Does Australia’s startup ecosystem even need late stage capital right now?

- April 22, 2014 10 MIN READ

High-speed internet. Microwaveable meals. Express deliveries.

We live in a culture of immediacy. The demand for instant results has seeped into every aspect of our lives – so much, that we don’t have the patience to wait for a sandwich or taxi, let alone business growth and profitability.

For the most part, brands are here to accommodate our sense of haste. Hungry? Microwave a McCain pizza pocket. Need a cab? Book one via goCatch. Need entertainment? Download a film through Apple TV.

This begs the question.

Could this cultural shift towards immediacy be the reason why Australian founders are so eager for a fully-fledged startup ecosystem?

If Silicon Valley can do it, why can’t Australia? This sentiment has been echoed across our startup community.

More specifically, founders have expressed their longing for an environment that supports startups throughout the entirety of their lifecycle – at least from a financial standpoint. One such person is Sam Chandler, Founder and CEO of Australian software company Nitro, now headquartered in San Francisco.

In an article on The Sydney Morning Herald, Chandler laments the lack of capital available in Australia for mid-to-late-stage startups. He argues that our funding environment is analogous to having a great primary school system, but no secondary schools or universities.

It’s true. Australian startups have access to a great support network at the base level – particularly with new incubators, accelerators and angel groups being introduced every year. Seed capital and Series A are easier to raise than ever before – a stark contrast to five years ago.

However, the system is still lagging behind in that it doesn’t quite cater to late-stage startups that may want to raise Series C or D (investments of $5 million plus).

This is why Chandler posed the question, “What happens when startups become grown-ups?” In other words, what happens when a startup has developed and launched its product, acquired a solid customer base, and is now ready for market domination?

This question can be interpreted as both literal and rhetorical.

A bootstrapped startup is fully capable of getting high returns, but the timeframe to reach that level of profitability is generally longer than what it would take VC-backed startups.

For example, Perth-based bootstrapped startup Ticketbooth are doing phenomenally at the moment, but it’s taken them 10 years to deliver millions in revenue year-upon-year. In fact, in the first two years of operation, their revenues were approximately zilch. Had they raised Series A and B, it’s likely that they could’ve sliced that time down to half or less.

So where do startups go when they become grown ups? Silicon Valley has been the top pick for many, includingHappyInspector, RecruitLoop and more recently, DesignCrowd. So Chandler is certainly not alone in his frustration.

But is he, like many other Gen Y startup founders, expecting too much too early from Australia?

VC fund dynamics

Before going further into the discussion, it’s important to understand the reason why startups can’t raise $5 million or more in Australia. Simply put, venture capital funds in Australia aren’t big enough. Rampersand is $6 million, BlueChilli is $20 million, and Blackbird Ventures is $30 million. Of course, it would be imprudent not to mention Sydney-based VC firm One Ventures that’s raising $100 million, as well as Former Microsoft Executive and serial investor Daniel Petre who plans to open up a $50 million fund, according to reports.

But prior to these happenings – which are as recent as last month – our community were relying on $30 million funds. This is where it becomes important to understand fund dynamics.

A VC firm will likely allocate that $30 million across at least 10 startups. Why 10? It could be 15, 20 or 30, but to make the math easier, we’ll stick to 10. The reason why VCs invest in that many companies is, more or less, to do with mitigating risk. It’s unlikely that all startups they invest in will be successful, but one in ten is a safe bet. As such, VCs need to diversify sufficiently to find a win.

Each of ten startups will be allocated $3 million, but this amount isn’t handed over at once. The money will be divided further, into three or four stages – Series A, Series B, Series C and ‘emergency’ capital.

‘Emergency’ capital is set aside in case the startup faces difficulty. Chandler explains this further: “What you don’t want, as an investor, is to be unable to save the company [if they face unforeseen circumstances]. If they invest the entire $30 million at once, and the startup needs a further $1 million to save itself, they won’t be able to provide it, and that’s not ideal.”

For various reasons, after raising their first round, many startups don’t get to Series B. It could be because they haven’t delivered sufficient returns or they’re not ready for high-growth. Whatever the reason, it seems we’re progressing slowly.

This is where Founder and Chief Executive of BlueChilli, Sebastien Eckersley-Maslin’s argument comes in.


While Eckersley-Maslin agrees with Chandler on the assertion that we need larger funds in Australia, he believes that rather than dwelling on the inadequacies of our current VC system, we need to focus on building the infrastructure “from the ground up”.

“There are a lot of funds that only make, in inverted commas, ‘small investments – from $500,000 to $2 million’, but you are only going to get larger funds when there is sufficient deal flow in assets for them to invest in – and that requires a bottom-up approach,” he says.

