The venture capital and private equity industry submission to the federal government’s Financial System Inquiry has a detailed overview of the current state of the Australian VC and PE markets, and no matter which angle you come at it from, it’s not a good picture.
It maps out a raft of untapped opportunities for investors, entrepreneurs, established businesses, and working Australians with their money tied up in super funds focused on short-term returns. And our PE and VC investments are comparatively weak compared to the US and Britain. For example, private equity accounts for only 5% of all mergers and acquisition activity and private placements, while in the UK it’s around 14%.
The submission says that without significant reforms to Australia’s financial system innovative businesses will go offshore in search of funding and the country will miss out on some substantial growth opportunities.
Australian Private Equity and Venture Capital Association Chief Executive Yasser El-Ansary said lack of funding access had resulted in the number of companies the VE and PE funds were currently invested in being limited to about 350 businesses, meaning “they presently have funding capacity to back less than two per cent of the total investable pool of up to 30,000 businesses”.
Australia’s VC and PE industry has an estimated $24 billion of funds under management, tiny compared to the broader investment management industry which is about $2.3 trillion.
The nation’s VC industry has a reputation amongst some entrepreneurs for playing too hard in deals, forcing them to turn down potential investors or look overseas, but El-Ansary points to Australia’s world-class fund managers as the answer to that. “On a case by case basis there will always be factors why VC or PE fund managers don’t get along with founders,” he told Business Insider. “Fund managers aren’t always going to be the best partners for some business owners, but it will case by case.”
“It’s important [founders] work alongside fund managers with skills and competencies they require to reach full growth potential,” he said.
The submission estimates only 500 Australian companies have received VC backing before, compared to 24,000 in the US, and while the industry is smaller and younger in Australia AVCAL said the reluctance or inability of super funds to throw cash at VC and PE was a key reason for the lower investment numbers.
“There’s a race to the bottom for super funds to invest in highly liquid asset classes with returns nowhere near the returns of asset classes with a longer term focus,” El-Ansary said.
One of the major parts of AVCAL’s submission is that the amount of capital available to support Australian businesses needs to grow, especially in cases where companies don’t have access to debt financing from banks.
“Venture capital and private equity funds can help to provide capital and skills to expand business operations and deliver growth in productive output and employment,” El-Ansary said.
The association blames structural and cyclical factors for the difficulty Australia is having attracting increased VC and PE funding allocation from super funds.
But AVCAL won’t find itself alone in arguing the super industry needs to rethink how it invests its money. It’s a giant pile of $1.75 trillion that will swell to around $6 trillion by 2030. Interested parties are always haggling for a bigger piece of the pie.
Given the last major review of Australia’s financial system was in the 90s, a lot has changed in global economies since and AVCAL says the current FSI is an opportunity to reform policies to nurture business development and innovation over the next decade, and unlock new growth in the Australian economy.
El-Ansary says the answer lies in superannuation fund investments. Currently only $17.6 billion or 1.2 per cent of super funds is allocated to private equity, and AVCAL says only half of that is invested in Australia.
This table shows the disparity in investment, with the proportion of super funds invested in VC and PE actually shrinking last financial year.
The submission tables changes to Australia’s superannuation system, saying policy adjustments could address an imbalance between investment in short term, high liquid assets, like equities and longer term investment plays such as private equity and venture capital.
“Superannuation funds have increasingly had to direct their focus towards short-term, low-fee, high liquidity investments – in preference to other asset classes that deliver high net returns and long-term investment horizons,” AVCAL said.
It said short-termism in superannuation policy settings was restricting the flow of investment into VC and PE options and argued the practice was “detrimental” to super fund members who are going to benefit in long term growth opportunities.
El-Ansary said current super policy wasn’t “driving the right behaviours in the market” and current policy settings were incentivising equities, cash, and low fee asset classes to the detriment of long-term asset classes.
One of the drivers of short term investment is the requirement for trustees to provide 30-day portability, a policy which El-Ansary says incentivises many trustees to allocate only a small portion of funds to relatively illiquid assets such as infrastructure, VC and PE.
Adding, without super funds taking a longer-term approach to its investment choices, VC and PE funding will dwindle and the innovators “will be forced to relocate to markets where more attractive policy and regulatory settings exist”.
AVCAL also said capital gains taxation reforms which promote longer-term investment in assets based on five, ten or 15 year holding periods would also improve the current situation.
“A smaller CGT discount could be offered for the holding of an asset for a relatively short holding period, and a larger CGT discount offered for a long holding period. A zero CGT rate could even apply for the holding of an asset for greater than 10 or 15 years for example,” it said.
Traditionally VC funding targets tech companies that either aim to expand smart sectors or make big industries smarter while PE is important for bankrolling capital expenditure.
But Australia is lagging behind global averages in terms of VC and PE activity, AVCAL said.
“In Australia, PE accounts for only 5% of all mergers and acquisition activity and private placements. In the US and UK markets, the comparative is around 14%,” it said.