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The rise of the start-up accelerators

Monday, 6 June 2011 | By Oliver Milman
A few years ago, the funding scenario for an innovative start-up was simple. Get a bank loan to get yourself started before turning to a grateful Australian-based VC who will help propel your business into the big time, in return for a juicy equity cut, of course.


However, this tried-and-tested formula is undergoing a radical shift. Declining VC activity in Australia, strong interest from US investors and the plummeting cost of setting up and establishing a business are bringing great opportunities, as well as uncertainties, to Aussie start-ups.


“Venture capital is broken in this country at the moment,” states Rowan Gilmore, CEO of the Australian Institute for Commercialisation.


“A large number of investors are retreating and the amount of dollars going into early-stage start-ups is reduced, which is horrible.”


“The returns for VCs in the last 20 years or so haven’t been good. There’s always space for biotech start-ups in their portfolios, but other businesses, such as serviced-based businesses, will struggle.”


Happily for Australia’s premier start-ups, US investors are stepping into the breach, as evidenced by several recent deals, including Accel Partners’ $35 million investment in crowd sourcing site 99designs.


The dog-eat-dog competition to find and invest in the best Silicon Valley start-ups has seen American VCs like Accel turn their attention to markets such as Australia, where there’s a clearer field. I


It’s unlikely that Melbourne-based 99designs would’ve got funding if it waited for a local partner, as founder Mark Harbottle puts it: “In the first three years of the business, I didn’t get a single phone call from an Australian investor. Not one. But I was getting calls from US VCs every week.”


With such disinterest in even a market-leader like 99designs, what hope do the next generation of start-ups have without going overseas?


A glimmer of hope is being provided by the rise of start-up “accelerators” such as Pollenizer and the establishment of seed and mentoring programs such as Startmate and PushStart.


Inspired by the success of YCombinator and TechStars in the US, these “angel aggregators” invest a small amount of money, typically $15,000 to $20,000, in a promising start-up, in return for a minor stake.


The start-ups are then offered mentoring and other help to get to the next level. Each works differently – Pollenizer, for example, is more like a incubator, nurturing a business until it’s ready for its big pay day, as in the case of Spreets’ $40 million sale to Yahoo!7.


Startmate, which kicked off at the end of last year, hand-picked five start-ups to be mentored by a star-studded line-up of mentors, investors and industry experts.


PushStart, the latest arrival, has a strong focus on mentoring. Its Mentor Connect program matches seasoned business owners with budding entrepreneurs, with a funding element set to kick in at the end of this year.


Kim Heras, founder of PushStart, says that Australian VCs have been missing in action when it comes to identifying and backing start-ups.


“For early-stake web and mobile start-ups in particular, there hasn’t been the backing there,” he says. “In comparison to the US, the funds for start-ups are so small.”


“Before StartupSmart, there wasn’t really a professional start-up media, so you had to be on the ground to know what was going on. The VCs just haven’t had the appetite to do that because the vibe is that nothing fits with their investment portfolio.”


“The US guys are far more willing to take a punt, there’s a real sense of adventure there.”


“There’s been a real disparity because Australian start-ups have seen all this cash being thrown around in the US and they’ve had an expectation that they will get some of that cash.”


Heras says that he created PushStart after seeing the success of YCombinator – it’s top 21-backed companies are worth $US4.7 billion – and TechStars in the US.

This success, in turn, is being fuelled by a fast-growth, low-cost, minimal barrier environment for start-ups, particularly in the tech space.


“This model is changing the start-up environment in Australia and globally,” says Heras. “Before the question was ‘How do I get money to build my technology and systems?’ Now it is, ‘I have all these platforms already – how can I tailor them to create a business?’”


“Businesses now have all the tools. It’s their job as entrepreneurs to create something and find a market for it.”


So where does that leave Australian VCs? Heras suspects that they will treat the start-ups emerging from initiatives such as Startmate and PushStart as “deal flow”, proving the next stage of capital, maybe via “super” angel funds. But the equation isn’t as simple as it once was.


“VCs in Australia can’t remain where they are – there’s no room for them in the web and mobile space because there is no need for them,” Heras says. “I think they’ll focus on clean tech, biotech and even hardware.”


“I know some VCs at Starfish and Southern Cross ‘get it’, but many come in way too late. I talk to start-ups who say they don’t need the money then, which is the conundrum that VCs face.”


“When they eventually come knocking, start-ups are already profitable. Atlassian is a perfect example – it was able to go to the US to get a huge round. It didn’t need to raise funds locally.”


With Accel, and others, increasingly eyeing up opportunities in Australia, it would be easy to think that local VCs are under the pump, forced to focus on other areas or act as affiliates for the major US players.


However, John Dyson, investment principal at Starfish, one of the largest VC firms in Australia, rejects the notion that there is scant investor focus on start-ups.


Dyson says that around half of Starfish’s portfolio has turnover of under $2 million, citing investments in up-and-coming companies such as Nitro PDF Software, Mimetica and iCiX, which has just expanded to California.


“We feel we keep in touch with early-stake start-ups pretty well and we’ve made a bunch of investments that have been super successful,” he says.


“Like any industry, there are different types of VC, so it’s hard to generalise. But I don’t think you can be a conservative VC. You have to be optimistic and take a calculated risk sometimes.”


Dyson says that Starfish is currently seeking a “handful” of start-ups to soak up the remains of a $185 million funding round that kicked off at the end of 2007. He insists that local VCs still have a vital role to play for emerging entrepreneurial talent.


“For Australia to produce a pipeline of great companies, they need capital at all stages, through to IPO,” he says.


“We are seeing an aggregation of angel investors and more capital for early-stage companies, which is a positive development. I see that as complementary to what we do. We manage around $400 million and we want to see that going into better-managed companies.


“There’s got to be a combination. Companies can raise an initial $500,000 and then come to use 12 months down the track for a $3-4 million cheque. We certainly aren’t moving away from that space – of our four last investments, two were with very early-stage companies.”


The idea that you can launch your company on $10,000 and be sipping a latte with Mark Zuckerberg in Palo Alto within a year without significant outlay is a misnomer, according to Dyson.


“It takes a lot longer, and far more capital, than people think,” he says. “If you need to go to the US, we can help you do that.”


Whatever the role of local VCs, it’s clear that the push to create the ‘Australian YCombinator’ isn’t set to slow down any time soon.


“The US accelerators will be tier one, but there will be heaps more in Australia,” says Heras. “With various niche plays in universities, I think there’s room for 10 accelerators to take place throughout the year. There’s real momentum in the sector at the moment.”