Australia's venture capital drought

"A young Australian today with a world-beating new technology has more chance of being struck by lightning than they do of raising capital."
Ivor Ries, Senior analyst at Morgans Financial Ltd

Australia has created few net new jobs over the past five years even though it sits on the edge of the fastest-growing part of the world. Clearly something (or perhaps a lot of small things) is not working.

One area where Australia falls way behind the United States and Western Europe - but could catch up relatively quickly - is in financing start-up businesses, particularly in the exciting growth areas of technology, communications and healthcare.

Australia has a venture capital drought and it is doing far more lasting economic damage than the periodic lack of rainfall does to our rural sector. A young Australian today with a world-beating new technology or a paradigm-shifting new business process has more chance of being struck by lightning than they do of being able to raise less than $1 million in venture capital.

The smartest of our next generation of technology entrepreneurs learn this quickly, which is why they head to the United States by their hundreds each year.

The net income effect of Australia's techno brain drain is hard to measure, but over time it will become substantial, probably costing us billions a year in foregone tax revenues.

To illustrate how little Australia invests in venture capital it's useful to make some comparisons with the United States, the home of kick-starting new businesses. Based on first half numbers, American venture capital firms will plough $US62 billion into roughly 4,500 startup or early stage businesses this year. These numbers are actually an understatement - they only capture the VC financings that are made public.

By contrast Australia's venture capital industry is starved of funds and is lucky to raise $A250 million in new money each year and will struggle to finance 150 new ventures.

In round numbers, the amount of new money we Australians invest in startup companies equates to just 0.3 per cent of what America does. On a GDP-adjusted basis, Australia spends just 3 per cent of what America does on funding the next generation of world-beaters. By comparison to Australia's puny investment in venture capital, the Federal Government invests around $A4billion a year in tax breaks to owners of negatively geared properties.

To put that into perspective, over the next decade the average Australian will donate (via the tax system) $1700 to other Australians buying a second or third house. The same average Australian will (through their super fund) invest less than $35 in venture capital.

Australia does have an early stage venture capital tax concession program, where local and international investors can obtain highly favourable tax advantages using a special-investment vehicle called an early stage venture capital limited partnership (ESVCLP). However the funds made available through these vehicles are a drop in a bucket, with only $A85 million invested over the seven years to June 30 in 2014.

Australia gets a lot of things right. Our superannuation savings system is the envy of the world, our banking system is highly efficient and survived the GFC better than most, and the distribution of wealth is better than most in the developed world.

But our inability to build a sufficiently big pool of risk capital for high-growth businesses will continue to act as a brake on the rate of new job creation. I suspect there is no simple solution to the problem, but admitting we have a problem, and quantifying the size of the funding challenge, would be a good start.

Ivor Ries is a senior analyst at Morgans Financial Ltd and a former Chanticleer columnist at The Australian Financial Review.