The prospects of advanced manufacturers picking up funding from venture capital are looking more remote.
Figures from the Australian Private Equity and Venture Capital Association Limited (AVCAL) show that in 2011, VCs invested $120.6 million in 76 companies, the lowest since 2007 when they invested $150 million in 68 companies. In 2010, they invested $186.5 million in 92 companies, in 2009 it was $209.9 million in 97 companies and in 2008, VC’s invested $201.9 million in 72 companies.
Brigitte Smith, Managing Director of GBS Venture Partners, says: “It’s going down fairly precipitously and that’s a global phenomenon. The volume of venture capital in the United States is probably at half to a third of the level that was being raised in 2007 so there has been an extreme contraction of the industry globally and we’re seeing that also in Australia.”
Chris Nave, a partner at Brandon Capital Partners, is even blunter. “Whilst the drop in Australia has been precipitous like in the US, Australia is starting from such a lower base. Whilst the US venture industry has contracted, there are still a lot of funds under management but because we have such a low base in Australia, we are not unrealistically facing a situation in two or three years where no venture capital will be available,’’ Nave says.
According to AVCAL, there are approximately 26 funds in Australia, but of these probably only 10 are actively investing. They most commonly invest in Life Sciences (45%), Information and Communication Technologies (30%) and Cleantech (5%). Life Sciences accounted for 29% of the total number of companies invested in. Most funds are mandated to invest in Australian business and it is estimated that 80 per cent of Australian venture capital goes to Australian companies. With some 250-300 active portfolio companies, the average investment range is $4-$15M. They are not drawn to anything less than that. Total funds under management are about $2.3 billion.
Only certain types of manufacturers would get a look in.
Starfish Ventures co-founder Michael Panaccio concedes that some industries will be overlooked. But he says eligible industries are self-selecting.
“Manufacturing hasn’t had the kind of support it probably warrants and most venture capitalists by their very nature are directed towards technology,’’ Panaccio says. “So unless you have a manufacturing enterprise with some world beating technology, you’re not going to draw the interests of VCs”.
At the same time, the AVCAL figures show that sales of companies by Australia’s $23 billion private equity sector jumped by 46 percent in the last financial year, despite shaky financial markets, although new acquisitions declined. The numbers show that buyout firms sold a total of 73 portfolio companies in the year to June 30, up from 50 in the previous year, and sales to trade and industry buyers remained the most common sale method.
Still, the number of companies receiving new investments declined 18 percent to 75 in the latest year — the lowest in at least nine years, since data was first compiled in 2002. This was interpreted as reflecting a more selective approach by buyout firms and increasing uncertainty over the economic outlook.
That said venture capital firms in Australia are now struggling to raise funds. The problems in venture capital are not unique to Australia. The problem however is amplified in Australia by the relative newness and size of the Australian industry which only really started in the 90’s.
In the US, the National Venture Capital Association estimates that the number of funds has shrunk by as much as 50%. In Israel, so often held up as an example that we should emulate, the venture industry has shrunk so much, and is viewed with such opprobrium, that they no longer have a VC industry association. Instead, they have become the High Tech Industry Association.
Specific issues facing Australian VC’s are the reduction and imminent termination of government support for the industry, coupled with a withdrawal of Australian superannuation funds from any illiquid assets.
The Australian superannuation industry has been a modest investor in venture capital over the last 10 years but that investment is now waning. There are several reasons for this.
The main one is the lack of consistent returns from venture capital. That’s hardly surprising given the newness of the industry. Another structural problem is that super funds are increasing in size and merging. With billions of dollars to splash around, they are finding it less attractive to make relatively small investments.
Super funds are now run by fund managers who have a two to three year investment horizon. Venture on the other hand is a 10 year game. Another problem is that with super choice, most people are now nominating that their funds stay in cash, away from investment. The global financial crisis has created a new conservatism. If each of the major super funds invested 0.5% of their portfolio in venture capital, the industry would have an extremely healthy flow of capital. This is not exactly a high risk strategy for the super funds.
VC specialists say they need to educate the public about the role venture capital plays in nation building and job creation.
