The common complaint of a “lack of suitable funding” for Australia’s tech startup ecosystem is very real. It is the biggest inhibitor to Australia being on a level playing field in the global startup industry.

However the solution is more complex than simply adding additional capital resources and the ecosystem needs to address the supply of suitably developed early stage ventures. The recent changes to the Significant Investment Visa scheme is expected to create an estimated $400m additional investment in the venture capital market — it will need to be matched by growth in the supply of investible startups.

So what is being done to support the supply of startups?  Let’s look at how the Australian governments support early stage ventures.

government-support-void

 

In the diagram above, we look at the full supply chain of ideation through commercialization and note the funding rounds of seed investment, angel and institutional funding (which is usually referred to as “Series A”, “Series B”, etc). Note there are also grants and initiatives available to support the development of intellectual property at universities and there are programs in place to support later stage development and commercialization including the successful and supported R&D tax offset program, ESVCLP funds and EIP grants – programs which BlueChilli startups take advantage of.

However you can see a problem in this diagram — there is a lack of support in the proof-of-concept phase, where ideas are being proven in the marketplace and are chasing seed funding, typically low $100,000’s. Entrepreneurs (particularly in younger demographics) struggle to reach commercialization as they are not supported during this phase.  This is the “death valley” of startup funding.

By addressing this gap we can ensure that ideas are proven and supported and therefore generate a consistent pipeline of businesses which will then attract later stage funding – thereby addressing the supply side problem faced by venture capital investors.

Accelerators and incubators (groups like Startmate, Angel Cube and BlueChilli) sit in this gap and provide an accelerated method for commercializing ideas, for taking these concepts from ideation and through to angel investment and beyond. Accelerators and incubators, although very different,  both bridge the same gap.  They are a critical piece of infrastructure in a startup ecosystem.

A governing thesis for government support should be that the market must remain the decision makers and government must avoid artificially stimulating opportunity. By leveraging the existing market decision criteria and treating the supply of early stage venture opportunities as a piece of education or infrastructure the government is best placed to accelerate the supply rather than control it.

The current EIP program provides a funding grant to startups which are unable to raise capital in the open market. While a few successful startups which have made use of this program (when it was called Commercialization Australia) this model is inherently flawed — it seeks to fund companies which are unsuccessful in raising private investment. Additionally, the government, through its contractors, is required to assess early stage venture risk, when it is ill-equipped to do so. This results in later-stage companies being funded and doesn’t address the supply problem as illustrated in the diagram above.

An alterative use of these funds is to provide matched funding to foster the development infrastructure bodies which already fulfill this role and are better suited to assess the opportunities — the accelerators and incubators. Here the accelerator programs would tender annually to receive a portion of funding and would receive the EIP money to leverage their own investments in to each early stage venture. The government would effectively be leveraging existing infrastructure to accelerate the growth of early stage ventures.

The Israel incubator program is an excellent example which illustrates the success of such a model, but it should be noted that there are additional factors which contribute to the success of the Israeli startup venture community.

Since 1991, the Israeli government has deployed $660m in funding to incubators with a five to one (5:1) matched funding program in eligible startups in incubators. The money is offered as a limited recourse loan, payable out of revenues (4%) with no penalty on early repayment. Since 1991, 24 incubators have been created and 1,600 startups have been funded with a 50% success rate. (Success is defined if the startup later raised funds greater than the government contribution.) $220m has been recovered by the royalty and repayments (so net $440m) and there is an additional recovery through the tax on salaries from the people employed through those startups. Importantly however, $5.1B of foreign investment has gone in to those successful companies.

So clearly an ecosystem approach makes perfect sense, the funds for the EIP program has already been budgeted for – we just need a holistic approach to supporting the ecosystem.

Filed under:   EIP   esvclp   funding   government initiatives   SEIS   startup