“The reason why there aren’t many big funds focused on startups is simply because there isn’t as much opportunity to invest at the moment.”

The more demands you have – i.e. the more companies asking for larger investments – the more likely that VCs will service that demand.

But is it really that simple? Over the past five years, as the demand for angel investment skyrocketed so did the number of angel groups. On the surface it is as simple as ‘supply following demand’.

Our ecosystem, however, requires more.

Eckersley-Maslin believes that it takes three waves (or ‘generations’) of investment to create a sustainable ecosystem, and Australia is currently sitting at the second wave.

“There are successful people who are reinvesting in our community. But you need the third generation – the companies that the second generation invest in – to be successful, so that they can reinvest in startups. At that point, you know you’ve got a sustainable ecosystem,” he says.

“But to create that, you need to create opportunity, you have to nurture talent, and you need to have capital coming in from the top end to support startups throughout their lifecycle.”

In Eckersley-Maslin’s public response to Chandler via The Sydney Morning Herald, he asks Chandler to return to Australia and reinvest some of his wealth into our startup ecosystem – whether by creating a private equity fund or investing in existing local funds like BlueChilli.

When asked about what he thought of the proposition, Chandler reiterates his initial point: “It’s a fair thing to say – ‘come back and invest’. But it’s not actually solving the problem … I don’t disagree that the ‘bottom up’ approach is a good way to go – starting with seed stage funds, and then VC. The Pollenizers and Blackbirds of today are certainly creating deal flows for companies, but the companies are finishing primary school and then there’s nowhere to go.”

Chandler admits he’s open to investing locally in the future, but not at this stage. Currently, he’s focused on his nine-year-old startup Nitro, currently delivering revenues of $30 million a year. In less than a decade, the company has been able to establish offices in Melbourne, San Francisco, Dublin, Slovakia and St Petersburg, with over 160 staff.

Nitro was founded in 2005, and bootstrapped for the first two years. They raised $1 million in seed funds from private investors in 2007, but it wasn’t until 2012 that they pursued institutional capital, raising $3.5 million from Starfish Ventures, and a further $3.1 million from the same firm in 2013. Though they raised Series A and B in San Francisco, the investors were coincidentally Australian.

He admits in his article, that Nitro is “one of just a handful of lucky companies that are Aussie-backed” and that there just “aren’t enough other similar stories”. Chandler’s frustration is valid and certainly admirable.

What he believes Australia needs, however, is unattainable at the moment – though realisable in another five or so years. Why? For one, because we can’t build something at the top without having a solid foundation first. Silicon Valley, as we know it today, has been 60-or-so-years in the making. The same chronological events would need to occur in the same order for us to be able to have a startup ecosystem as strong and vibrant as the Valley.

Arguably, we only started building infrastructure about six years ago when Pollenizer was launched.

Then again, it’s not necessarily about replicating the Valley, but the strength of its support arms, which requires pulling our own weights.

Chandler says, “We need to take all the good stuff from Silicon Valley and repurpose it locally. While there are a lot of cities aspiring to become Silicon Valley, very few have a genuine shot at replicating the magic of the Valley – and Australia is one of them.”

Nitro’s Director of Operations, Gina O’Reilly, echoes a similar view: “We need to create an ecosystem of our own. We can take the good from other environments like Silicon Valley, but we have to create our own flavour of it.”

In a previous article titled Australia vs. Silicon Valley: Replicating a culture of innovation, I argue that we will never become Silicon Valley v.2, but more importantly, we shouldn’t strive to replicate another culture or ecosystem.

Eckersley-Maslin holds a similar belief, saying, “We will never be Silicon Valley. There is only one Silicon Valley, just like there is only one Tel Aviv, one London, and one Sydney. If we want to copy someone else’s ecosystem, we will always be second. We need to create our own ecosystem, and that requires building from the ground up – building assets, opportunities, and communities. We will find our own identity,” says Eckersley-Maslin.

Superannuation – an untapped pool of funds?

Unlike many who protest without presenting a solution, Chandler proposes that we tap into Australia’s superannuation funds – which tend to sit quietly on government shelves, gathering dust and cobwebs.

“One thing I would be looking very closely at is superannuation. It’s a trillion dollar pool of funds; it’s the fourth largest pool of pension funds in the world, yet very little goes to VC. If you mandate superannuation funds and force the industry to invest in VC, then that might be a solution,” he says.

“I’m not sure how well it would work in practice, but I’m sure there is something the government can do in terms of policy to encourage the behaviour.”

Although Chandler is not immersed in Australia’s startup scene at the moment, he makes a compelling point that if we invest heavily in innovation over the next 10 years, it will pay off for the next 50 years.

