The IT crowd: Australia embraces crowdfunding

Six venture capital partners are sitting in their Sydney office looking for potential deals. They have a mandate to invest in Australia and New Zealand but without a permanent on-the-ground presence in the likes of Perth, Brisbane and Auckland, even the most astute networker would struggle to assemble a full opportunity set.

Technology - in the form of crowdfunding platforms - can extend these investors' reach. An entrepreneur from Perth appears on the radar without anyone needing to get on a plane. Initial due diligence can also be conducted through the online platform, with video chat and document sharing. Suddenly VC investors and start-ups have been brought closer together.

"Crowdfunding enables start-ups, especially those in the high-tech sector, to speed up their capital-raising process," says Jason Best, co-founder of industry consultancy Crowdfund Capital Advisor. "They can get it done in four weeks rather than 6-9 months."

The global crowdfunding craze is only two years old. An estimated of $5 billion was raised through these platforms in 2013, almost doubling the 2012 total. Crowdfunding has also taken off in Australia, with the Australian Small Scale Offering Board (ASSOB) facilitating more than $135 million in start-up funding last year. The country's traditional VC industry saw investments totaling $149 million.

Last week, two more platforms launched Australian operations: Israel-based OurCrowd and VentureCrowd from local player Artesian Venture Partners. Private equity firm M.H. Carnegie & Co. is expected to join them with The Crowd in the next few months.

"I'm sure there will be more competitors, which will be both a validation of the sector and a good result for start-ups and investors," says Jeremy Colless, managing partner of Artesian and founder of VentureCrowd.

Meeting a need

Australian venture capital fundraising has struggle ever since the global financial crisis. According to AVCJ Research, VC firms raised only $37 million and $96 million in 2010 and 2011, respectively. Last year, the total soared to $250 million, the highest level in six years. However, the bulk of this capital went to the Medical Research Innovation Fund, which is managed by non-profit organization AusBiotech and part-bankrolled by the Australian government.

Industry participants say the superannuation funds no longer have an appetite for domestic venture capital, prompting newer firms to look elsewhere for support, notably US VC players and high net worth individuals (HNWIs). The rise of crowdfunding can be seen in a similar context. It has gained traction almost by necessity, providing capital to entrepreneurs who would not otherwise get any, and presenting HNWIs with a pipeline of potential investments.

It is, however, important to separate the gift givers from the professional investors. While the likes of Kickstarter and Indiegogo, which match investors with entrepreneurs and offer tangible awards to the former for backing the latter, are present in Australia, ASSOB, OurCrowd and VentureCrowd operate under the equity model. They invest in start-ups and then take them to the platform to source capital from the crowd.

Traditional venture capitalists are obviously far more interested in equity-based platforms. There is the same element of quality control and business development support, yet the capital-raising mechanism has a much broader reach.

"I think the fundraising environment for early-stage companies will shift towards crowdfunding platforms to allow access to a national and international investor base," says Zachary Midalia, investment associate at M.H. Carnegie & Co. "Crowdfunding allows people to invest smaller amounts of money across multiple deals and build their own portfolios. Whereas VC has traditionally been private and exclusive, crowdfunding opens it up to every investor."

It is also suggested that crowdfunding fills a gap in the market. While an individual angel investor is generally reluctant to go beyond $500,000, a traditional VC fund in Australia might not write checks smaller than $10 million. Crowdfunding has the capability to exist in between, typically focusing on companies at the seed or Series A stage.

Furthermore, these platforms can address particular market niches, be they defined by geography, sector or size. There is no remit enshrined in a limited partner agreement, although those running the platforms recognize the merits of diversification.

OurCrowd, for example, focuses on global companies for individual global investors. It conducts in-house due diligence, selects promising start-ups and invests $50,000 of its own capital before opening the funding round to its accredited wholesale investors.

Only 16 new companies are expected to be selected this year and they will all have a presence in multiple markets. "We are only looking for companies that want to address worldwide markets. If a company doesn't have plans to go global, we are not interested," says Jonathan Medved, CEO of OurCrowd.

The platform itself has aspirations to grow beyond Israel and Australia, with New York, Hong Kong and Singapore on the agenda. It claims to have built a network of 4,000 investors in the past year, with 50-100 newcomers each week. Individuals commitments begin at $10,000.

"Being only local doesn't make sense today," Medved adds. "Last year we invested about $34 million in our deals. That may not sound like a lot, but for a typical VC it is a lot for a single year. A VC firm might raise $100 million and invest only $15-20 million a year, because capital must he held back for follow-on investments and fees."

VentureCrowd is arguably OurCrowd's polar opposite. It concentrates exclusively on Australian investors, having opened with 200 registered participants and 36 start-ups that were pre-screened by more than 25 accelerators, incubators, and angel groups and university programs. The minimum investment is $1,000.

"There are over 200,000 wholesale investors in Australia managing more than $680 billion in assets. Even if equity crowdfunding platforms access just 0.04% of this market it would match the paltry $300 million that VC firms invested in Australia in 2013," Colless says.

For M.H. Carnegie & Co's The Crowd, the differentiating factor will be size. The platform is being positioned as a later-stage specialist that is used to raise additional capital for portfolio companies already seeded by M.H. Carnegie & Co. through its venture funds.

"We are interested in Series A onwards," explains Midalia. "We have many deals that require follow-on capital and as a fund we will invest in various degrees in all of them. The platform allows co-investment from people outside our funds."

In this respect, The Crowd is the odd-man out in Australia's crowdfunding space. It wants to attract capital for companies that already have venture capital backing; the other equity-based platforms as looking to bring potential deal flow to traditional VC players.

Crowdfunding operates in the space from seed rounds through Series A, but rarely higher in the institutional spectrum - the platforms aren't able to provide that quantum of capital and they are not set up to contribute on-the-ground operational expertise.

"It's very early for these platforms in terms of understanding their operational dynamic," says Gavin Appel, a partner at Square Peg Capital, a growth stage venture firm that focuses on internet technology investments. "There may be opportunities for collaboration between the people running the crowdfunding platforms and VCs, to cooperate and co-invest together."

The long game

As it stands, crowdfunding tends to be limited to high-tech start-ups, but over time Crowdfund's Best expects it to extend into new areas, starting with those that share borders with the tech space, such as medical device manufacturing and drug development. Models for collaboration with the crowd will emerge for different sectors.

The growth driver could come from the Australian government. Regulators are considering revisions to equity-raising laws to making them compatible with crowdfunding. This would involve easing restrictions on capital-raising outside public markets, which is capped at A$2 million or 20 investors in a 12-month period. Exemptions are made for sophisticated or wholesale investors and it is here the government could be more accommodating.

"I would like to see a relaxation in the definition of a wholesale investor, which would allow a larger universe of investors to support the future of innovation," says VentureCrowd's Colless. "Encouragingly, Australian Communications Minister Malcolm Turnbull recently flagged support for the potential of crowdfunding models to address Australia's lack of VC investment."

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• Topics
• Venture
• Early-stage
• Australasia
• Australia
• Venture
• Crowdfunding