This post is a collaboration between BROSO™ and Tom Spencer, and was originally posted on Truth Has No Temperature.
Why is the Australian venture capital industry almost non-existent and irrelevant on a global scale?
- A massive misallocation of capital, particularly when it comes to Australia’s $1.7 trillion superannuation bolstered capital pool, the fourth largest capital pool in the world.
- An attitude of risk-lethargy that impedes any real innovation from happening within Australia.
- An ingrained fear of failure that extends to the commercial world and business start-ups, to the point where in Australia there is a very negative attitude towards anyone who declares bankruptcy, the net result of which is less risk-takers, less innovators, less venture capitalists, and most importantly less GDP growth and a diminished tax base.
Many of the start-up opportunities for venture capital exist in the digital or online space, and these ventures by their very nature belong in an international market. Failure of Australia to play in this global sandpit means that Australia is experiencing a flight of human and intellectual capital.
In order to have a functional venture capital industry you need quality start-ups.
So where do these come from, exactly? Generally in the US and Europe it is from within high-quality University programs.
So where are the incentives to start new ventures in Australia’s vibrant University culture? Perhaps the answer is that Australia has a much too generous University and accompanying welfare system that fosters a sense of entitlement and robs young Australians of the desire to create, or take on any risk.
Why does this matter?
With the level of imagination, commercial creativity and desire to innovate in Australia there are all the ingredients for a thriving startup culture and venture capital industry.
But of course there’s the other side to the coin: capital. This is where the Australian venture capital industry has bordered upon impotence.
They simply can’t seem to raise serious capital.
Here are the facts:
- Total venture capital investment in Australia in 2013 was barely AU$150 million; and
- Total venture capital investment in Australia in 2014 increased significantly but still only amounted to AU$516 million.
Compare this with the total venture capital investment in Europe and the US:
- Total venture capital investment in Europe in 2013 was AU$9.5 billion (63 times the amount of Australian venture capital investment over the same period); and
- Total venture capital investment in the US in 2013 was AU$42.3 billion (282 times the amount of Australian venture capital investment over the same period).
An interesting comparison is to consider the total investment by Chinese Investors in Australian residential property:
- Chinese investors pumped AU$5.9 billion into Australian residential property in 2013 (40 times the amount of Australian venture capital investment over the same period); and
- Chinese investors pumped AU$12.4 billion into Australian residential property in 2014 (24 times the amount of Australian venture capital investment over the same period).
But a lack of capital is absolutely NOT the problem. It’s where Australia is deploying that capital.
Australia has one of the largest wealth markets in the world. Australia’s capital pool has grown at an annual compound growth rate of 12% p.a. since 1992.
The unprecedented growth in Australia’s capital pool has obviously been underpinned by its superannuation system which requires a portion of all Australian workers’ incomes to be contributed to a retirement pension fund.
Are there unintended consequences of the private and public sector both ignoring venture capital as an asset class in Australia?
One of the unintended consequences of ignoring the venture capital industry in Australia is human capital flight. What we mean by this is that if the money is not available to invest in new initiatives and to enable young entrepreneurs to start and grow their ventures in Australia then many of these people will simply leave the country. If the government invests in 13 years of school education and then 3 to 5 years of university education only to see the best people leave the country, then this is a huge gift to the rest of the world and represents both lost opportunity and a huge drain on the Australian economy.
A lack of venture capital money means that it will be difficult for innovative young Australians to launch new ventures and manage to survive long enough to reach profitability.
Consider the enormous tax losses suffered by the ATO and the general reduction of the Australian tax base as a result of losing an entire multi-billion dollar asset class to another hemisphere.
Australia could realistically expect to have a $5 billion a year VC industry.
Now let’s make some assumptions about income tax, corporate tax, and GST.
Assuming there are 250 investee companies and on average each of them generates revenues of $20 million per year that equates to $5 billion in annual revenues overall. If the average company has 20% net margins, then this would produce earnings of $2.4 million and the government could hope to collect $180 million in corporate tax revenues. The government would also pocket $500 million in GST revenues (more than what the VC industry invested in Australia in 2013).
Assuming that salary and wages for each company represents 30% of gross revenues and that the blended income tax rate is 28% then this would also mean that the 250 investee companies would produce $420 million in income tax revenues.
All in all, the government is missing out on a potential $1.1 billion in tax revenues per year.
What are the problems with the ingrained culture of the Australian venture capital industry?
American VC funds are willing to invest serious money in early stage ventures because they know how profitable it can be.
The US sees more exits, at higher valuations, and the success of American VC funds has attracted more VC players, more money, and more entrepreneurial ventures.
Part of the problem in Australia is that there is less money available, which means that it is harder for Australian startup founders to get meetings with investors and harder for them to secure investment.
But lack of money is only part of the problem. Another problem is that startup founders typically have to work harder and wait longer to secure investment. At the early stage of a venture where every day counts, delays in securing funding can mean the difference between success and failure, and distract founders from the vital task of growing the business.
Lack of money and longer waiting times are not the only problems though. The main problem is that the Australian VC industry lacks the visionary mind set required to grow successful new companies in Australia.
In the States, the VC industry is enthusiastic about investing in early stage ventures, whereas the mood in Australia is sceptical and hesitant. American VC investors look for passion and market potential, and know that asking for financial forecasts from a seed stage company is pointless. Down under it is a different story. Australian investors typically require a full blown business model with financial forecasts, which is genuinely impossible to provide if the venture hasn’t proven its business model and doesn’t yet have any customers.
What is the New Philanthropy?
Philanthropy is defined by the Merriam-Webster Dictionary as the practice of giving money and time to help make life better for other people.
The push for a more significant, better funded venture capital industry in Australian can be framed as a type of New Philanthropy.
We believe business is about solving problems and delighting people, and this becomes viable when businesses manage to do this in a financially sustainable way.
In any case, the New Philanthropy is not a new concept: this is basically what Richard Branson already does when he says he believes in supporting new entrepreneurial ventures and to our knowledge he signed Bill Gates’ giving pledge on that basis, which means he is not conforming to the way that most people would delineate business and philanthropy/charity.
Australia requires the New Philanthropy, and the push for a Renewable Capital Innovation Fund.
By Benjamin S. Broso B.Bus LL.B (Hons) and Thomas D. Spencer B.Com LL.B (Hons) (Sydney) MSc Financial Economics (Oxon).