Venture Capital in Australia


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Venture Capital in Australia

  1. 1. Venture Capital in Australia a how to guide contents What is Venture Capital? .................................................... 2 The Australian Market – an Overview ............................... 4 Competitive Environment................................................... 7 Legal Issues ....................................................................... 12 Market Contacts ................................................................ 13 Venture Capital Definitions .............................................. 14 This document is one of a series of free information tools for exporters produced by New Zealand Venture Trade and Enterprise. We provide a wide range of standard services and sophisticated solutions Capital in that assist businesses through every stage of the export process. Australia For information or advice, ring NZTE on 0800 555 888, visit, email October or contact your NZTE Client Manager. 2003 1
  2. 2. What is Venture Capital? Venture capital (VC) is a means of financing fast-growing private companies. Finance may be required for business development at a number of stages in a company’s life including start-up, development or expansion, whole or partial purchase of another enterprise or the rescue of a faltering business. Venture capital is most often an investment in private companies or enterprises although the term has slightly different meanings between countries. Growing businesses always require capital and there are a number of different ways to fund growth. New capital may be sourced from personal resources, family and friends, wealthy individuals and private investors, other companies and organisations, and the professional venture capital or private equity industry. The venture capitalist acquires an agreed proportion of the equity of the company in return for the required funding. When venture capitalists invest in a business they become part-owners and typically require a seat on the company's board of directors. They tend to take a minority share in the company and usually do not take day-to-day control. Rather, professional venture capitalists act as mentors and aim to provide support and advice on a range of management and technical issues to assist the company to develop its full potential. Advantages of Venture Capital Venture capital has a number of advantages over other forms of finance, such as: • Finance - The venture capitalist injects long-term equity finance, which provides a solid capital base for future growth. The venture capitalist may also be capable of providing additional rounds of funding should it be required to finance further growth. • Business Partner - The venture capitalist is a business partner, sharing the risks and rewards. Venture capitalists are rewarded by business success and capital gain. • Mentoring - The venture capitalist is able to provide strategic, operational and financial advice to the company based on past experience with other companies in similar situations. • Alliances - The venture capitalist often has a network of contacts in many areas that can add value to the company, such as in recruiting key personnel, providing contacts in international markets, introductions to strategic partners and, if needed, co-investments with other venture capital firms when additional rounds of financing are required. • Facilitation of Exit - The venture capitalist is experienced in the process of preparing a company for an initial public offering (IPO) and facilitating in trade sales. Disadvantages of Venture Capital • Dilution of company ownership by previous investors • High level of returns sought by an investor • Professionalism – international knowledge and skills of venture capitalists may be daunting Venture for companies who have had little or no experience or expertise in the international arena. Capital in Australia • Duration of commitment – Are investors in for a ‘quick buck’ or are they in for a more stable medium term investment. October 2003 2
  3. 3. • Unclear exit strategies - What impact will the strategy have on the company in the short-term and long-term. Do you have a clearly defined process to overcome such a situation? Venture capital firms typically source most of their funding from large investment institutions such as superannuation funds and banks. These institutions often invest in a venture capital fund for a period of up to ten years. Funds however can also be obtained from high net worth individuals whose expectations and motivations may differ. To compensate for the long-term commitment and lack of security and liquidity, investment institutions expect to receive very high returns on their investment. Therefore, venture capitalists invest in companies with high growth potential or in companies which have the ability to quickly repay a high level of debt - as in the case of a leveraged management buyout. Venture capitalists typically exit the investment through the company listing on the stock exchange, selling to a trade buyer or through a management buyout. Although the venture capitalist may receive some return through dividends, their primary return on investment comes from capital gain when they eventually sell their shares in the company, typically three to seven years after the investment. More venture companies, particularly in Singapore and the United States, are examining share retention should companies list on the stock exchange as a way to maintain ongoing financial and business involvement in the company while receiving financial benefit for the firm. Venture capitalists are therefore in the business of promoting growth in the companies they invest in and managing the associated risk to protect and enhance their investors' capital. Venture Capital in Australia October 2003 3
