Venture Futures for Australia Two

My blog entry of yesterday attempted to explain why injecting more funds into the Australian venture capital sector might just annoy the pigs and not teach any of them to sing. It has become apparent to me from some of the feedback that I received that I am going to have to be much clearer on the subject …

Say, purely for argument’s sake, that there are 1000 start-ups in Australia this year, mostly garagistas lurking around incubators.

Then assume this:

10 of these start-ups are potentially great companies, and another 20 are potentially OK companies, and the rest are zombies or write-off’s waiting to happen, no matter how much funding they get.

Then assume that the current Australian VC market can provide at most $50m per year to all of these start-ups, which will be divided up between the top 10 and also the next 20, and maybe a handful of the zombies too (because some of the VCs aren’t that bright).

That is the companies are getting a couple of million each, at best.

If that amount of VC funds jumps to $1b per year (say under a mandated golden visa scheme) then one of two things will happen:

1. A large number of $50-100m VC funds will be formed, or
2. A small number of $1b funds will be formed

My guess is number 1 because a lot of people who have never been VCs have already contacted me to see if I want to be part of a new VC partnership.

So we will have 10-20 VC funds chasing the same mediocre deal flow that we have today.

Each will need to invest in 10 or so deals in the first 4 years.

So there isn’t enough good deals for them all to invest in and the top 30 will be over-subscribed pretty quickly, and the rest of the funds will start pumping money into the zombies with the intention of trying to ‘fix’ them.

Thus the overall return on Australian VC, the average or the mean return to be specific, will be dragged down substantially by the expected zero return on all that money going into the zombies.

Once an asset class doesn’t return, on average, the required risk-adjusted IRR then it pretty quickly disappears or gets seriously re-structured.

And the VC guys that get their money into the top 30 companies will still under-invest because with that small $50-100m fund size they won’t be able to invest more than $5-10m in a deal. And they won’t be able to manage co-investment with more than 3-4 other Australian VCs without imploding under mutual loathing (they all end up hating each other for some reason).

Those top 30 companies which will each receive $15-30m over their start-up life and each will have a number of silicon valley competitors that are raising this sort of money; $150k incubator, $1m Seed, $10m Series A, $100m Series B, $1b Series C…

Is that clearer?