Tony Boyd recently published an article in AFR about the lack of “depth” of Australia’s venture capital (VC) landscape. Nothing new there, I think it is an acknowledged and reasonably recognised fact. It is undeniable that there have only been a handful of VC success stories in Australia, particularly in the life sciences. However, the part of this article that really irritated me was the assertion (via Martin Rogers) that the lack of sovereign/pension fund engagement in Australia was the underlying cause.
I will get to that bit in a minute.
The article is duly scathing about Innovation Australia and its efficacy. I have mixed feelings about this point, mainly because I know there are a lot of very bright and passionate individuals trying to push this agenda ahead but then I also know that the process and bureaucracy is hampering success in many cases. I have been peripherally involved with some of these initiatives and there is no doubt that they are cumbersome. In general, I would say that the deployment of government funds in Australia hasn’t picked up on best-practice from around the globe. Having recently attempted, for example, to establish a couple of industry university-industry Linkage grants, I can say that it is not just Innovation Australia that needs a re-think. The ARC is also in desperate need of re-tooling (I will discuss that in a minute too).
The biggest reason why Australia’s wealth funds will not invest in the domestic landscape is precisely because guys like Martin Rogers churn out underwhelming companies that are possibly designed to make money for a few early investors but have almost zero potential of a long-hold benefit to shareholders. Because pension funds are grown-up entities that have high-throughput tools at their disposal and sophisticated analysts, it takes about 30 seconds to realize that an awful lot of Australia’s biotech companies don’t stand up to international peers. Not all, but most. And by the way, there is a cadre of about a dozen individuals that have touched almost 100% of Australia’s crap (public) companies and they have made a good business out of it, so even the first-pass triage process isn’t intellectually daunting. Ironic to me in Tony’s article that the finger is being pointed at the quality of the investor, not the quality of the investment.
Over the last few years, I have slowly begun to form the opinion that capital intensive / long duration investing in sectors like biotech are not a good fit for private investment. I have written at length about it in this forum and elsewhere. In Australia, the problem is exacerbated by the fact that we are the “lucky country”. Everyone wants our minerals, food, to visit us, to buy our land and send their sprog to our schools. There are so many unbelievably lucrative things to invest in, why would you throw money at biotech? As an illustration, one of my friends put a few $100k of SMSF into a REIT focused on Brisbane commercial property development and got an annual IRR of 15% over 5 years (with a security interest on the property) and COMPLAINED that it was an “okay return”. That’s how spoiled we are. Compare that to US bank interest rates or T-bill yields.
… but I digress.
Everyone points to the US as the bastion of venture capital – but in my view it is mostly a “grass greener on the other side of the fence” situation. In 2011 when I raised a Series A for an antibody company in California, only 17 companies (out 5,200) searching for a Series A financing raised more than $10m. That’s the name of the game – it is incredibly tough to raise money in the US, not the financial free-for-all that everyone thinks. Moreover, I would argue that the recent IPO boom in the US and emergence of the “cross-over” financing strategy means that more and more early-stage companies are tapping the public markets, precisely because it’s easier to raise capital and the cost of capital is considerably lower. Australia, whether by design or happenstance, is actually “ahead” of the curve and it is my opinion that US life sciences is sort of heading more towards a model where the public purse is tapped early. Plenty of top-end VCs are also getting out of biotech in the US and the VC model is harder than ever and probably also has to change in the US as well (see for example Bruce Booth’s excellent Forbes article last year). In Australia, we don’t really have a venture-capital landscape, instead our companies get bootstrapped with government and high net-worth individuals (also not an easy path), and then tap into the ASX. I actually think is a really great thing – long investment horizons and liquidity are a highly aligned concept, because ownership can change, especially in a retail-centric model. As someone who is sitting on a portfolio of over a dozen illiquid small-cap tech companies, I see the merits…
And by the way, don’t think all US venture capital is quality. It isn’t – as a very influential Kauffman Foundation report wrote. Anyone who critiques Australian venture capital, should read this document before opening their mouth (yeah, that’s you Tony).
