Some people still don’t get why Australian startups need alternate policies

Although the differences between small businesses and startups have been subject to ongoing debate, there are many who don’t quite understand why these differences necessitate different policies.

What started out as a light conversation with a small business owner via Twitter DM, turned into a heated argument. The opposite party was convinced their business was a startup and deserved media attention. Once the differences between small businesses and startups were explained to the business owner, the conversation took a drastic turn, with the man saying, “startups think they’re special” and “there are two million small business owners in Australia and they’re not asking for special treatment from everyone they come meet”.

The rant continued long past I fell asleep, but to sum up his argument, he was trying to say that startups are undermining the plight of small business owners. Rather than arguing back 140 characters at a time, it would be easier to summarise my points in one article.

The term ‘startup’ is often synonymous with high growth and innovation. #StartupAUS, the non-for-profit body formed in 2012, defines startup as an emerging high-growth company that is using technology and innovation to tackle a large and often global market.

According to #StartupAUS, there are two defining characteristics of startups: 1) they have great potential to grow (or in other words, are highly scalable); and 2) they create disruptive innovations that often reshape the way entire industries work.

This definition of startup aligns with what Paul Graham, Co-Founder of American accelerator Y Combinator, wrote in his essay Startup = Growth. In short, he describes startup as “a company designed to grow fast”; and for a company to grow fast, they will need to create something they can sell to a big market.

This is where technology comes in. Although Graham doesn’t explicitly state in the essay that startups are responsible for creating new technology, there are clear synergies between startups and technology. Compared to the local cafe or barbershop, technology has greater global potential; it can be rolled out into different markets much faster. Therefore, technology is highly scalable – the first defining characteristic of a startup.

Noble told Startup Daily last year, “Technology is invariably crucial because it provides the competitive advantage and leverage necessary to grow quickly.”

He stressed further that ‘technology’ is not confined to software, hardware, mobile and net; it encompasses biotech, clean tech, advanced manufacturing, or anything where innovative technology provides a competitive advantage.

Startup vs. Small Business

Although ‘startup’ is a hot topic in Australia, it is too often confused with ‘small business’. In previous interview with Startup Daily, Kim Heras, General Partner at 25Fifteen, said most startups are small businesses, but most small businesses aren’t startups. This is because most small businesses are service businesses – restaurants, electricians, plumbers etc.

This is not to say that small businesses aren’t tech-savvy. As Noble pointed out last year, “[W]hile small businesses often utilise innovations, they typically do not create disruptive innovations of their own, and certainly not “new to world” truly differentiated innovations.”

It’s true that all businesses want (and need) to grow, but small businesses aren’t designed to grow at the speed of startups. In fact, small businesses cannot handle high-growth. If 500 customers walked into a cafe, the business would crash. Whereas, if a startup had 1 million users all signed in at once, with a good server, it can handle it. Due to the inherent nature of technology, tech startups can handle the growth that small businesses can’t.

This is one of the reasons why startups have different pain points to small businesses, and cannot be put into the same category if we really want this sector to flourish.

“It’s important to carefully define what we mean by ‘startup’ because startups have the potential to generate so much economic wealth. Although startups naturally start out as small companies, unlike other small businesses, they have great potential to grow,” Noble told Startup Daily last year.

But let’s be clear: small businesses play a critical role in Australia’s economy. Small businesses create a bulk of net new jobs in the country, “accounting for almost half of employment in the private non-financial sector and over a third (35 percent) of production” (see Connolly, Norman and West 2012).

Although data from the Australian Bureau of Statistics indicate that small businesses are less likely to engage in innovation (compared to large businesses) almost 90 percent of businesses engaging in innovative activity are small businesses. According to Connolly, Norman and West (2012), this indicates that small businesses are much more numerous. I would speculate that a bulk of small-sized businesses are actually startups, though frankly, the statement above doesn’t quite make sense. If around 10 percent of businesses engaging in innovative activity are large businesses, how are they more likely than small businesses to contribute to innovation?

From various conversations with startup founders, it’s easy to make the generalisation that most startups are not interested in becoming small businesses. They want to become large scaling businesses like Apple, Google and Facebook. When we think of successful startups, we think of hard-working entrepreneurs who took extraordinary risks in uncertain marketplaces and beat the odds.

