VCs or Angels leverage, making an otherwise unacceptably risky venture, acceptably risky. The loss of CR will fundamentally mean fewer businesses secure early-stage funding, threatening the whole early-stage funding ecosystem.

There is a belief and expectation that the Federal Government needs to reassure participants that the Innovation review was one of substance and not simply for show.

What is clear is that many entrepreneurs, inventors and members of the investment community will watch the 2009 Budget with interest to see if the support and commercialisation of innovation are truly priorities for the Federal Government.

Nick McNaughton is CEO of Blue Cove Ventures, an investor in early-stage Australian companies.

There are some signs the Government is listening. On March 18th Senator Carr announced the creation of the Innovation Investment Follow-on Fund (IIFF). This $83M fund will be accessible to early stage start-up companies and managed by over twenty venture capital fund managers licensed by the Commonwealth under existing programs. The money will be used to invest in innovative firms bringing promising new technologies and services to market.


COMMON VIEWS

The general feedback received on the axing of CR revealed common themes. It was generally agreed that the scheme, as it stood:

  • Provided incentive to attract external investment and also gave technical credibility to the recipient company and increased their chances for success in gaining external funding.
  • Provided a commercial training ground for entrepreneurs, scientists and engineers.
  • Focused on fostering “technology-based” small businesses, which drive significant economic development.
  • Helped companies extend their runway by leveraging the scarce early-stage funds available in the Australian market.
  • Ultimately, didn’t cost the government much money. A significant proportion of grant money was returned to government coffers.

A strong consensus has now emerged within the investment and SME communities that the axing of Commercial Ready will lead to:

  • The rapid acceleration of the “Brain Drain”.
  • Intellectual Property (IP) being lost overseas as companies go offshore to raise funds.
  • A reduction in capital flowing to the early-stage sector, with less Angel and VC money available for start-ups, from both domestic and foreign sources.
  • A loss of the ability to put in place the critical barriers to global competition.
  • A restriction of new export opportunities.
  • The loss of a well-qualified and experienced team of public servants in AusIndustry – this cannot be replaced in a short or medium time-frame.
  • The loss of jobs. Putting companies on slow growth paths and restricting R&D expenditure to preserve cash usually equates to job losses in early-stage companies.
  • Lost leverage. The loss to the industry is well above the approximately $700 million in ‘savings’, taking into account the matched funding.
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