The Australian startup investment sector is looking in rude health.
SEEK co-founder Paul Bassat has launched a $200 million fund attached to his Square Peg Capital investment firm. The round has been backed by James Packer, a number of investment bankers, and some super funds.
Tank Stream Ventures recently closed a $20 million fundraising. And last year AirTree Ventures raised $60 million to invest in startups.
But how does all this venture capital money work?
There are numerous venture capital models out there. You have traditional, establishment firms like Kleiner Perkins Caufield & Byers, which has invested in companies like Google and Amazon over the last forty years. And you have newer, “full service” firms like Andreessen Horowitz, which has invested in Facebook and AirBnB, and employs a large staff of experts to support their founders.
One of the differences between them are the stages they target to invest in – some specialise in earlier rounds, where smaller investments can net larger equity stakes because of risk. Others wait for later rounds, when companies have revenue or are even profitable, but need increasingly large cash injections to grow.
But a bigger, newer difference is the critical mass of venture capitalists who were technologists or entrepreneurs, and who head “full service” VC funds. Marc Andreessen of Andreessen Horowitz, for example, created Netscape, one of the first internet browsers. Chris Sacca of Lowercase Capital, another prominent VC, was one of the first Google employees.
The ‘creed’ of Lowercase Capital exemplifies the full service approach. Specifically, it downplays the important of their money: “frankly, capital just isn’t that important to the early triumph of a company anymore. Much more vital in those inaugural days is collaborating side by side with a founding team that controls its own destiny.”
Speaking with Craig Blair, partner at Airtree Ventures, it sounds like Australian venture capital is increasingly trending towards this full-service approach. Blair, for example, is an engineer, and both he and fellow Airtree partner Daniel Petre have spent decades in the Australian tech industry. The same with Blackbird Ventures, whose Niki Scevak built realtor review site Homethinking and founded the accelerator Startmate.
Airtree offers its founders a “menu” of services to assist their growth. They have a recruitment service to help their startups stock up, they have a data and finance service to help get finances in order, they have nineteen companies in the current and previous portfolios who they tap for events and advice. Blair talks about “cross-pollination” between his portfolio companies, and of the experience of his team, who have founded, run, or invested in 27 companies between them.
Blair, Petre, Bartee and Scevak are all what’s called “general partners”. They administer the funds and are responsible for laying out the “thesis” under which the fund invests – certain kinds of companies, business models, industries, funding rounds etc.
The other kind of partner in a venture capital firm are called limited partners – limited because they have limited exposure. Limited partners are the money. They are generally wealthy families, individuals or institutions. In Blackbird’s first fund, the limited partners were mostly tech industry veterans, who were tapped as much for their possible mentorship and connections as their cash.
There has been a rapid increase in limited partners lately, as Super Funds and banks, especially have joined the fray. Blair chalks this up to negligible yields in other asset classes, which may not have influenced super funds, but has individual investors scrambling for good investments.
When limited partners contribute to a fund, say the $60 million fund that Airtree recently raised, it is for a set period of time. Usually ten years, after which the money is returned minus fees and hopefully with some capital gain. But the big numbers that are announced when a new fund is raised are actually just pledges. The investors who contribute to a $200 million fund aren’t writing out cheques for $200 million right away.
All of that money sitting in a bank while the venture fund tries to find a productive investment would be a misuse of capital. Instead, the money is called as and when the venture capitalists find something to invest in.
“If we raise $30 million dollars, like in our first fund we raised right at $30 million dollars, we don’t call $30 million dollars,” explains Bartee.
“As we find companies that we like to invest in, we call the capital that is enough to invest in those companies plus a little bit more.”
Often funds invest in more than one round of the startups they like. For example, with Canva, Blackbird invested in the first round, and called enough money to keep investing in subsequent rounds.
For funds like Blackbird that invest in early rounds, they have to spread their capital wide, in the knowledge that many of their investments won’t pay off. So, if there are investments 10 different startups, the goal is for at least one of them to grow so big as to not only compensate for the others, but provide a sizeable return for the limited partners.
“Out of ten portfolio companies, you might have one, lets say that is a rocket. You might have two that are ok. And then you might have four or five that don’t work out at all,” explains Bartee.
Venture firms that target later rounds are investing in companies that have a track record and millions in revenue. As a result, he risk-reward ratio is flipped. The companies are less likely to fail, have more tangible value and there may be more competition among investors chasing safer investments, all of which push up the price of an equity stake.
When early stage investors look at companies, there are a number of factors they look at. Blackbird, for example, wants to see a product that already has a core set of customers. But Bartee puts extra emphasis on the person and drive behind the product.
“We are looking for companies that have a chance of really busting and owning a global market,” explains Bartee, “we like to invest in Australian companies where you have a group of founders that have outsized ambitions. They are very very ambitious, who are global from day one, meaning they are selling to people across the globe from the first day.”
The emphasis on global is because of the need for massive growth in a short space of time. As noted, the venture capital funds are on a pretty strict 10 year cycle. They have to invest in something that can grow big and do it fast. And they hope to have at least one hit that can pay off for all the misses.
“At the end of the it you hope to have 2 or 3 really good companies in a 20, 25 portfolio that are really stars,” says Bartee, “and if you have that then the likelihood is the return to investors is better than the public market.”
The different venture capitalists all have different policies when it comes to equity stakes, board seats, and the role they play in companies. Bartee says that Blackbird looks to take a “low double digit percentage” in the companies they invest in, although this can add up through numerous rounds.
Some VCs will look to take board seats, which Freelancer CEO Matt Barrie has reservations about. And through equity stakes and board seats, the venture capitalists can take control of companies, pushing them to early exits for example.
But the venture capitalists we spoke to don’t sound rushed, and indicate a preference for being hands off. Blair points out there are ways to keep stakes in companies beyond the life of a venture capital fund, such as selling the stake directly to investors, or extending the fund for a few more years.
“Is ten years a short time, or is 12 or 14 years a short time? Well,it can be, but we’d much rather invest in a company that wants to build something for the long term, and build value over the long term,” Bartee said.
Most of the Australian venture capital funds are new, so have 9 or 10 years left in their investment timeline. So keep an eye out as all of these pieces come together to fund the burgeoning startup scene.
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