For Australian start-ups looking for venture capital, 2009 was a very bad year. 2010 may be no better.
With the local venture pool running dry, the limited partners that are their source of funding (most often Australia's massive superannuation funds) are unlikely to be in any hurry to replenish them. And there is a further danger that those limited partners who are keen on venture capital may start shifting their investments into offshore venture capitals (VC).
None of this is good news to any local start-up not yet ready to source funds from offshore sources.
The recent annual report by Australian Private Equity & Venture Capital Association Limited (AVCAL) painted a fairly bleak picture. The 2009 AVCAL Yearbook showed that in the 2009 financial year venture firms raised only $263 million — down 19 per cent on the previous year, and an outright appalling result.
While $180 million was invested into 103 companies — a 26 per cent increase over the previous year in the number of companies that received money — the average investment size fell from $2 million to $1 million, as VCs focused on propping up existing investments.
The decline was undoubtedly the product of the global financial crisis, as the superannuation funds were hammered by their members for massive losses and fled from anything that involved risk. But the counterpoint of risk is reward — without taking risks now, these same funds won't be reaping rewards in the future.
Will the Australian venture capital industry bounce back?
According to Sydney-based VC Innovation Capital's Michael Quinn, even with a recovering economy, it's going to be hard for VCs to raise capital. Super funds already face calls on their cash from redemptions due to early retirement, members wanting more conservative investments, and being forced to make investments in existing mainstream asset classes to protect existing investments.
"Some [funds] are probably considering reducing allocation to alternative assets in general as they have been hit by losses in infrastructure, private equity and so on," Quinn says. "2010 will be better than 2009 but I suspect it will not be an easy year."
Quinn says another problem facing local VCs is that they are likely to be competing for funds with American VC firms.
"US VCs who two years ago would not return a phone call to an Australian super fund, all of a sudden are looking for investors due to their domestic limited partners retreating," Quinn says. "There is a temptation for the super funds to be attracted to investing in these US funds despite the fact their existing (US) investors are now not prepared to do so."
Does that mean money destined for Aussie start-ups will now fund their American competitors? Not everyone agrees, including Larry Marshall, an Australian ex-pat working with the Australian-US VC Southern Cross Venture Partners.
"In the US the number of funds are decreasing and it is reverting back to old school venture capital with smaller funds [that are] more hands on," he says. "The banker and private equity types in VC are getting out."
That said, Marshall believes there are only three VC firms in Australia that actually have dollars to invest today — slim pickings for companies seeking money or any superannuation funds wanting to invest it. Australian companies are getting better at raising foreign capital, such as ThreatMetrix and EvoStor, but not all companies are ready or sufficiently skilled to do this.
One of the VCs that still has money is Starfish Ventures. Investment principal Michael Panaccio has a more upbeat view, fuelled in part by economic inevitability.
"As the economy continues to strengthen, superannuation fund portfolios will get back to their previous size and then be able to consider further investments in alternatives," Panaccio says.
The cycle should take 12 to 18 months to get back on track.
Other models are also emerging, as groups such as IPitch, Sydney Angels and Capital Angels seek to organise angel investors. Melbourne-based Map Venture Partners has also raised funds on behalf of two companies by creating a syndicate from high net worth individuals, and partner Marco Marcou plans to do more of these raisings next year.
"A typical raising is $2 to $3 million, and is there to expand something that we feel is definitely worth a go," Marcou says. "What we're trying to do is create a portfolio of these investments, around six to eight, and because we have a three-year average period before we see some sort of exit."
These efforts will still leave many start-ups wondering where their funds will come from. Quinn says not to expect the government to step in and make early-stage investing more attractive however, as Canberra has been hammering the industry through policies such as its taxation of options (although he says the new R&D tax rebate does make life easier for some start-ups).
"The government support of the sector is insignificant compared with the expenditure on the much rorted roof insulation program, support of last century's car industry or other high profile spending initiatives, and this would not be encouraging investors," Quinn says.
The upshot is that the remaining Australian VCs such as Innovation will continue to slow their spending in the hope that the capital market will eventually improve. Except there is no guarantee of when that will happen.
"It is a shame, as activating a few inexpensive policy levers would make a big difference," he says.