In my last article I responded to an interview in Vox with Marc Andresseen where he lamented that, in spite of a historic gold rush in technology companies, the IPO is dying in the United States due to zealous over regulation of the likes of Sarbanes Oxley. As a result, the general public is missing out on the incredible gains that were experienced in the listed technology companies of yesteryear in the US. Yes, the regulators have gone too far and it’s serious friction on the IPO pipeline, however I argued that perhaps the real reason that technology companies appear to Marc to be listing later and later is because, not surprisingly, the top venture capitalists are keeping these returns all for themselves.
It’s been a relatively recent phenomenon that US technology companies have been waiting longer and longer to go public. In the US technology IPOs of yesteryear companies went public much earlier, with market capitalisations in the hundreds of millions of dollars instead of the tens of billions. As a result, the general public had the ability to share in the spectacular returns that technology companies can generate over time as software eats the world and industry after industry is being wholesale remapped and reshaped with revenue growth at a speed unprecedented in history.
Even though eBay’s share price went up a spectacular 163% on opening day, if you bought shares on market after this rise and held on until today you’d have made over 3,500%. If you bought Amazon the day after it listed, you’d be up over 27,000%, and if you’d bought Microsoft at IPO in 1986, you’d be up 66,500% today and 3,000% in the first eight years alone. Unfortunately for investors in the US, the general public is missing out; you only have to look at Facebook listing at $104 billion and Twitter listing at $24 billion to get a feeling of just how late these companies are going to market. So who is making all the money as the stocks go from the tens of millions of dollars in market capitalisation to the tens of billions? The answer, not surprisingly, are the venture capitalists. You can’t blame them for doing so, because of course their business model is to make as much money as possible for their limited partners.
There is another stock market however outside the US that is not subject to Sarbanes Oxley and where technology listings are about to boom. This market is already quite a large market for equity capital issuances, and in fact as much money was raised there in the last five years as NASDAQ. The only problem from a technology company perspective is that most of the money raised there has been for resources companies. This market is the Australian Securities Exchange.
Now let me tell you how this has all come about, and why now.
There is a disaster in venture capital in Australia with only around $30 million per annum for the whole of seed stage investments, $40 million in early stage and $20m in late stage. AVCAL reports there were 16 “investments” done with this grand sum of $20 million in late stage venture capital in 2013. I am quite perplexed about how they defined “late stage” here, because the very definition of a late stage round size is usually greater than $20 million in one single investment, let alone sixteen. The only conclusion I can make is that these investments were triage into bleeding zombie companies, hardly a sign of a successful late stage industry. Either that, or AVCAL has now taken up reporting of late stage investments into lemonade stands. Atlassian, one of Australia’s most successful technology companies, just raised US$150 million in a late stage round. The entire Australian venture capital industry simply isn’t big enough to fund that single round.
In addition to the lack of venture financing, a major terraforming of the economy is needed. Although we have $1.5 trillion dollars in the fourth largest pool of retirement funds (superannuation) in the world, these funds don’t invest very much in Australian venture capital because none of the VCs to date have demonstrated that they can generate a return. It’s hard to claim that venture capital is even an asset class in this country, as it’s missed every single major technology success story this country has produced all the way back from Radiata; Atlassian, Kogan, Big Commerce, RetailMeNot, Campaign Monitor, OzForex and the list goes on and on. For the life of me, I can’t think of one they actually invested in.
The funds being invested into Australian VC come roughly equally from corporates, government and high net worth individuals. Corporate investment in VC in Australia is in decline, and with the government recently turning its tap off with the cancellation of the IIF program, I don’t see a path to resurrecting a domestic venture capital industry any time within the next decade or two without a serious change in philosophy that is not going to come from either of the two major political parties. The incumbent Liberal party is currently implementing a program of austerity, and the previous Labor government at best was only interested in trying to win union votes from bailing out the inefficient and dying local manufacturing sectors. The biggest impact Labor had on the sector during their tenure was to change the laws on the taxation of option schemes, which wiped out the primary incentivisation mechanism for the technology industry (and, ironically, the primary means by which wealth is redistributed from owners to workers).
While I personally was not sorry to see the IIF go, I was hopeful that the axing of the program would be replaced with something more effective for financing technology companies down under. A better way would be through taxation reform for investors in qualifying risky technology ventures (front-end relief in the form of tax credits or a reduced rate of tax and back-end relief in the form of capital gains tax reductions or exemptions like the UK’s Enterprise and Seed Enterprise Investment Schemes). At the end of the day, the Australian government only provided $25 million a year into the IIF program, which is paltry when you consider Singapore, with a population of 5.4 million has committed S$16 billion (US$12.8 billion) into scientific research and development over a four year period from 2011 to 2015.
So how are Australian companies getting financed? Whilst the big US VC brands like Accel, Sequoia, Spectrum and Insight are actively prospecting down here, they are mostly just looking for cheap deals by value investing in late stage companies outside the hot money Silicon Valley market. The investments that they have done to date that have been trumpeted in the media have for the most part been majority buyouts or exits (Campaign Monitor, 99designs, RetailMeNot, etc). A notable exception to this however has been Accel’s investment in Atlassian.
