Australia is awash with private equity. So why is so little of it finding its way into the hands of entrepreneurial start-ups in the information technology sector? Phenomenal amounts of capital have been raised in the last six months. More than $1.8 billion was poured into cash-boxes through private raisings in 2004, through vehicles such as Allco Equity Partners and Soul Pattinson Private Equity (which raised $183 million and $125 million respectively from the public market). Most of the money raised now is earmarked for corporate buyouts and later-stage investments.
But almost none of this money went to early stage venture capital. According to the Australian Venture Capital Association Limited (AVCAL), the $123 million raised by Starfish Ventures in November 2004 was the only significant new fund raised that year. For entrepreneurial companies, this was a disaster. According to the last reported figures from AVCAL – for the 12 months to June 30, 2004 – formal early-stage VC investors (excluding angel investors and expansion capital investors) made only 19 new investments in early-stage technology companies.
Other AVCAL figures are equally alarming. In 2000, 19.81 percent of Australian private equity deals were early stage investments. By 2004, this had dwindled to just 1.9 percent. The AVCAL database may not catch every deal, with many angel investments slipping under the radar, but as a market sample it is disturbing.
The public market has regained some of its appetite for technology-based companies, as shown by the massive Google IPO in the US and locally with the recent $170 million listing of the online job advertising company Seek. But AVCAL reports there was only one Australian technology IPO in 2004 that was backed by formal early stage VC, compared to 12 in 2000. While IPO is not the only path to exit for an investor, to have only one of these events occur in a year when there was a record total of 163 IPOs is scary.
There have been signs of a turnaround this year, with the specialist early-stage investor Innovation Capital planning to raise $75 million, and Allen & Buckeridge joining with the US tier-one VC firm Draper Fisher Jurvetson to raise $200 million. But one of the dangers is that funds raised now will be investing at the wrong point in the cycle. The fortunes of the technology sector have been on the rise for a couple of years, since the tech crash. It is possible that the next few years will see another downturn in market sentiment for the technology industry. VC firms that make investments in 2005 will need to be prepared for a long haul, as a five-year exit strategy could see them looking for a way out at the time of the next downturn.
All in all, no one can expect stellar returns for Australian VCs to appear for many years yet. But the matter is becoming critical, as the lack of success among Australia’s VC funds is continuing to play against them. It has long been recognised that in comparison to the US, Australian super-funds are significantly under-invested when it comes to high-risk, high-return opportunities such as VC. To date, the superannuation funds who invest in VC have seen a lot of risk for only sporadic returns. While it is true that investors are short-changing themselves when it comes to long-term high-growth opportunities, the poor track record of VC investments is an easy deterrent against this investment class.
The introduction of portability in superannuation presents an unprecedented opportunity for Australians to decide how they maximise their retirement funds. Theoretically, that means there is a strong opportunity for many Australians to consider moving funds into companies that are more willing to invest in Australia’s long-term future by backing entrepreneurial ventures.
But unless VC funds can find a new way to sell themselves, they may miss the opportunity. And that potentially will hurt everyone.
Brad Howarth is a journalist and author of ‘Innovation and Emerging Markets: Where the Next Bulls Will Run’, a study on the challenges facing small Australian technology companies.