What makes a venture capitalist tick?
Su-Ming Wong knows.
Wong lives and breaths risk and reward. From his early days with the pioneering private equity fund Australian Mezzanine Investments, to his most recent $165 million private equity play with CHAMP Ventures, Wong has built a career around the birth, growth and maturity of the Australian venture capital industry. Australian Anthill cornered this elusive VC to get a ‘behind closed doors’ look at raising private capital in Australia. By James C. Tuckerman.
What is the Su-Ming Wong story? How is it that you arrived on the Australian venture capital scene?
Before I joined the company that became CHAMP, which was Australian Mezzanine Investments (‘AMIL’), I was an advisor at one of Australia’s merchant banks. It doesn’t exist anymore, but it was called Capel Court. I used to bring young companies in to meet Bill Ferris and Joseph Skrzynski, the founders of AMIL. As a result, I got to know Bill and Joe quite well and they took a liking to me and it went from there.
How has the industry changed since then?
You’ve got to think back to 1991, when the private equity industry was very much still in its infancy. In fact, you could count on one hand how many active managers occupied the market. Bill Ferris was one of those. AMIL raised its fi rst fund in 1988, which was only $30 million. Today, we can do one deal and invest that much.
At that time, venture capital had a bad name. We’d just come off the back of the MIC Program, it was a tax driven venture capital investment scheme and a lot of investors hadn’t done so well. Since then, the industry has changed quite remarkably.
We raised our second fund in 1993 — a grand total of $50 million. And then we raised our third fund in 1996, which was $85 million. In 1999, Australian Mezzanine Investments merged with Castle Harlan to form Castle Harlan Australian Mezzanine Partners, which is where the acronym CHAMP comes from. My partner, Andrew Savage, and I formed CHAMP Ventures.
Our most recent fund CHAMP Ventures Investments Trust 5, in 2003, raised $165 million.
How do you define CHAMP Venture’s stake in the market?
At this stage, we are very broad. Our traditional areas are early expansion stage, expansion and buyouts. But our fourth fund, called AMWIN Innovation Fund, which is an early-stage fund, gave us the opportunity to be involved across all stages.
So in terms of what we do, you can’t simply classify us as an early stage investor. We look at any business that has the potential for profi table growth. We have technology investments that we make money out of, but we also make money out of more mundane, old economy style manufacturing businesses as well.
Is there a reason why you don’t specialise in any industry sector?
There are two reasons. Firstly, The Australian market, unlike the US market, is quite modest in its scale and depth. If you want to specialise in 3G telecommuciation technology investments, like some US firms can do, you’re going to be waiting a long time for the next deal in Australia. Equally, if you want to be a media investment specialist, looking for media communication investments, again you’re going to have to wait a long time.
The second reason is that we believe that the way we can add value, apart from money or capital, is really by offering business management skills, strategic thinking and business development. And those skill sets cut across all industries.
Does size matter? What is the average size of a CHAMP Ventures investment?
Our fund size has grown over the years — $30, $50, $85, and then $165 million. So, our minimum investment size has also grown over the years. Our minimum investment from our latest fund is about $7.5 million. So, there are a lot of early stage expansion companies that we can’t do.
What sort of turnover are you looking for?
Our smallest investment is nudie Foods. We put about $7 million into that business — it’s a business that we like. We like Tim [Pethick] and the brand, and we’re helping the company to consolidate its strengths, so that it will grow into a much bigger business. The minimum turnover of a potential investee company averages at about $10 to $11 million. But the turnover is not so important. It’s more about how we rate the potential of the business.
How do you go about evaluating many of these businesses? Is private company evaluation a science or a black art?
It’s not so much a black art. It does involve a lot of intuition. But it also involves financial analysis, risk analysis. It’s a combination of all these things. There isn’t a formula that you can always apply. A company can come in and give me a very formulated company valuation, and say, “There’s a company in the US, in my space, trading at 3 times revenue. So, my company evaluation should be three times revenue as well.” I don’t think that you can translate a company’s value by proxy. I think it’s a combination of many things.
For me, the most important question is whether I feel I can work with the entrepreneur. That is the first question. If I can’t work with them, there’s no point talking further. And how do I make the fi naljudgement call? It is experience, checking with other people that have worked with the entrepreneur before and finding out if they can accept advice.
Entrepreneurs are passionate about their businesses. They’ve got to be really focused. But often they can’t take constructive criticism or others’ ideas well, they think that changing the way they do things will negatively impact their execution. I find our most successful partnerships have happened with people who want to engage with us, who listen to us, understand the issues and go back and change things for the better.
What advice can you give an entrepreneur speaking to a VC?
Try and see it from the investor’s perspective as well as your own.