  4. 4. The Australian Market – an Overview Number of Firms 179 Total Capital AUD$8.828 billion minimum Invested Capital AUD$4.560 billion minimum Available Capital AUD$4.358 billion minimum Total number of Investments 1,308 Current Portfolio 880 Completed Divestments 428 Professional Staff 614 VCs may only provide investment opportunities to companies within specific stages of business development. The preferences by stage of capital of VC firms break down as follows: • Seed 59 • Start up 69 • Early expansion 93 • Expansion 101 • Management buyout 73 • Management buyin 61 • Turnaround 42 Information technology and communications have traditionally been high areas of investment. Following is a breakdown of number of new investments by industry from 2000 / 2001 financial year. • Internet specific 26 • Computer software 18 • Consumer related 16 • Biotechnology 15 • Financial services 15 • Communications and media 11 • Business services 10 • Medical/Health 9 • Industrial/Energy 8 • Manufacturing 8 Venture • Agriculture/Forestry/Fishing 7 Capital in Australia • Computer Hardware 7 October • Semiconductors/other Electrical 5 2003 4
  5. 5. • Utilities 2 • Construction 1 • Transportation 1 • Other 1 Growth Rate The Australian VC sector has experienced rapid growth since the mid 1990s, both in terms of managed total capital and the number of venture capital firms operating in the market. Key drivers include: • Institutional investor awareness of venture capital as a separate asset class • Increased awareness and participation of private investors • Government programmes to encourage participation in the sector • Building on Information technology (BITS) Program • Innovation Investment Funds (IIF) Program • Pooled Development Funds (PDF) Program Industry growth • Increased interest in technology investment In October 2001, the Australian Government reformed Commonwealth legislation changing the way private equity (venture capital) funds may choose to operate. New legislation has provided for tax concessions for investors from outside Australia making it more attractive to allocate a portion of their global portfolio (funds) to Australian venture capital partners. Through the establishment of the venture capital limited partnership (VCLP), the Australian venture capital industry will be brought into line with the structure operating in most other countries. International investors who fall within the criteria of the legislation will be tax exempt from capital gains on their investments in Australian VCLP’s. VCLP criteria states however that these investors must be resident within a ‘designated country’ which at the moment only includes the United States, UK, Japan, Germany, France and Canada. There are plans to further extend this list. In addition, changes have been made to rules covering other investors ie. Individuals or institutions. Any investor who invests less than 10% of a VCLP’s (Australian coy) capital will also do so without incurring capital gains tax. There are no country restrictions with this clause. There are however criteria that Australian companies must meet to be classified as a VCLP. These are: • Limit its investments to unlisted companies or trusts, or listed companies in the process of delisting Venture • Invest only in companies when the value of the assets of the company is less than $250 Capital in million Australia • Not invest in property development October 2003 5
  6. 6. • Limit its investments to businesses that are primarily based in Australia at the time of the initial investment • Not invest more than 30% of its committed capital in any single investment • Structure its partnership so that it does not own more than 30% of the VCLP • Structure its fund within the investment time horizon of 5 – 15 years. Venture Capital in Australia October 2003 6
