EARLY STAGE FUNDING
(ANGEL, SEED, AND ACCELERATOR)

In contrast to later-stage venture capital, angel and seed investment in Australia has fallen for the last three years, both in terms of number of deals and aggregate value of early-stage investments. While this is broadly consistent with global trends toward fewer higher-value deals, the steep decline in Australian deal numbers is notable.

Very early stage funding in private companies is notoriously hard to measure. It is often not announced publicly and typically involves companies that are too small to feature in most data capturing initiatives.

Nevertheless, trends here are concerning. Analysis of Pitchbook data suggests a significant decline in the volume and aggregate value of deals over the last few years (Figure 8). In 2018-19 that decline continued, with only 138 deals totalling US$75m - a fall of 46% in volume terms and 29% in aggregate dollars invested. These numbers are down from US$180m invested in 2015-16 across 273 deals.

FIGURE 8: EARLY STAGE FUNDING, AUSTRALIAN STARTUPS (JUNE 2014 - JULY 2019)
crossroads 2019 WEB Charts Figure 8

This downward trend is particularly problematic when considered in the context of Australia’s low base for early stage funding. The 2018-19 figures represent early stage funding of about US$3.05 per capita. Over the same period the UK saw US$781m invested in seed and angel rounds, or about US$15.84 per capita – more than five times Australia’s rate.

Clearly, early stage funding is an area where Australia still lags.

Anecdotal evidence suggests there is also a problem in terms of the quality of Australian early stage investment. For the most part, seed investment remains a cottage industry, with individual investors sourcing deals directly and with little amalgamation or professionalisation. The few notable exceptions are angel investment groups, typically located in major cities. These account for as little as 5% of all angel investments made in Australia.

Outside of these groups, seed investment is fragmented and opaque, making it hard for founders to connect with investors (and vice versa). This fragmentation also means best practice is hard to find, increasing the risk of poor or harmful deals. Many accelerator operators and later-stage investors note that they regularly see startups with seed stage terms so onerous that they are unable to attract any further funding down the line, crippling the business from the outset.

IMPROVING THE QUANTITY OF EARLY STAGE CAPITAL

There have been some efforts to boost seed investment rates in Australia in recent years. As part of the 2015 National Innovation and Science Agenda, the Turnbull Government introduced the Early Stage Innovation Company (ESIC) tax incentives to encourage more early stage investment in startups. It is one of the most generous incentives of its kind in the world, providing a 20% income tax offset and capital gains exemption for eligible investments. Nevertheless, the impact of these measures has been hard to quantify, with no official data on the scheme being made public.

Some tweaks to the program could undoubtedly help it improve, including broadening the qualification criteria for eligible companies. More active publicity for the incentive would also help drive uptake. We outline policy levers available to increase uptake in our ESIC policy proposal.

IMPROVING DEAL QUALITY AT SEED STAGE

Tax breaks can help address the shortfall in volume of seed investment but are unlikely to boost the quality of early stage funding. It’s possible that an influx of additional capital could even drive the quality of deals down as inexperienced investors enter the market.

Standard terms: Establishing standard terms for early stage investments would help address some of the quality concerns around seed-stage deals. For later-stage deals, an industry standard has begun to emerge around the open source seed financing documents produced by AIC, the venture capital sector’s industry body. However, these resources are aimed at venture capital firms, and are not necessarily appropriate for investors at the earliest stages. The establishment of a similar set of resources for genuine seed and angel investments would be highly valuable.

Investor education: A strong focus on investor education could also help improve deal quality. Improved awareness of the growth-limiting nature of onerous terms should drive higher quality outcomes as more investors take a longer view. It’s unlikely that most investors genuinely want to hamstring companies in which they invest.

A governing body for early stage startup investors: Improving two-way access and visibility between startups and angels is also an area where productive work could be done. Encouraging the establishment of angel collectives could help here, as could the development of a governing national body. Similar organisations have previously been attempted, most recently with the Australian Association of Angel Investors (AAAI), but these organisations have consistently failed to find a sustainable business model.Government support will likely be required if such a push is to be successful. If a national representative body were tasked, in part, with collecting and reporting on data and trends in the seed and angel investment space, government support would be warranted. This sort of data is hard to acquire and is critical in designing and assessing the performance of costly public programs.

RECYCLING SEED CAPITAL FROM STARTUP SUCCESSES

One positive emerging trend is that Australia’s most successful founders are starting to reinvest in Australian startups. Atlassian’s co-founders, Mike Cannon-Brookes and Scott Farquhar, have both established investment funds (respectively Grok Ventures and Skip Capital). Paul Bassat, a founder of SEEK, went on to establish Square Peg Capital, one of Australia’s biggest venture firms. As the pace of successful company exits increases we are likely to see this trend continue, helping inject smart capital and experience in building high-value tech businesses back into the sector.