I think entrepreneurs are often very unforgiving of venture capitalists. One of your last editorial pieces mentioned ‘VC bashing’ and things like that. I sense that there is a perception in the market that venture capitalists treat entrepreneurs unfairly. The focus of good venture capital funds, or private equity funds, is on making good investments to generate good returns for their investors. That way they can build up a sustainable funds management business.
I think entrepreneurs, on the other side, who have been living and breathing their business for a long time, don’t understand where we are coming from. They think, “Gee, I’ve gone through all that analysis. I’ve removed all the risk. This is a surefire business plan. All you have to do is sign a cheque. What’s the problem?” I have never come across a business owner that hasn’t said that to us. Every business plan has a revenue growth trajectory that is always up.
Another magazine recently used the term ‘vulture capital’ to describe ‘venture capital’. How does that make you feel?
I know that all my colleagues in the venture capital industry are working very hard to find good, young, innovative Australian companies to invest in. I think this ‘vulture’ connotation can be tied to perceptions about valuation. Entrepreneurs feel that they never get a fair valuation. I can understand the emotional cross they bear because, as I said earlier, the entrepreneur has sacrificed a great deal. The opportunity cost has been very high and sometimes the venture capitalist’s valuation is painful. But to say that venture capitalists are ‘vultures’ is to say that we are out to buy something on the cheap. If that’s the case, the venture capital industry should be showing much, much better returns. Brad Howarth’s article in your last edition says that venture capital returns have been disappointing. That has been the bane of the whole industry. The average investor has never received good returns in the early stage investment area. And that to me is the test. If vulture capitalists are preying on start-ups, they should be showing better returns.
Many people believe that the US venture capital industry is more entrepreneurial than the Australian industry. Do you think that is true?
That’s not true. I think that people have this romantic vision that a US early stage start-up has a greater chance of success than an Australian one. Frankly, there’s something that Australians need to understand. It’s only on the West Coast in California, in Massachusetts and maybe in Texas that there are vibrant venture capital industries. Other states, like Michigan and Kansas, are just like Australia. All the smarts are in the north east, the west and the south east.
It’s important to understand that it’s a holistic thing. You have to have entrepreneurs and investors, and you have to have channels to market. Australia suffers on every facet of a holistic entrepreneurial eco-sytem. We have a small domestic market.
The mining industry is a classic example. The Australian mineral industry is supported by one of the most vibrant venture capital industries in the world. If someone at the back-of-Bourke decided to explore a mine, you probably could raise some money to do that. And then you have sophisticated channels to market, all the way from mining service providers to help you to bring out the ore, process the ore and sell it overseas. We have a whole service industry that understands mining. We have an ecosystem to support a mining start-up.
But think about a technology start-up in Australia, whether it’s in life sciences, software or hardware. We don’t have the holistic ecosystems that we have in mining that can help a technology startup to get its products or services to the global market.
Is there more capital available to early stage companies in the US?
I think that the US VC industry is vibrant, but if you think about the amount of money that is dedicated to early stage VC in the US compared to late stage buyout capital, the later stage buyout wins hands down.
Why do you think that is the case — in Australia and the US?
In early stage funds, the risk-reward trade off is not attractive. One of the first investments made by our firm was a midsize buyout of about $9 million. After two years, we listed the company and our investors got five times their money back. I can put $10 million into five early stage companies — $2 million each. I would have to work five times as hard and what is the pay-back? Two of them will probably go nowhere, one might give me my money back, and two might give me three to five times my money back. In dollar returns, there is no comparison.
If this is an issue in Australia, what can be done about it?
We are talking about market failure in the early stage investment arena. That’s where the Government should intervene. The Government have a early-stage venture capital support programme called the Innovation Investment Fund (IIF). The IIF has been going for only seven years and have invested in nine early-stage vc funds. I believe the government needs to continue with this programme and do more follow-on investments in the proven IIF managers.
So how can that higher risk be addressed?
We’re getting onto my hobby horse right now. The Innovation Investment Fund, where the government contributes $2 for every $1 of private capital invested. Also, the government’s return is capped at the long term bond rate plus 10 percent of the profit. Sometimes a deal doesn’t work out. But that’s ok, because the leveraging effect of the high government contribution, coupled with capped return, will give the private investor a much more equitable return on their investment — to reflect the risk.
How do you go about raising the money for your funds?
We have a good track record that we can point to. Institutional investors know us well. For someone who is trying to start a new fund, it’s a lot more challenging. You’ve got to find some institutional investors and convince them that you are worth their support.
Are there more opportunities than capital available to invest, or vice versa?
There are certainly enough opportunities out there for private equity investors, but there is a lot of competition at the moment. The challenge for the investor is to remain patient, to do deals only where the risk factor is adequately addressed in the price.