  7. 7. Competitive Environment Major Players in the Market There are 131 companies operating within the Australian VC market offering a total minimum of AUD$8.828 billion. The largest companies based on total capital available are: 1. CVC Asia Pacific US$10+ billion 2. Advent International Australia US$ 5 billion 3. DB Capital Partners AUD$1.6 billion 4. Castle Harlan Australian Mezzanine Partners AUD$550 million 5. Pacific Equity Partners Pty Ltd AUD$500 million 6. AMP Henderson AUD$406.8 million 7. Macquarie Direct Investment AUD$395 million 8. Catalyst Investment Managers AUD$350 million 9. RMB Ventures AUD$300 million 10. GS Private Equity AUD$295 million Selecting the Venture Capitalist Investor The Australian Venture Capital Association represents most venture capital organisations in Australia. The AVCAL Directory of Members provides basic information about each member's investment preferences and is available from the association via its website at The Australian Venture Capital Guide, published by Pollitecon Publications, provides information on venture capital as well as listing companies who offer business introduction services, product development funding and infrastructure equity. The most important thing before even considering a VC partner is to get one’s company “investment ready” – most VCs are inundated with proposals from companies that are not ready for a VC investment. Before selecting a venture capital partner, companies should study the particular investment preferences set down by the venture capital firm. Often venture capitalists have preferences for particular stages of investment, industry sectors, geographical location and amount of investment. Once a short list of potential venture capitalists has been drawn up, it is often a good idea to contact the venture capital firm and request a copy of their publications, or look on their website, to clarify the type of investments they favour. An investment in an unlisted company has a long-term horizon, typically four to six years. It is Venture vital to select venture capitalists with whom it is possible to have a good working relationship as Capital in these individuals will be closely tied to the company’s success. Australia October 2003 7
  8. 8. Often businesses do not meet their cash flow forecasts and require additional funds, so an investor's ability to invest further funds if required is also important. Finally, when choosing a venture capitalist, companies should consider not just the amount and terms of investment, but also the additional value that the venture capitalist can bring to the company. These skills may include industry knowledge, fundraising, financial and strategic planning, recruitment of key personnel, mergers and acquisitions, and access to international markets and technology. Surveys in the US consistently rate management support as the most important contribution of a venture capital firm. There are many sources of capital, but only a venture capitalist can provide experienced management input gained by helping many other companies successfully conquer the inevitable problems and growing pains. What does a Venture Capitalist look for? Venture capitalists are higher risk investors and, in accepting these higher risks, they desire a higher return on their investment. Venture capitalists have differing operating approaches. These differences may relate to the location of the business, the size of the investment, the stage of the company, industry specialisation, structure of the investment and involvement of the venture capitalists in the company's activities. Companies should not be discouraged if one venture capitalist does not wish to proceed with an investment in the company. The rejection may not be a reflection of the quality of the business, but rather a matter of the business not fitting with the venture capitalist's particular investment criteria. Venture capital is not suitable for all businesses. A venture capitalist typically seeks: Superior Businesses Venture capitalists look for companies with superior products or services targeted at fast-growing or untapped markets with a defensible strategic position. Alternatively, for leveraged management buyouts, they are seeking companies with high borrowing capacity, stability of earnings and an ability to generate surplus cash to quickly repay debt. Quality and Depth of Management Venture capitalists must be confident that the firm has the quality and depth in the management team to achieve its aspirations. Venture capitalists seldom seek managerial control; rather, they want to add value to the investment where they have particular skills including fundraising, mergers and acquisitions, international marketing and networks. Corporate Governance and Structure In many ways the introduction of a venture capitalist is preparatory to a public listing. The venture capitalist will want to ensure that the company has the willingness to adopt modern corporate governance standards, such as non-executive directors, including a representative of the venture Venture Capital in capitalist. Australia Venture capitalists are put off by complex corporate structures and where personal and business assets are merged. October 2003 8
