The Federal Government should consider underwriting the management fees of venture capital firms to attract large-scale institutional investors like the superannuation funds, Starfish Ventures founders John Dyson and Michael Panaccio say.
Starfish Ventures, one of Australia’s most experienced VC companies, says government policy should encourage the creation of funds of at least $100 million, which they say has arguably become the minimum viable size for the Australian technology-focused venture capital industry to meet the current gap in the market.
And the two veterans have also warned that an influx of Chinese capital via the Significant Investor Visa scheme may have a disastrous impact on the local market – with too many small funds created with under-qualified managers.
Too much money is not a good problem to have, Mr Dyson says. The advances made in the past five years toward creating an attractive asset class of technology and tech-enabled firms for investors –both in VC and equity markets – can quickly be undone if underperforming managers undermine the credibility of top tier managers.
The impact would be felt not just in the early stage startup sector, but among Australia’s existing mid-tier technology success stories. Whatever attraction for listed technology stocks has been built in the past several years in Australia can disappear just as quickly.
The issue is real, and one that needs to better understand by governments. After a long period of rebuilding credibility in Australia after the excesses of the dotcom era, Mr Dyson says the nation is “poised in position where we can drive really strong returns [from the sector] over a long period.”
But the VC sector still needs market intervention in order to build a capability to cover the funding gap between the growing angel investor market and the larger rounds of $10 million to $50 million or more.
It is “near impossible” to raise money in the $2 million to $5 million range in Australia, driving some great entrepreneurs out of the market prematurely (either offshore in search of funds, or as a starved and unloved market failure.)
Mr Dyson says the government needs to consider new measures to create funds of scale and expertise to service this market. This should include incentives to get the super funds and other large institutional investors active in the tech asset class.
The much unloved Innovation Investment Fund (IIF), which was scrapped in the 2014 budget, needs replacing, he says, not because it was such a stellar success (it wasn’t) but because the market problems the IIF sought to address still exist.
Starfish Ventures, like a whole lot of local VCs, are looking to attract large-scale investment from institutional players. While they say there is growing interest in early stage tech companies, (and we know the exposure of many of these funds to VC wholesale funds in the US underscores this) there remains a “sensitivity” about management fees.
For a large fund, VCs will typically charge a fee of two per cent of funds under management.
Where a fund of critical mass is put together, then government should consider under-writing that fee. “Investors would find that very attractive,” Mr Dyson says. And no wonder, its free money.
Without the support, it is unlikely that these bigger institutionals can be attracted at the scale needed to drive Australia’s tech entrepreneur sector.
It seems completely counter-intuitive for the free-marketeers of the VC industry to call for government intervention, or for large institutional investors to demand that government pay their fees before they take an interest in the local sector. But for Mr Dyson and Mr Panaccio, this is the reality.
The sector cannot become a sustainable source of returns for Australia without scale, they say. And institutionals won’t invest large-scale funds until they see good, sustainable returns.
In the interim, the sector wants government to subsidise the involvement of the big funds.
The notion that government should underwrite fees is growing currency. Paul Cheever from the Australian Institute for Innovation has argued it is the most efficient way for government to provide assistance.
Brandon Capital, which manages the Medical Research Commercialisation Fund (MCRF), was able to raise institutional money with the Victorian Government assisting with management fees. That company (which recently exited Spinifex through its $200 million trade sale) is performing very well indeed.
The IIF had provided matching dollar investments in sub-scale VC funds that have had mixed and modest success. The VCs were selected by government through a long and questionable process. Once the lucky VCs were licenced, they would then go off and raise rest of their fund.
By underwriting management fees only in funds that have achieved scale, effectively government is letting the market decide which fund to subsidise – because they have already raised the fund.
There is also the reasonable question about where these companies that have enjoyed government subsidies end up. Is it too unreasonable to expect that having subsidised the formative years of a successful company that Australian tax-payers might expect that they stay in Australia?
Starfish Ventures says no. About one-third to one-half of its portfolio companies move offshore (for a variety of reasons.) Mr Panaccio says Australia needs to take a longer term view, that there are benefits that ultimately return to Australia as these companies are a success elsewhere.
“The aim might be that fewer of these companies go offshore. But they need to have the freedom to go where they want, to pursue the opportunities where they see opportunities.”
Ultimately, he says tethering Australian entrepreneurs to remaining in Australia because of government assistance to build the funding market would not work.
“What we are saying is that until we are able to bridge that funding gap in Australia, companies will continue to (go offshore),” Mr Panaccio said. “And that means that we will lose the benefits of all that Angel activity, or colocation spaces or even government investment in R&D.”
“There are simply not enough people who can write the next cheque of $2m $5 million.”