Investment into Australian venture capital and private equity opportunities (Australian Investees) have historically provided investors with strong returns and portfolio growth. According to Deloitte Access Economics, Australian Investees achieved an average revenue growth of 20% and EBITDA growth of 8% in FY16, whereas economy-wide company gross operating profits fell by 2.6%. Similarly, Australian Investees made a positive contribution to employment, expanding the size of their workforces by 24% on average, whilst employment in the wider economy grew by a mere 0.3%.
Access to strong deal flow (the flow of investment opportunities to VC firms) has generally been insulated from the political and global economic volatility Australian investors have started to see in more traditional investment classes.
Helped along by the Australian government’s support for innovation and technology development through various grants and tax concessions, the Australian venture capital market attracted US$130.5 million of domestic and foreign investments in Q1 2018.
According to the Australian Private Equity and Venture Capital Association Limited (AVCAL), well-known Australian graphic-design tool website Canva raised US$40 million of venture capital in H1 2018. Canva has evolved into a significant business with revenues of $23.5 million and an estimated value of $1.4 billion by FY17.
"Canva has evolved into a significant business with revenues of $23.5 million"
Investor appetite for venture capital and private equity portfolio investments is increasing, with capital raising for 2018 set to surpass the highest levels seen in the last 10 years. On the venture capital investment front, 2018 is expected to exceed the records set in 2017, which saw investments totalling $962 million across 135 deals.
The Australian government continues to support venture capital investments through regulatory reform designed to improve foreign investment framework. The government continues to encourage participation in this exciting sector—especially the fintech industry that PEF Capital operates in—with various funding and incentive programs.
Venture capital and private equity investments play a significant and indispensable role generating growth and innovation across many industries. By 2016, these investments accounted for $43 billion in total value added to the economy (or 2.6% of GDP), and supported over 325,000 FTE jobs.
A key characteristic of Australian Investees is their collaboration with others to deliver innovation. In FY16, more than 85% of Australian Investees introduced some type of innovation, whilst more than half of them collaborated with others to deliver innovation. This rate dwarfs the participation rate of 15% for businesses in general.
Early stage investments (pre-Series A funding rounds, including Seed and Angel investing) generally accounts for the largest proportion of total deal transactions each year. Since 2012, Early stage investments has accounted for more than one third of all venture capital deals (including Series A through D, grants, PIPE, growth capital and venture debt).
Early stage venture capital investments carry greater risks (and types of risk) to traditional investments like property development, land ownership, finance, insurance, or investments made to receive interest, rents, dividends, royalties or lease payments. Returns are more varied to those of traditional investments—a few “unicorn” investments will have the potential to provide a 10X to 30X return over a 7 to 10 year investment period, whilst as many as half of all total investments will fail.
Accepting and taking on risk is a fundamental part of early stage venture capital investing. In recognition of this, the Australian government provides general tax concessions for early stage investments through its Early Stage Venture Capital Program (discussed below).
Compared with traditional investments, risks which may be more significant in early stage venture capital investments include a lack of: operating history; liquidity (both in the investee entity and venture capital fund); certain or frequently-updated valuation, unlike listed investments; and key person risk for investments heavily reliant upon their founders to succeed.
Many of these risks can be mitigated by strategic relationships, such as providing comprehensive hands-on support for founders from an early stage and seeking out synergies with other portfolio investee entities. Other risk types, such as illiquidity, require investors to take a mid to long term view of investments.
"risks can be mitigated by strategic relationships...and seeking out synergies with other portfolio investee entities"
The success of most Australian Investees as they navigate the risks present in the early stages of formation and development depends on the support of various service providers. a number professional services providers like PEF Capital, LegalVision and Talbot Sayer have developed practice groups and services dedicated to supporting early stage venture capital clients.
To incentivise venture capital investment in early stage companies, the Australian Government has introduced the ESVCLP programme. A fund is eligible to apply for registration where it:
- secures between $10 million to $200 million in investor capital
- invests in entities carrying on early stage innovation
- is established in Australia (or a country with a double tax agreement)
- is established to exist for 5 to 15 years
Innovation and Science Australia currently considers a company to be ‘early stage’ if it has been incorporated for less than 7 years and its average revenue over the last 2 years has been less than $3 million. ESVCLPs are limited to acquiring shares or units in companies where the investments:
- complies with the ESVCLP's approved investment plan
- does not represent more than 30 percent of the ESVCLP's committed capital
- is an acquisition of new shares or units (there are limited provision to acquire existing interests)is ‘at-risk’ and the investee company meets the following requirements:
- the total value of its assets is not more than $50 million
- at least half of employees and at least half of assets are located in Australia
- its predominant activity is not in property or land development, finance, insurance, construction or infrastructure or making investments.
Compared to the Australian market, international venture capital is relative well-established. For example, the US venture capital funds have traditionally yielded the best risk-return profile globally, followed by funds based in UK and China.
Examples of international venture capital investments which have returned up to 25X to investors since 2011 include Uber and Snapchat. Meanwhile, successful investments in YouTube, PayPal and WhatsApp from 2011 to 2013 led to a 50X return in one year for investors as Facebook extended its technology portfolio. Globally, Australian venture capital investing is yet to catch up with other countries. Currently, Australia’s venture capital investing is significantly lower than the “2 percent of global markets” seen in other investment sectors.
Australian-based venture capital GPs collectively rank sixth for Asset under Management value within the Asia-Pacific region, following the likes of China, Japan and India. Compared to traditional investments, venture capital and private equity investment opportunities have provided stronger and more consistent returns to investors. Accepting and taking on risk is a fundamental part of early stage venture capital investing.
PEF Capital delivers a range of services to early stage venture capital businesses aimed at reducing their risks and increasing their profitability. As part of establishing a new venture capital investment opportunity, PEF Capital is currently seeking expressions of interest from potential stakeholders. For further information on its corporate advisory services or venture capital investment opportunity contact PEF Capital at email@example.com.