Most startups won’t make it to their tenth year, but when they do, they create new markets, increased competition and they attract partnership proposals from smaller businesses. By creating innovative products, they transform industries or build new industries, and safeguard the nation’s economic prosperity. Not only do they create new jobs, they introduce new career paths.

Funding

Bringing new products to unproven markets is inherently risky and costly. Capital is therefore the lifeblood of startups, particularly pre-revenue startups that need to address both operational costs and human capital. Unfortunately, traditional bank lending via business loans is ill-suited to the high-risk nature of startups.

Startups rarely qualify for traditional financing via bank loans because bank loans are generally asset-based – and we’re talking physical assets. Mobile applications, algorithms and patents cannot be converted for a loan, because their values are difficult to determine. This is why we’re seeing an increasing number of funding pools emerge in startup communities across the world – like angel investment, private equity, venture capital, crowdfunding, equity crowdfunding, etc. Some pools are certainly more advanced than others.

It’s much easier for small businesses (that have physical assets) to get bank loans; and because they’re not seeking to grow fast, they don’t need as much funding. This is why startups are fighting for more options – including, for example, the legalisation of equity crowdfunding. (More on that can be read here).

It is worth noting that, currently, the Australian government is offering various grants to ‘small businesses’ that startups would qualify for, but don’t necessarily know about. Startups looking for seed funds (say, up to $250,000) can use the Grant Finder feature on Australian Government Grants to find appropriate grants.

I tried out the Grant Finder feature and selected the following multiple choice answers: NSW (location); I want to expand my current business (business ambitions); I am a woman, I am between 18 and 30 years old and I am in business with a woman (personal information); less than $150,000 (revenue generated in the last year); information technology and telecomms (type of industry); and  developing a new product or service, purchase/improve equipment, hiring and/or training new staff, and marketing and advertising (financing needs). With these selections, I qualified for 14 grant programs and up to $202,900.

The following is some of programmes startups may qualify for:

Scaling businesses, scaling policies

Adding to previous sections, let’s first acknowledge that a startup is generally not a storefront. Aside from laptops, desks and occasionally whiteboards, all their assets are in intellectual property (not physical infrastructure). Startups’ assets are usually (though not always) online, in the cloud, and based in the client relationships they’ve built. Rather than storefronts, startups are like spacecrafts – in that pace is a defining characteristic. Startups can grow from a one-(wo)man show to a company with 100 staff in 12 months, or grow from 100-strong user base 500,000 users in 12 months.

One of the grievances communicated by startups in Australia is the slow pace of policy changes. Startups feel that the government needs to act much faster to keep up to pace with startups. There are accelerators in the US that received a very small amount of funding (around $200,000 to $250,000) from the government.

But the accelerators were able to seed that investment and end up having a $2.5 million run rate within five or six months. Those accelerators grew to accommodate hundreds of startups, and created several hundred jobs – all off a small initial investment. Due to the government’s quick action in places like Washington DC, the accelerators were able distribute that investment and help startups get off the ground faster.

The reality is that many startups overestimate sales, underestimate expenses, overestimate margins, and underestimate the time, effort and resources is takes to grow fast. Accelerators, incubators, and even co-working spaces, as long as they use funding responsibly and have the right mentors involved, can distribute government funding appropriately. Local organisations that interact with startups regularly are probably best equipped to understand the needs of startups and effectively distribute funds (for instance, in small increments or stages).

The problem (though not necessarily a problem) is that many of these local firms are raising funds from investors who are seeking to profit from their investment – which is completely fair, because that’s the game. But startups are also quite protective of their IPs, and don’t want to give away equity or are not equipped to afford the repayments demanded within a particular timeframe. Incubators have business models too; and in Australia, those business models are often seen to be too stringent for startups that need more flexibility.

In a similar way to educational scholarships, I would argue for government to provide resources to those who know their community best – coworking spaces like Fishburners, River City Labs and York Butter Factory. South Australian government has been very supportive of Majoran Distillery, Adelaide’s only coworking community, allocating allocate $400,000 worth of funds to industry-led skills programmes.

Sam Chandler, Founder and CEO of Nitro, suggested last year that we tap into Australia’s superannuation funds – which tend to sit quietly on government shelves, gathering dust and cobwebs. If even a small portion of this was allocated to help entrepreneurs grow the economy, the long-term impact would be substantial.