However, the lack of funding has not deterred Australia’s entrepreneurs from building world class technology companies.
Instead, they have focused on raising funds from the best source possible- from selling something valuable to their customers. Almost all of Australia’s best technology companies have bootstrapped all the way through. Those that did take outside funding, for the most part, didn’t take it until they reached quite a late stage. As a result, we have some very well run technology companies, and some world class companies in the making. Although I am pretty active in the startup community, every second week I am shocked to discover yet another Australian technology company that I have never heard of generating $10 million, $20 million, $50 million or more in revenue per annum. Until recently, I had never heard of companies like RedBubble, Nitro and Pepperstone (who, in three years has become the 11th biggest forex broker in the world, turning over $70 billion a month through their online platform).
Because the Australian technology industry is mostly bootstrapped, it took longer to get here, but coming down the pipeline are an incredible number of great technology companies.
So if the Australian VC industry is dead, then how are these great companies going to raise funds when they need them? Well, I believe the answer is staring them right in the face, and it’s called the Australian Securities Exchange (ASX).
After all, what better way to fund a company than by crowdsourcing it? This is what the resources industry already does today, via the ASX. If you have an early stage speculative mining company, you don’t go begging down Coal Hill Road pitching to mining VCs and spending six months negotiating a telephone directory thick preferred stock structure; you write a prospectus detailing what you’re going to do with the money and list it on the ASX. Likewise if you’re BHP or Rio Tinto, you can go to the ASX and the market is deep enough to raise billions. Crowd sourcing equity from the public has been done successfully for decades in resources, the ASX is in the top five globally for the total amount of money raised for equity issuances from 2009-13. There is no Sarbanes-Oxley in Australia, and listing costs are quite low (In Freelancer’s IPO, the underwriting fees were $450,000, legal fees were around $100,000 and investigating accountant cost about $50,000).
Why go to a venture capital middle man unless they are a rock star with solid operating experience that can add demonstrable value in some way?
I believe that Malcolm Turnbull will bring in legislation to allow the general public to crowdfund early stage ventures without a registered offering document as is starting to happen elsewhere around the world. This will generate further interest and appetite in investing in technology companies from the general public which already actively takes a punt on speculative, early stage mining companies (not to mention the Melbourne Cup). At the moment, to invest in companies without a registered offering document you need to be a “sophisticated investor”, which is curiously defined as a person having income of $250,000 per annum in each of the last two years, or net assets of $2.5 million. I don’t know why at the moment being rich makes you automatically sophisticated and being poor you’re assumed to be incompetent with your money, but I’m sure that something sensible will happen here. If, by miracle, we see some taxation relief for technology investments, then this will be accelerated (but I’m not holding my breath, although the Australian government used to provide some form of taxation relief for investors in the mining industry).
When we were considering listing Freelancer on the ASX, many people gave us the usual regurgitated responses on why it wouldn’t work; investors here don’t understand technology and that we would trade at a discount compared to US markets. Professor George Foster from Stanford Graduate School of Business showed some time ago that country specific factors were a lot less important than company specific financial statement based information in explaining valuation multiples in an international setting. Markets are increasingly globalised; it’s almost as easy for a US investor to buy Australian shares as US ones. Money flows to where it gets the greatest return for a given risk profile; basically if arbitrage exists, someone will take it. Our stock going to $2.50 from a 50 cent issue price in the biggest opening in the last 14 years and third biggest opening ever on the ASX for an issuance larger than seed size is testament to the amount of pent up interest amongst the general public to invest in technology.
We took a calculated risk- nobody wants to be the first to try something new, and so far it has paid off. It’s great to see the sector now heating up with recent listings from companies like Ozforex, iSelect, iBuy and MigMe (up 95% yesterday on their IPO, and like I did, broke the bell), and with WiseTech Global, Vista Group, 1-page, Covata, BPS Technology, Grays Australia imminently coming down the pipeline. I suspect Ruslan Kogan will also be considering his options given the tremendous effort he has done bootstrapping Kogan to date. What surprised me is that the process was significantly easier, quicker and resulted in a more equitable and transparent capital structure than what I have experienced in any of the dozen venture capital financings I have been involved with in the past.
Projecting forward, I think that the ASX will be the primary way in which technology companies raise equity in this country in the future. The ASX realises this as well, and is moving to position itself as a regional hub for the Asian technology sector. If it is successful, and I think there is a good chance it will be, it will cover a massive market. There are significantly more people in Asia (with dramatically rising incomes), significantly more micro, small and medium enterprises (MSMEs), it’s a much bigger market for many industries, and there are a lot more mobile phones than the US to draw comparison to just a few metrics.
The ASX is in a fantastic position to capture this opportunity. In the second half of 2013 a total of 14 technology companies listed on the ASX. Since January 2014 there has been 55. In the entirety of 2013, a total of 59 companies were financed by Australian venture capital.
This is the future for technology company financing in Australia.
Freelancer Limited trades on the ASX with the ticker FLN.