  9. 9. Appropriate Investment Structure As well as the requirement of being an attractive business opportunity, the venture capitalist will also be seeking to structure a satisfactory deal to produce the anticipated financial returns to investors. An Exit Plan Lastly, venture capitalists look for clear exit routes for their investment such as public listing or a third-party acquisition of the company. Marketing Strategies Once a short list of appropriate venture capitalists has been selected, an approach can be made. The venture capital firm will ask prospective investee companies for information concerning the product or service, the market analysis, how the company operates, the investment required and how it is to be used, financial projections and, importantly questions about the management team. In reality, all of the above questions should be answered in the business plan. Assuming the venture capitalist expresses interest in the investment opportunity, a good business plan is a prerequisite The Business Plan Venture capitalists view hundreds of business plans every year. The business plan must therefore convince the venture capitalist that the company and the management team have the ability to achieve the goals of the company within the specified time. New Zealand Trade and Enterprise has provided general comment on the types of information that should covered within an investment business plan. More detailed information, however, is available on the AVCAL website. The business plan should explain the nature of the company's business, what it wants to achieve and how it is going to do it. The company's management should prepare the plan and should set challenging but achievable goals. The length of the business plan depends on the particular circumstances but, as a general rule, it should be no longer than 10 pages. It is important to use plain English - especially if you are explaining technical detail and avoid jargon and general position statements. Executive Summary This is the most important section and is often best written last. It summarises your business plan and is placed at the front of the document. It is vital to give this summary significant thought and time, as it may well determine the amount of consideration the venture capital investor will give to your detailed proposal. It should be clearly written and powerfully persuasive, yet balance "sales talk" with realism in Venture order to be convincing. It should be limited to no more than two pages and include the key Capital in elements of the business plan. Australia October 2003 9
  10. 10. Background on the company Provide a summary of the fundamental nature of the company and its activities, a brief history of the company and an outline of the company's objectives. The product or service Explain the company's product or service in plain English. This is especially important if the product or service is technically orientated. A non-specialist must be able to understand the plan. Market analysis You need to convince the venture capital firm that there is a real commercial opportunity for the business and its products and services. Offer the reader a combination of clear description and analysis, including a realistic "SWOT" (strengths, weaknesses, opportunities and threats) analysis. Marketing Having defined the relevant market and its opportunities, it is necessary to address how the prospective business will exploit these opportunities. Business operations Explain how your business operates. The management team Demonstrate that the company has the quality of management to be able to turn the business plan into reality. Financial projections Consider using an external accountant to verify and act as "devil's advocate" for this part of the plan. AVCAL has a range of national and regional corporate members who could help you with this. Relevant historical financial performance should also be presented. The company's historical achievements can help give meaning, context and credibility to future projections. Amount and use of finance required and exit opportunities State how much finance is required by your business and from what sources (i.e. management, venture capital, banks and others) and explain the purpose for which it will be applied. Outline the capital structure and ownership before and after financing. Consider how the venture capital investors will exit the investment and make a return. Possible exit strategies for the investors may include floating the company on a stock exchange or selling the company to a trade buyer. Investment Process The investment process begins with the venture capitalist conducting an initial review of the proposal to determine if it fits with the firm's investment criteria. If so, a meeting will be arranged with companies/management team to discuss the business plan. Venture Capital in Australia October 2003 10
  11. 11. Preliminary Screening The initial meeting provides an opportunity for the venture capitalist to meet companies and key members of the management team to review the business plan and conduct initial due diligence on the project. It is an important time for the management team to demonstrate their understanding of their business and ability to achieve the strategies outlined in the plan. The venture capitalist will look carefully at the team's skills and backgrounds. Negotiating Investment This involves an agreement between the venture capitalist and management of the terms of the memorandum of understanding. The venture capitalist will then study the viability of the market to estimate its potential. Often they use market forecasts that have been independently prepared by industry experts who specialise in estimating the size and growth rates of markets and market segments. The venture capitalist also studies the industry carefully to obtain information about competitors, entry barriers, the potential to