That said, given the unstable nature of politics (and especially Australian politics), over-reliance on the government is not the best idea. Initiatives can change with changing governments (for example, Commercialisation Australia to Entrepreneur Infrastructure Programme), which means established systems can fall apart and leave startups picking up the pieces when they least need it.

Again, small businesses don’t face the same problem. Small business grants and bank loans they receive are pretty straight forward – they’re not faced with layers of complexity associated with ownership and equity.

Let entrepreneurs lead the way

The Australian government isn’t known for its entrepreneurial spirit. At the #TechMyWay Conference last Friday, actor-entrepreneur Ashton Kutcher spoke about how governments (referring to the US) sit on tonnes of data and waste, yet spend our tax dollars on substandard products.

Different levels of Australian government are certainly attempting to introduce more technology into public life (e.g. Opal cards, road safety apps, healthcare apps, etc.), but whether they fully understand technology’s potential to effect change is uncertain. Kutcher believes that entrepreneurs need step into the municipalities that we as citizens pay taxes for and improve them with technology.

Following on from this logic, I argue that instead of spending tax dollars on government-led products, the government could set aside funds and let entrepreneurs lead the way when it comes to innovation. Apparently, there’s a saying that goes, ‘know your weaknesses, and let the experts handle it.’

To really build a sustainable startup ecosystem, entrepreneurs need to be at the forefront of it. Government organisations and universities should play a role, but their role is to support entrepreneurial-led efforts through policy, initiatives, funding and selfless promotion.

When it comes to smart, game-changing solutions to big societal problems, small businesses can certainly use, support and even help create them. But generally, small businesses are more focused on local dominance – for instance, they might create smart home solutions that they only sell in-store and install in particular locations.

Attracting and retaining talent

One of the most common challenges startup founders face is attracting and retaining talent, especially when restricted by budget. Startups around the world often trade equity to employees as a non-cash incentive to compensate for lower salaries and high-intensity work environments.

However, this became an unfeasible option in 2009 when Labor introduced stringent tax laws to stop high-income executives (earning over $180,000 per annum) from minimising their tax. Inadvertently, these laws discouraged startups from providing employee share options to employees due to hefty upfront tax bills on shares.

Towards the end of last year, after much anticipation, the Liberal government announced that it would revoke Labor’s rules that required employees to face immediate tax costs on share options they receive from employers. The controversial 457 visa programme would undergo amendments so that employers can more easily hire skilled overseas workers, “while maintaining strong safeguards against abuse”, according to the Australian Financial Review.

The government also promised a science council will be introduced to provide advice on science and technology, with $12 million being invested to improve science, technology, engineering and mathematics (STEM) subjects in primary and secondary schools.

While this is was celebrated as a positive step towards creating employment opportunities within startups, Freelancer founder Matt Barrie dissected the policies around the new employee share option scheme and found a number of problems. He told BRW that instead of charging upfront tax, the government is “doubling the tax rate by charging income tax when the options vest”.

“It will [help early-stage startups] but that’s not where the bulk of the employment is – it’s when you can hire 200 or 300 staff that it really matters,” Barrie told BRW. “If you need to bring in a vice president or someone who’s really going to make a difference to the company, you just can’t compete with Silicon Valley if they’re going to get such a big tax bill.”

As such, the government is not alleviating tax burdens, it’s giving it a sneaky make-over. (Barrie explains exactly why the new scheme is problematic via YouTube).

The point is…

I acknowledge I have not dug deep beyond the surface of the issues startups face. It’s my intention to dissect these issues in upcoming articles. For the moment, this is a simplified summary of what’s been communicated by startup founders. Their grievances don’t centre on not being able to get ‘special treatment’; rather, it’s about inclusiveness.

If the government’s job is to implement policies that take into account the diversity of its citizens and their varying needs, then ignoring the startup sector is marginalisation. Nobody is trying to undermine the struggles of small business owners. They’re just saying, ‘what about us?’

And to be fair, there are MPs working on initiatives to help Australian innovators – it’s just that their work is not visible at this time. In the upcoming months, we’ll be able to find out exactly how their work will benefit entrepreneurs, so stay tuned.

illustration by Ghada Sleiman for Startup Daily