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Editorial Time to Back the
Technology Punter Is Australia's venture capital
industry on life support? It sure looks that way with the Federal Government
pumping $64 million into 11 of its leading venture capital fund managers
who in turn are investing it in 35 of their most promising early stage
technology companies. The Government says it's a
temporary measure to get these innovative companies over the capital crunch
caused by the global financial crisis and without which the companies
may not survive. But the real story is that
the institutions and super funds who were already co-investors in these
venture capital funds have chosen not to invest. A small number may do so,
but the lack of interest supports anecdotal evidence that institutions
and super funds have gone off venture capital. This must be very disappointing
for the government in particular, as it has now spent 26 years trying
to establish a formal venture capital industry that still can't walk on
its own. But it's doubtful they are
surprised. Most institutions have never shown an interest in venture capital.
The 1984 Management and Investment Companies (MIC) program and the 1992
Pooled Development Funds (PDF) program were both meant to attract the
institutions, but neither did in any real way. In 1998 the venture capitalists got another chance with the Innovation Investment Fund (IIF) program, which did get some interest. But after a full 10 year venture capital fund life cycle, their performance is said to be quite modest and certainly not compelling. The government now needs to
rethink its entire venture capital strategy. When entrepreneurs think of
growing the industry, they think of having more venture capitalists to
approach. When venture capitalists think of growing the industry, they
think of growing their own funds under management. Apart from one or two
co-investors, the last thing they want are lots of other venture capitalists
bidding up the price. There is a contradiction in these two views. So the first question the government should ask is does it want to fund innovative companies, or does it want to build a venture capital funds management industry? Clearly, it wants both, but
it needs to approach each aim differently. Its 26 year strategy of commercializing
innovation by growing a venture capital funds management industry based
on institutional capital is not working. It may work one day, but most
innovators can't wait that long. The government's new strategy could begin by expanding its concept of venture capital. So far the government has put all its focus on formal or managed venture capital - where venture capitalists manage funds that invest in companies. But developed economies have not one but three venture capital models, all working simultaneously. The largest is thought to be
the informal venture capital sector - where the capital comes directly
from private sources, mostly high net worth or angel investors. This informal
sector is believed to be many times larger than the formal sector, and
many thousands of private companies have some form of informal venture
capital. The second venture capital
market, also bigger than the formal market, is the bottom 80 per cent
or more of the stock market inhabited by small, mostly prerevenue or unprofitable
micro caps that have many of the investment characteristics of unlisted
companies. Many also have intellectual
property or other innovative business angle and like unlisted companies
they need capital to grow. That capital comes from private, retail, and
high net worth investors and also some institutional investors. The informal and micro cap
sectors are likely to have much more innovation and intellectual property
than the formal sector, and they provide the government with the biggest
return for the billions it spends on research and development. Yet formal venture capital
gets all the money and attention, while informal venture capital and micro
cap venture capital receive no comparable support. That should change. Supporting these two sectors could be as simple as funding a professionally managed venture fund for each sector, in the order of say $100 million plus. The informal angel fund could
be along the lines of the New Zealand and Scottish angel co-investment
funds. The micro cap fund could be along the lines of a Pooled Development
Fund. That means the fund would not be "playing the stock market"
but would be a minority co-investor investing only in new share issues
such as initial public offerings, placements, rights issues and share
purchase plans. Both funds would add capital
depth to their sectors, make available more capital more quickly to more
innovations, and over time could develop a track record that attracts
institutional investors. A solution for the formal venture capital sector is more problematic, as it is not just the supply of capital that is drying up but also the inflow of new managers. Since 1984 the government and
venture capitalists have been chasing the fantasy of institutional investors,
while their real but much plainer looking admirer has been beside them
all along. That admirer is the technology
punter. The same retail, high net worth and angel investors who have made
the informal and micro cap sectors a success. They backed the MIC program
when institutions wouldn't; they backed the PDF program when institutions
wouldn't; but they were left out of the IIF program, which institutions
now seem to be backing away from. Thanks to them the MIC and
PDF programs brought in more new venture capital managers and supported
more innovative companies than the IIF program has so far. In hindsight, ending the PDF
program, or not keeping some version of it, was a mistake. The program
was excellent in bringing in new managers, even if most had to start small.
The formal venture capital sector badly needs such a vehicle that allows
new fund managers to get a foot in the door. This could be done by bringing
back the PDF investment vehicle in some form, or by modifying the Early
Stage Venture Capital Limited Partnership vehicle to open it to high net
worth and large retail investors. Technology punters can give formal venture capital its best chance to grow. The institutions will follow when they are ready.
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