exploit substantial niches, product life cycles, distribution channels and possible export potential. The due diligence continues with reports from accountants and other consultants. Approvals and Investment Completed The process involves exhaustive due diligence and disclosure of all relevant business information. Final terms can then be negotiated and an investment proposal submitted to the board of directors. If approved, legal documents are prepared. A shareholders' agreement is prepared containing the rights and obligations of each party. This could include, for example, veto rights by the investor on remuneration and loans to executives, acquisition or sale of assets, audit, listing of the company, rights of co-sale and warranties relating to the accuracy of information enclosed. The investment process can take up to three months, and sometimes longer. It is important, therefore, not to expect a speedy response. It is advisable to plan the business financial needs early on to allow appropriate time to secure the required funding. Venture Capital in Australia October 2003 11
  12. 12. Legal Issues Confidentiality Issues All venture capitalists that are members of AVCAL are bound by the AVCAL code of conduct and will respect confidential information supplied to them by companies looking for venture capital. The AVCAL confidentiality agreement can be used to ensure that information given to investors is provided on the basis that the investor will maintain its confidentiality. This document can be obtained from the AVCAL website at Resource Centre > Industry Tools. Legal Terms It is likely that a shareholders' agreement would be prepared containing the rights and obligations of each party. This could include: • Amount and terms of investment. • Dividend policy. • Composition of the board of directors. • Reporting - management reports, monthly accounts, annual budgets. • Liquidity (exit) plans. • Rights of co-sale. • Warranties. • Matters requiring venture capitalist approval (such as auditors, employment contracts, major asset purchases, major debt obligations and significant variations of plans). It is important that companies are fully informed and are aware of the legal responsibilities and restrictions placed upon them under any investment agreement. New Zealand Trade and Enterprise recommends that companies seek legal council from venture capital / investment experts prior to confirmation of any deal. New Zealand Trade and Enterprise can provide details of such companies should they be required. Venture Capital in Australia October 2003 12
  13. 13. Market Contacts Investment New Zealand Level 10 GPO Box 54 55 Hunter Street Sydney NSW 2001 Sydney NSW 200 Australia Ph: 61 2 9234 2700 Email: Fx: 61 2 9234 2701 Web: New Zealand Trade and Enterprise Level 10 GPO Box 54 55 Hunter Street Sydney NSW 2001 Sydney NSW 200 Australia Ph: 61 2 9234 2700 Email: Fx: 61 2 9234 2701 Web: Contact: John Nicholson – Senior Trade Commissioner Australian Venture Capital Association Limited (AVCAL) Level 5 88 Phillip Street Sydney NSW 2000 Australia Ph: 61 2 9251 3888 Email: Fax: 61 2 9251 3808 Web: Contact: Andrew Green – Chief Executive Pollitecon Publications PO Box 324 Five Dock NSW 2046 Venture Australia Capital in Australia Ph: 61 2 9713 7608 Email: Fax: 61 2 9713 1004 Web: October 2003 13
  14. 14. Venture Capital Definitions Early Expansion Growth funding for a relatively new business Expansion / Development Growth funding for an established business Initial Public Offering When a company offers shares to the public and lists on the Stock Exchange Leveraged Buyout (LBO) Buyout that is funded with both equity and debt. LBO’s include but need not be MBO’s or MBI’s Management Buy in (MBI) Funding to enable a new management team to buy into a business Management Buyout (MBO) Funding to enable a current management team to buy into a business Pre-listing Where a company plans to list on the Stock Exchange, usually within a period of a few months Replacement / Secondary Purchase of existing shares rather than new equity Seed Funding to develop, test and ready a product for production, a service for commencement and other pre-first-sales activities such as company formation Start Up Funding to commence commercial business operations ie. When a business starts taking and fulfilling commercial orders Turnaround Funding to enable an established (faltering) business to be rescued Information sourced from: Australian Venture Capital Association Limited, Australian Venture Capital Guide 2002, Bivell (ed), Pollitecon Publications, Five Dock, Australia, pp9 – 23. Australian Venture Capital Association Limited 2001 Yearbook, Thomson Financial/Venture Economics, AVCAL, pp17-19, p41. Disclaimer: While New Zealand Trade and Enterprise has verified the information in this document, we make no representation as to the completeness, correctness, currency, accuracy or fitness for any purpose of the information. New Zealand Trade and Enterprise will not be responsible for any damage or loss suffered by any person arising from the information contained in this document, whether, that damage or loss arises from Venture negligence or otherwise. Capital in Australia October 2003 14