“The mining boom is going to end. What’s going on right now is akin to the next Industrial Revolution – except it’s happening much much faster. Australia has a very special opportunity, over the next 5 to 10 years, to make really good policy decisions in the national interest to drive investment in innovation for all stages of a company’s lifecycle. And generations to come will benefit from it,” he says.

Superannuation, however, may not be the answer in the short-term. As Eckersley-Maslin points out, “Startups are high risk. Whereas superannuation is the dead opposite.”

This means there needs to be a diversity of assets in which super funds can invest in before it becomes a viable proposition. To allocate the money to high risk assets – which startups are – will require a major change in mindset, and so it would be unrealistic to think super funds will invest in startups at this time.

But what we can do while super funds have their eyebrows raised, is demonstrate that we’re worth investing in. This requires creating a self-sustaining cycle of success and support, so that they know returns will be made.

Many agree that the government needs to take action. In fact, #StartupAUS, last week published a comprehensive report which calls on the government to take swift action to support our startup ecosystem and safeguard the country’s long-term economic prosperity.

The Crossroads report acknowledges entrepreneur and author Adrian Turner’s observation that Australia’s startup ecosystem is maturing at a slower rate than many other developed and developing nations due to the “absence of direct government support”.

However, given the unstable nature of politics, relying on the government for support is generally not a good idea. Eckersley-Maslin admits that communities that have government support are easier to grow and prosper, but believes that “for a community and ecosystem to survive, must do so without government support.”

“On the flip side, when you got the right level of support like what’s offered in Israel, with the matched funding program for the incubators, where the government provides $5 to every $1 raised, then that’s incredibly helpful. They invested $660 million dollars into this program and it’s created $5 billion worth of foreign investments into those companies with a 60 percent success ratio,” Eckersley-Maslin explains.

“So when you’ve got government support and its done correctly, it can dramatically increase the success ratio of a community. But I think for a community to be successful, it must not rely on any third party or any external driving force because it’s too unpredictable.”

VCs, super funds and government. The three main subjects of this debate are all third-party support mechanisms, which suggests that Australia is less interested in the ‘slow and steady wins the race’ approach.

In a previous interview, Founder of Pollenizer and respected personality in Australia’s startup scene, Mick Liubinskas said, “we need to put more focus on sales and drop the focus on capital-raising”. In his opinion, keeping more companies based in Australia while having global sales is “critical to building the compound interest for our ecosystem.”

Why only Australian?

One thing that’s lurking behind the debate like a shadow is the following question: Why can’t Australia-born startups be mix-blooded? The debate rests on the assumption that it’s better if startups remain 100 percent Australian, which involves local development, talent, funding, etc.

But we live in a globalised economy – where money flows across national borders. In fact, in our current economy, business success is increasingly contingent on the effective use of intangible assets such as knowledge and skills; and we’ve seen a dramatic increase in international trade and investment flows over the past two decades, with many industries offshoring computer, consumer, financial, data-processing and business services.

Adding a new layer to the debate, Rampersand Managing Director, Paul Naphtali says that “We are seeing a dramatic flattening of the world. The first flattening of the world of relevance to us, is the ability to sell software from anywhere to anywhere. That has broken down the tyranny of business in Australia. The tyranny of capital, however, hasn’t broken down. So what Sam [Chandler] is trying to say is, if we can build these great companies from here, why can’t we fund them from here?'”

“But as part of this flattening of the world, the proportions of valuable businesses that are going to remain purely domestic is going to diminish. So the question of ‘how do you build an Australian startup that only takes Australian capital’ is a bit irrelevant.

“As patriotic and as passionate as we all are about building the Australian ecosystem, we also have to recognise that it lives in the global context.”

At the same time, we’re seeing an increasing appetite from offshore VCs to invest in Australian companies. Recently, Cronulla-based email marketing company Campaign Monitor secured USD$250 million (AUD$266 million) of funds from US-based venture capital firms – the largest ever capital injection experienced by an Australian technology startup.

Led by Insight Venture Partners, the venture round strongly indicates that Australians are on the radar of international investment firms. According to AFR Weekend, several major US firms, including iSelect backer Spectrum Equity, Accel Partners and Technology Crossover Ventures were vying to invest in Campaign Monitor, alongside Melbourne-based Square Peg Capital.

Managing Director of Insight Venture Partners, Deven Parekh, told AFR Weekend, “There’s a tremendous amount of interest in [Campaign Monitor]; US and foreign investors are comfortable with making investments in Australia.”

You may ask whether this entire debate is irrelevant? It’s not, because at the moment, Australian startups don’t have the option of raising investments of $5 million or more, without packing their suitcases and moving into a more mature ecosystem.

Australia’s savviest minds are working day-in and day-out on building our ecosystem. We just need to join the movement, contribute our share, and wait.

Patience is a virtue.

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