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Published 03 October 2012 23:37, Updated 04 October 2012 04:32
The venture capital industry wants super funds to commit more to the sector, arguing that it is Australian money and so – at a policy level – it should be directed to supporting local innovation. Illustration: Karl Hilzinger
There’s a pothole in the road for the founders of early stage companies chasing equity capital to fund their ventures. On the drive, small seed funding opportunities are accessible, especially from start-up incubators and accelerators and, in some cases, government grants. Companies looking to raise up to $1 million are having a smoother ride, thanks to more organised and sophisticated angel groups. If founders manage to avoid the hole, US venture capital funds are happy to write $10 million cheques from their growth funds for businesses with solid revenue. And for very large businesses, there is significant private equity activity in Australia.
But few manage to miss the venture capital-shaped hole for funding between $1 million and $10 million and their start-up businesses can stall as a result.
The establishment of Blackbird Ventures , a founders fund-style operation, with backing from successful entrepreneurs such as Homethinking’s Niki Scevak and Atlassian founders Mike Cannon-Brookes and Scott Farquhar, is one exciting development.
Another positive will be the federal government announcement, slated for early 2013, of which local funds it will co-invest $100 million with, as part of its Innovation Investment Fund’s next move.
Such improvements aside, there’s still a very limited market for early stage capital.
Some are optimistic that a superannuation-shaped peg will fill the hole, but local venture capital funds complain that they get muted support from Australian institutional investors.
Data from peak body the Australian Private Equity and Venture Capital Association (AVCAL) shows that of the $931 million raised between 2008 and 2011 by local VCs, 29.7 per cent or $260 million came from retail and industry super fund limited partners. Almost a third might sound generous, but it’s the quantity the industry has concerns with. In the four years during which Australian funds raised nearly $1 billion, US funds raised $73.7 billion.
At the moment, superannuation funds have about $2 billion invested in venture capital, here and overseas, Association of Superannuation Funds of Australia chief executive Pauline Vamos says. She notes it is a “teeny” percentage of the $1.2 trillion under management, but says that because venture capital is an illiquid asset class, superannuation funds prefer to have exposure to innovation by investing in small and mid-cap companies in equity markets. Funds have about $21 billion invested in such stocks, she says.
Data from research firm Chant West shows most default superannuation funds have an average 2.5 per cent allocated to private equity, but investment research manager Mano Mohankumar notes there is a divergence. “Not-for-profit funds (industry funds and public sector funds) have an allocation of about 4 per cent to private equity while retail funds don’t invest anywhere near as much (about 1 per cent),” he writes in email. However these numbers do not give a good indication of what, if any, proportions are allocated to venture capital. In contrast to private equity funds, venture capital funds invest smaller amounts in much earlier stage companies.
The venture capital industry wants super funds to commit more to the sector, arguing that it is Australian money and so – at a policy level – it should be directed to supporting local innovation.
“I think it’s a sin that it doesn’t [go to venture capital],” Southern Cross Venture Partners managing director John Scull says. “I’ll go that strong. I know this is controversial.”
And while he notes that on a fund-by-fund basis, an “incredibly conservative” approach makes sense when a mandate is to build and preserve members’ money, nevertheless, “from an overall perspective, the unintended consequence of that decision . . . is it will have a long-term detrimental impact on the vibrancy of this small nation’s intellectual capital creation, and that’s the shame.”
“The super issue; for me it’s a call to the superannuation industry to say you could make a big difference to the Australian economy by investing more in technology, biotechnology,” says the chief executive of building software outfit Aconex, Leigh Jasper. “I’d stop short of saying the government should mandate it but the government could certainly encourage it.”
But there’s a disconnect here. Although superannuation funds might spruik their records as good corporate citizens, their role is not to ensure early stage companies are kept in beanbags and offsite development days. They have a mandate to return funds plus some, to ensure that, come retirement, their members will be kept in motorhomes and Pumpkin Patch gear for the grandkids.
“Once you start directing trustees as to where they invest . . . an asset class is not assessed on its merit,” Vamos says. “Once you say 20 or 10 per cent has to be invested in a certain asset class, you get a lot of below market assets on the market to fill in what they think is a market demand, and everybody loses out. The only winner is the intermediaries.”
But venture capital’s real problem is not that super funds aren’t required to invest in them. Rather it is that they haven’t performed well enough to attract their investment. They need to prove themselves as lucrative investments rather than good policy investments.
It’s very difficult to get data on returns for individual funds, but it is generally understood that they have been poor. Cannon-Brookes says the last generation of VC funds, which were raising money at the end of the 1990s, are coming to the end of their 10-year terms and “haven’t had hugely positive returns”.
Scull concedes that local venture funds haven’t proved themselves. “It’s getting close in my opinion but it’s not yet there,” he says.
That’s as true abroad as it is here. A damning report from prolific US limited partner the Kauffman Foundation, which has about $249 million of its $1.83 billion of assets in venture capital, found that of the 100 funds it invested in over its 20-year history, only 20 generated returns that beat a public market equivalent by more than 3 per cent annually. It concludes that institutional investors that chase the feted venture capital booms only have themselves to blame if it ends badly, because they “invest too much capital in underperforming venture capital funds on frequently misaligned terms.”
Australian Super is one fund that is happy to talk about its exposure to venture capital. Of its $45 billion under management, just north of $2 billion is invested in private equity and of that, about $300 million is invested in venture capital, the fund’s head of Australian equities Innes McKeand says. The split between local and overseas ventures – predominantly US-based – is 50-50, he says.
McKeand is acutely aware of the patchy record of this risky asset class. To exceed the return from listed equities – to make up for the higher fees paid in VC and private equity – “you need to be with the top quartile guys,” he says. “You need to be with the top managers.”
VC managers know it is an uphill struggle to get investors such as McKeand to look at them. Southern Cross Venture Partners managing director Larry Marshall says its $200 million renewable energy fund was a joint venture of the Australian government and Softbank China. Similarly the firm’s $40 million Innovation Investment Fund was split 50-50 between government and foreign limited partners. “The government will have to be the main domestic supporter . . . for the next few years until the LPs [limited partners] get comfortable with domestic VC,” he writes in an email.
And at Starfish Ventures , where about 98 per cent of the $400 million raised in 2007 came from Australian institutional investors, managing director John Dyson warns that “times have changed . . . a number of investors have moved away from the asset class”. Starfish will be raising again in the next year; but while Dyson says “we feel confident we’re going to have a pretty good story”, he says the money won’t come exclusively from Australian institutions.
Fixing the hole will be a dual effort. Australian venture capital funds need to prove they are shrewd pickers and managers of early stage ventures while risk- and fee-averse super funds will need to change their tune.
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