The REAL difference between the US and Australia is the public markets. The US has an awesome VC scene because the markets are, on the whole, high-quality, have good coverage and are efficient when it comes to life sciences. This then sets the quality bar for the VCs that they ultimately have to meet in order to push a product out to either the public markets or into the hands of an acquirer (who is also usually under scrutiny from the public markets). I am not saying there are no crap companies – there are – but they are identifiable precisely because the market is efficient and well reported. They are easily identified. Such firms have poor market cap relative to asset valuation and they struggle to raise money. I think being the investor or entrepreneur in a public micro-cap US company with no trading volume must be a most soul-destroying experience. In order for people to want to put money into VC, there has to be an efficient and proven exit mechanism. When you have an IPO market that is vibrant, this feeds the cycle of investment and exit, especially VC. By the way, when considering this phenomenon, one has to be really careful to look at the cyclic timing of private VC fund establishment, capital deployment into investment companies and exits – you will realize very quickly that IPOs fuel the cycle even if the outcomes appear to have no temporal causality.
And that, in my opinion, is why Australian biotech is mostly underwhelming (at best), and why the money cycle is broken. Our market makers are financially and reputationally far too entrenched in the equities they sell. There is very little objective analyst coverage and frankly, my heart goes out to all those poor individuals who have to sit there at their desk every day and write up a turd to make it look like a Godiva chocolate. When you read the reports that are product by BBY, Baillieu Holst and Bell Potter, to name but a few (though I note that BP’s head of life sciences research is a talent…) and see the absolute crap they sell, it’s no wonder that the sophisticated money sources won’t touch the market. That’s also the reason why Martin Rogers has no platform to point his finger at the pension/wealth funds. If he was really committed to Australian life sciences and healthcare, he wouldn’t be involved in packaging up quite so many questionable investments.
To be a world-leader in life sciences, we only need to do three simple things (policy makers take heed):
1) Re-program the culture of our universities and public research institutions around innovation capture. We need to include industry engagement and IP capture as part of the success metric for career advancement in our tertiary institutions. We need to educate and encourage our doctoral/post-doctoral brainpower to be proactive with intellectual property, and we need to benchmark our senior luminary academics (and we do have some fantastic brains here) on their ability to engage with industry. University administration needs to be brave about this, but the ARC also has an awful lot to answer for in the way it disseminates funds, and to what industry sectors. It’s not just Innovation Australia that needs a rethink when it comes to R&D expenditure, I assure you. It will take time but it is not hard, it just requires leadership.
2) Government should meddle less and not more. Our political leaders should avoid screwing around with things like R&D incentives which are not only a waste of taxpayer money, but frankly don’t align with the fickle and pointless value destruction cycle of Australian politics. Our government leadership is not sophisticated enough to make those bets effectively and nothing damages industrial recruitment and development more than unpredictable economic policy (not even cyclic, given the idiosyncratic state of our democratic process). How can biotech investment in Australia be effective unless an incentive scheme is going to be consistent for a 8-10 year period, or longer? What we do want from government is an overhaul of the tax system, take a fresh look at VC/PE tax structure, and (finally!) make a commitment to cleaning up the disaster that is equity incentive schemes. Because our policy makers, for the most part, have never run businesses they are utterly clueless about why this really matters and the profound impact it will have on the ASX micro-cap environment (i.e. no more zombie companies with execs just drawing a big salary).
3) Build an efficient market. That’s means no more bullshit companies. It means higher quality analysis from the brokerage houses. It means rethinking whether ASX continues disclosure rules work effectively for biopharma (they don’t). When we can show quality and performance, I have no doubt that Mr. Costello and his highly talented team will rethink how to supercharge the capital flow in life sciences.
Awesome Photo Credit: Ryan McGuire. http://www.gratisography.com/