Still no update on Federal Government’s VC review

A review into venture capital and entrepreneurship was expected to provide an update on the future of the Innovation Investment Fund (IIF), and the Federal Government’s policies related to the taxation and support of early-stage companies. However, months later, there is still no response from the Government on its findings.

The submissions (which closed in April) raised topics such as the continuation of the IIF scheme, changes to tax rules for employee share option plans (ESOPs), the way money is allocated, and new potential funding sources. Others suggested the creation of a VC training college, and the need to build a crop of skilled potential startup CEOs.

“A review of venture capital and entrepreneurship was undertaken in the first half of 2012,” said Tricia Berman, head of the Industry and Innovation branch, at the Department of Industry, Innovation, Science, Research and Tertiary Education. “The review included analysis of the existing support for venture capital such as the IIF program.”

The Department’s review was forwarded to Minister Greg Combet for a response. Yet, we’re still in the dark on what exactly it will be. Some people think that’s cause for concern, particularly as the future of the IIF scheme is unclear.

Since 1997, the IIF scheme has helped commercialise Australian research, by co-investing dollar-for-dollar alongside private investors. The final tranche of the third round of the program is currently being determined, with a final $100 million to be allocated in early 2013. To date, more than $300 million has been invested alongside private venture funds.

Katherine Woodthorpe, CEO of peak VC association AVCAL, said discontinuing the IIF program would have serious implications for Australian innovation and productivity: “I think the IIF scheme has been shown to be a very effective way to support the VC industry. They (the Government) have reduced the risk, and increased the potential upside for investors. It’s been an important anchor.”

The concern for the startup industry is that the longer it takes the Government to make a decision on the IIF scheme (or any potential replacement) the bigger the funding gap faced by investment funds. The lag effect will mean the implications won’t be felt for a decade or so.

Although it seems unlikely the Government would discontinue the scheme, a delay in clarifying its future may affect confidence in our still-fledgling VC industry. The previous Minister for Innovation, Industry, Science and Research, Kim Carr, acknowledged in 2008 the role of venture capital in supporting early-stage companies, and the role played by the IIF program: “Venture capital is increasingly important in funding high-risk innovations world wide. The IIF program plays an important role in developing fund managers with experience in early stage investing and in stimulating technological innovation, which contributes to productivity. This program has been central to growing a viable venture capital industry in Australia over the past 10 years.”

Anything that might affect the health of the VC industry potentially affects all Australian startups: the truth is, it’s still incredibly hard to raise a venture round locally. It also means many startups are not given a serious chance at surviving.

On the whole, our ecosystem is otherwise doing well, despite its youth. Sydney is now ranked 12th and Melbourne 18th in the Startup Genome Project survey of startup hubs globally. However, despite an apparent growth in the number of startups, it seems the VC crunch will remain; at least without a more efficient model of Government support.

The 2012 Global Competitiveness Report from the World Economic Forum shows Australia ranks 21st worldwide when it comes to the availability of venture capital, lagging behind countries including Qatar, Israel, Singapore, Finland, Netherlands, Taiwan, and even Indonesia.

Matthew Macfarlane, Investment Director at Yuuwa Capital, thinks some tweaks to the way the Government support is allocated could help drive diversity and build a greater number of experienced VCs.

“To my mind, if you’re an existing VC, you shouldn’t have access to Government grants. What you want to do is spread far and wide,” he said.

“It would be much more beneficial to have five new $40 million funds, rather than another $200 million fund. I was hoping they’d realise the ability for smaller VC firms to thrive.”

Macfarlane says in the last six years, not one venture fund has got off the ground without Government support. By supporting new funds you provide more new investors with an opportunity to participate, and those which have success will find it much easier to raise money from other sources later.

There has been renewed talk of the angel boom/series A crunch in startup circles recently. Data from the U.S. (see Pando Daily story here) shows a rapid growth in the number of early-stage companies being funded, but minimal change in VC investments. While Australia may be facing a similar problem, the VC industry is still in its infancy, and it’s probably so small that it’s not worth drawing comparisons. If anything, we’ve always had a series A crunch.

Starfish Ventures Investment Principal John Dyson agrees the continuation of the IIF scheme is the number one priority: “We’d love to see the continuation of the IIF program. I think for the Government to come out and make a bold statement it was committing to an ongoing investment would be good for confidence.”

It was expected that Minister Greg Combet would announce the future of the program, and highlight a policy position on VC generally, before year’s end. However, the Minister’s office has told FLT the Government is still considering the VC review, and plans to release an Industry and Innovation Policy Statement in early 2013. FLT understands this statement will provide a response to the review. However, it’s not clear whether or not the actual review will be released.

“The review is under consideration, [and] no decisions have been taken, including on release,” said a spokesman.

It’s a change of rhetoric from the Government’s previous statements, which suggested the full review would be released alongside the Government’s response. Also worth noting is the nature of the process which has been used to undertake the review. A number of VCs we’ve spoken to have been critical of the drawn-out process. While some have said it’s positive that Government is looking at the industry, they labelled the review process as being ‘opaque’. Some others have not been so kind. Woodthorpe has labelled it as a “dog’s breakfast”. It seems part of the problem has been a lack of clarity on what was on or off the table.

Many people have suggested Australian superannuation funds should be mandated to invest a portion of their portfolio in early-stage VC. With $1.3 trillion in the collective kitty, it’s a potentially large source of new money. As Jessica Gardiner wrote in the AFR, less than $2 billion, or 1.5%, out of this huge reserve is invested in VC. The Minister’s office wouldn’t say whether or not the Government was considering mandating superannuation funds invest part of their portfolio in VC.

Woodthorpe said she was initially told the review would be managed by the Secretary of the Department, and a senior Treasury staffer. However, the process ended up being coordinated by a number of policy officers. She says the scope, and timeline for a response has been unclear.

“First of all we were told it was going to be announced mid-year, then it was Spring, then Christmas and now it look like it’s been put off until Autumn 2013.”

In August, Minister Combet’s office released a statement saying the Industry and Innovation Statement would be released in the final quarter of 2012. Again, that deadline slipped.

Let’s hope the Government’s response will be a positive one for startups. It’s critical that the issues around capital and incentives for entrepreneurial activity are considered alongside the important issues being considered as part of the Government’s recently announced Digital Economy White Paper.

The implications of policies in areas like taxation, investment, ESOPs and industrial relations are significant. With less than 5% of Australian tech companies successfully scaling, getting good policy Government policy on VC will be critical to the future health of Australian startups.