Jennifer Hewett, The Sydney Morning Herald, 3 February 2001
IT firm 80-20 is a home-grown success story with a growing global focus. But our fledgling VC industry still has a long, long way to go, reports Jennifer Hewett.
Frank Stranges jokes that a lot of people think he's nuts to remain in Australia. He refuses to concede the point at least so far.
"Our goal was to become a global company,'' he says. "But I wanted to create an organisation that allowed people to be collectively gathered in Australia to work on developing intellectual property here as opposed to creating a brain drain.''
And so far, he's been able to do just that. Stranges is CEO of 80-20 Software, an information retrieval company that is now exporting heavily into the US and moved its headquarters to Seattle last year but maintains all its research and development facilities in Australia. "Are we serious about wanting a culture that is serious about intellectual property in Australia?'' he says. "I didn't want to die wondering ... I believe it's one of the last frontiers for this country in terms of putting a stake in the ground.'' With 80-20, Stranges has at least started hammering in a small peg. But the reason most people have never heard of the company despite its success is that Stranges has never tried to take 80-20 public not even during the frenzy of the tech boom before dot com life started turning so sour last April. Instead he's relied on venture capital to fund his expansion. He's not alone.
PricewaterhouseCoopers estimates that such private equity is likely to be the principle source of cash for all those hopeful new start-up firms, particularly now that the stock exchange is proving such an unwelcoming place.
Think of these companies as the unknown Australian soldiers in the larger war for the new economy. They are armed with products like photonics or intelligence networks or optical switches or voice recognition systems. And one of the essential requirements to attract investors, according to most venture capitalists, is that these companies all have the potential to grow and compete in a global market.
This is not just an academic point. The resilience of the economy will be increasingly dependent on the ability of its smaller IT companies to grow and expand into global exports and investments. Certainly, all that optimistic talk about the need to commercialise Australian R&D and making the most out of promising opportunities in the universities and public institutions will prove illusory without funding to smooth the way. The tech wreck casualties are demonstrating the perils of relying on the stockmarket.
The basic idea behind venture capital is for a group of private investors to get together and back start-up companies either to begin or to expand. The attraction is the prospect of much higher returns on their investment even though they will have to wait several years to get them usually when the company eventually goes public or is sold to a larger one. The US is, of course, the home of the global venture capital industry, with Silicon Valley its epicentre. It raised $US70 billion in venture capital in the first nine months of this year.
Australia is now desperately trying to replicate that in its own modest fashion and from almost a standing start a few years ago. According to the Australian Venture Capital Association (AVCA), just under 200 companies received funding last year and about 300 will get injections this year. The other relevant figure is that the industry raised about $1.9 billion in new capital commitments last financial year and actually invested around half of it.
Most of this is channelled into smallish companies that rarely attract media attention. But it turns out that venture capital has quietly funded quite a few success stories in the largely unpopulated landscape of Australian entrepreneurialism while so many of their listed cousins are reeling. That still doesn't guarantee Australia's ability to develop the necessary critical mass nationally, of course. There is a very long way to go. A sizeable percentage of new companies backed by venture capital will still fail despite their promising beginnings or get picked off early.
A study last week by Ernst & Young found that Australia's venture capital industry was Big dollars... the US venture capital market is awash with deals. Photo: Reuters
seriously underdeveloped according to an international comparison of entrepreneurship. In terms of investment in IT, Australia ranked 16th out of 17 countries and in terms of venture capital as a percentage of GDP it ranked 15th out of 19 countries.
But the experience of Stranges is heartening for those who despair of Australia being able to keep up and create new technology players in such a fast shifting world. His company now employs 60 people, with 40 of them in R&D and the rest mainly focused on marketing, in the US. With a background in consulting and software distribution business, Stranges says he saw a gap in the market for knowledge management products. "It doesn't matter where you develop your intellectual property,'' Stranges says. "What matters is how you execute your sales and marketing strategy in the North American marketplace.''
After receiving some initial seed funding from Telstra in early 1998, he relied on the backing of Allen & Buckeridge, an Australian venture capital company specialising in IT. That funding, in December 1998, was combined with a crucial investment from one of the world's largest technology companies, Intel. From Stranges' point of view, it meant the best of both worlds a strong Australian venture capital firm to assist with management and experience as well as the global brand and pull of Intel.