Another big problem is that the Future Fund does not invest in venture capital. Instead, it is focused on financial returns. Ironically, the Future Fund has $2.8 billion worth of assets in the troubled euro zone, including almost half a billion dollars in the most debt-stricken nations like Greece. The Future Fund has confirmed that of the $2.8 billion worth of European shares, $315 million was held in Greece, Ireland, Portugal, Italy and Spain. The fund had $178 million invested in debt assets from the most troubled nations, and $3.8 million in sovereign assets from across the euro zone. All of this accounted for about one per cent of its investment portfolio. But if that money was directed into venture capital, the industry would have received a much needed boost.
AVCAL CEO Catherine Woodthorpe says the Future Fund does not seem to be interested in nation building. “The Future Fund is actually precluded from taking nation building into account when it makes its decisions, it has to be purely on a financial basis and that’s unique in the world. Most sovereign funds have an element of nation building in their mandate whereas with the Future Fund that is quite the reverse.”
Australia has a lot of money that could be directed to VC’s. The Future Fund has $67.3 billion in total assets, there is $1.23 trillion invested in Australian super funds and according to Deloitte, Australia’s superannuation pool will grow more than fourfold within 20 years to $6 trillion. The Federal Government could mandate that the Future Fund and super funds invest a small proportion of their funds in venture capital. Arguing that the government should not interfere does not make sense when one considers that the Future Fund was set up by the government and the super industry exists by government mandate, taking out 9% of salaries every year – and soon to be 12 per cent – and has a beneficial tax regime.
The other issue is to change the focus of venture capital firms. Entrepreneurs say the industry is too conservative. Also, venture capital firms will not invest anything less than $5 million. This creates the so called “valley of death” for start ups. Put simply, most Australian innovators and entrepreneurial firms do not have access to affordable capital especially when they need $2-$5 million, and venture capital does not fill that gap.
And this is where an organization like the Advanced Manufacturing Co-operative Research Centre comes into its own. The AMCRC works to bridge this gap by co-investing federal funds with industry cash and in kind from R&D providers in high impact projects. And with fewer venture capital funds flowing to industry, the AMCRC will become even more critical.
Furthermore, SMEs would be eligible for tax deductions if they work with the AMCRC which can fill the gap for SMEs and entrepreneurial firms that don’t have access to affordable capital in the $2 – $5 million range. Put simply, venture capital does not go there.
The real solution therefore is to make it tax effective. Under the Federal Government’s new R&D tax concession scheme, an SME is classified as an “R&D entity” if it enters into a partnership with a CRC. The $20,000 expenditure threshold is waivered for R&D entities using official research provider services.
AMCRC Managing Director Bruce Grey says SME’s would be eligible for the tax incentives funding the innovation if they worked with the AMCRC.
“Further, if the SME has a turnover of less than $20 million, it may be able to claim a 45 per cent refundable tax offset which would be equivalent to a 150 per cent deduction,” he says.
He says the aim of the legislation is clearly to encourage these partnerships. In the absence of venture capital funding, it is a real and viable option for SMEs to fund innovation and new business ventures.
With few venture capital funds willing to back SMEs, there are significant gaps, he says. For SME’s, working with the AMCRC is the alternative because that will deliver tax deductions and in some cases a tax credit.
“The AMCRC works to bridge this gap by co-investing federal funds with industry cash and in kind from R&D providers in high impact projects,’’ he says. “With fewer venture capital funds currently flowing to industry, the AMCRC will become even more critical.”
He says the AMCRC will work to ensure the innovation and IP is commercialized and turned into a real business venture. Put simply, the AMCRC will step in where the VC will not go.
“The current global manufacturing system includes cutting-edge science and technology, innovation, skills, design, systems engineering, supply chain excellence and wide range of intelligent services, as well as energy efficient, sustainable and low carbon manufacturing,’’ he says. “We are focused on getting IP out of the universities coupled up with aspiring SMEs and getting it commercialized internationally. We can help VCs evaluate this IP as often it is difficult for a VC to risk assess the opportunity.”