Earlier this year, he attracted another key investment from US giant GE Capital. It means 80-20 is in a much more comfortable position from which to weather the present market turmoil. Not surprisingly, it expects more of its earnings to originate in the US where it already has several prominent clients such as Harper Collins, JP Morgan and Panasonic.
Stranges does rail against what he considers a punitive and ridiculously complicated taxation system and the Australian Government's failure to understand what it takes to create a high tech industry. But he is confident of strong future growth for his company. Maybe 80-20 will eventually become a big name. Or maybe not. The point is it's out there with a good chance.
The other part of the equation is that Australian companies are finding that they get much bigger bang for their buck if they can keep and build research and development teams here. The quality of science and innovation is high and the price relatively low.
The issue has always been commercialising and marketing the product. "Universities are now very focused on this area but they have a chequered history and don't have the professional venture capital industry with a lot of people and a lot of money,'' says Roger Allen of Allen & Buckeridge. "There are a series of government programs but they are little Band-Aids around the problem ... There's no point in pumping up public R&D when you don't have a system in place to commercialise it.''
But as Les Fallick, head of a private equity fund at Gresham Partners, points out, venture capital is becoming a very important part of the commercial food chain in Australia. "There has never been a better time to obtain private equity funding in Australia,'' he says. "There is more finance available than ever before. That doesn't mean everyone will be successful but there is no shortage of capital in Australia for good quality deals.'' Forget buckets of easy money awaiting anyone with a big idea and a small business, however. The venture capital market here is still immature and extremely cautious about risky investments, particularly in the very early stages. A lot of the money is still sitting in the venture capital funds waiting for the right deal to come along. Or it will be spent on larger and later management buyouts of existing companies.
In the Australian financial vernacular, management buyouts are also included under the heading of venture capital whereas the US restricts the term to funding start-ups and early stage development. "In the US, there is an acceptance that you have to take a portfolio approach and that out of every 10 investments, only one or two will be winners,'' says Vivian McCarron of PricewaterhouseCoopers. "Here venture capital funds tend to want everyone to be a winner. They are more risk averse, they may be investing for the first time and they want to set up a good track record. They tend to put less money in a deal and they are a lot more cautious.''
That means the average deal size in Australia in the March quarter of this year was only about $1.6 million, according to the Australian Venture Capital Journal. That compares to an average of about $US11 to $US12 million in America. So local companies are having to do a lot more with a lot less, particularly given the dollar's decline.
"We're usually asking them to get big on the smell of an oily rag,'' says McCarron.
One option is to proceed directly to GO by trying the US market. But the catch is that most US venture capitalists are already awash with deals and tend to be suspicious of anyone who hasn't first obtained local backing. The optimistic view is that the amounts available here will improve and more money will eventually filter down into the seed funding and early stage start-ups to ensure that plenty of deals keep bubbling up. It's still hard going.
"We haven't seen a drying up of funds quite the opposite,'' says Megan Clark of Rothschild and the CEO of e-fund, Rothschild's new $50 million IT venture capital fund. "But venture capital is still quite primitive compared to Israel or the US.
"We need to deliver two things a return to investors because there is still not the track record you see in the US and a delivering of value back to the entrepreneurs. Only when both of those are addressed with the venture capital industry mature.''
This also reflects the fact that venture capital is about a lot more than capital. A good venture capitalist is supposed to be a paragon of business virtue, helping provide a new company with market discipline, strategic direction, management expertise and useful introductions and access to other markets.
"Of all the things we give people,'' says Allen, "money is the least important.'' In fact, one of the biggest complaints is that the local venture capital industry just doesn't have enough good management teams and experience to cope with the rising demand for such non-financial assistance.
There are increasing suggestions that too much money is being doled out by people who call themselves venture capitalists but who don't necessarily have the expertise or background to go along with the cash. And even with the best cash and support that is available, it may not be enough.
Another little known wireless technology company, Radiata Communications, was bought out by Cisco Systems for $567 million last month. It was a deal which suddenly made wealthy people out of researchers and became the first local investment by the US tech giant. But the AVCA was among those criticising the early sell-out of a potentially great Australian company and its world-leading technology.
Such criticism is missing the point, according to Clark. "It was fabulous," she says of the deal.
"It helps secure Australia's position as a place where great wireless and chip technology can occur. It will bring other companies to invest and actually add to Australian exports in the long term."