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Lagging behind: An analysis of Australia’s start-up sector

Thursday, 25 July 2013 | By Yolanda Redrup

Australia has no Silicon Valley, but with a few reforms we could. Australian entrepreneurs rank among the best in the world when it comes to generating business ideas, but when it comes to the commercialisation of ideas, we fall flat.


In this year’s Global Entrepreneurship and Development Institute index Australia ranked fourth, behind the United States, Sweden and Denmark. Intuitively, fourth seems decent, but dig deeper and there are a number of issues reducing our potential to become a global leader.


In terms of the venture capital environment, research suggests Australia is lagging behind most of the developed world. When it comes to gender diversification, the number of male entrepreneurs still outnumbers females by four to one. In terms of the Australian mentality toward entrepreneurialism, our attitude to failure and willingness to encourage entrepreneurialism is markedly different to established entrepreneurial hubs such as the US and Israel.


Research from PwC published earlier this year revealed Australia’s economy is likely to fall out of the world’s top 20 by 2050 and with the mining boom ending, the federal government is searching for a sector of the economy to pick up the slack. There are many experts who believe our best bet lies with the entrepreneurial community.


SmartCompany has analysed the statistics and spoken to the experts to provide a snapshot of Australia’s entrepreneurial environment – what we do well, what we could do better and how we’re placed globally.


Venture capital


To kick-start new business ventures, a strong venture capital community is vital. But Australian entrepreneurs are unable to access the same level of funding as other developed nations.


According to the Organisation for Economic Cooperation and Development’s latest Entrepreneurship at a Glance report, venture capital spend represented an average 0.03% of GDP internationally in 2012, but in Australia it’s only 0.02%.


While Australia is behind the average, Israel greatly exceeds it, with venture capital spend amounting to 0.4% of GDP. The US also dedicates convincingly more than Australia, with venture capital equating to 0.17% of GDP.


These higher results are a reflection of more mature markets, but also of the countries’ strengthened support for entrepreneurial endeavours.


Other OECD countries which ranked higher than Australia were: Canada, Hungary, Sweden, Ireland, Korea, Finland, the United Kingdom, Switzerland, Denmark, Netherlands, Norway, South Africa, France, Japan, Luxembourg and Belgium.


The OECD study also revealed that globally, venture capital spend was 40% lower than in 2007 – bad news for entrepreneurs looking for funding.


Ernest and Young’s Oceania Entrepreneur of the Year leader Bryan Zekulich told SmartCompany there has been a decline in the creation of new venture funds over the past three to five years.


“Institutional money is hard to come by in the start-up sense since the risk is so high and they’re not willing to take that risk.


“The government incentive plans have been appropriate in terms of structure, but the money from the Australian Innovation Investment Fund, which has been established for a long time and is continuing, is just money coming back in from investments and there is no new money in that either,” he says.


The Australian Private Equity and Venture Capital Association Limited 2012 Yearbook found Australia has the lowest number of active venture capital managers doing deals in the last ten years. In 2012, $122 million was invested, a 4% decrease from FY2011. Only 42 new companies received fresh investments.


When it comes to fundraising, venture capital funds raised $240 million, an increase of 200% year-on-year, but $200 million of this was raised as part of the Southern Cross Renewable Energy Fund under the government’s renewable energy venture capital fund co-investment programme.


“When start-up companies go to Silicon Valley, there are more companies which have done something similar before and the understanding basis is much higher than here in Australia,” Zekulich says.


“They find this to be a huge benefit and when they’re pitching they’re positioned against their peers, people doing similar things to them, and the investor already has an understanding of what they’re doing.”


Commercialisation of ideas


Market Gap Investments director Mike Sewell told SmartCompany Australian entrepreneurs and businesses have historically been on par with the other developed nations in terms of idea generation, but they’ve struggled with turning ideas into reality.


“Australia’s spend on research and development is the same as any industrialised country in the world, but if you look at the commercialisation of ideas, there is a huge difference,” he says.


“We don’t have a good track record in investing in ideas, the statistics prove this and there isn’t an easy solution for that, but it’s why people go to Silicon Valley.”


However, research suggests in the long term the rate of idea commercialisation could be starting to improve. The most recent 2010-2011 National Survey of Research Commercialisation found there has been a steady increase in the number of invention disclosures and in the number of patents issued to publicly funded research organisations. It also found an increase in the number of capital-raising start-ups and the amount of institutional equity they received.


Despite the likely long-term increase in the commercialisation of ideas, the survey found the number of new spin-off companies per $100 million of research expenditure decreased in 2010-2011 to 0.4 from 1.3 in 2009-2010. The research also found the rate of invention disclosure still lags behind the developed world.


Per $100 million of research spend, Australia disclosed 28.1 new invention ideas compared to 43.7 in the UK, 41.6 in Canada, 35.8 in the US and 28.4 in Europe.


While Australia is struggling to keep up with the invention creation rates of the UK and the US, we are getting more value for money. The income of the start-up spin-off companies has increased from $2,000 per $100 million in research expenditure in 2008-2009, to $6,000 in 2010-2011.


Zekulich says part of Australia’s problem with ideas commercialisation stems from a lack of business mentors.


“We don’t have a lot of overt mentors and leaders for start-up companies to give them some degree of framework to be successful. We talk about commercialisation, but that looks at the structure of the business, the processes, how you go about the marketing and generally making start-ups a bit more professional than many are.


“It’s really about having a professional way to manage the front and back office of the business. Many start-ups lose their way and their idea dies in terms of excitement and enthusiasm. Many start-up companies have a really tough first year, but if they get through it and get the practices going well then they’re more likely to succeed,” he says.


Gender diversity


This year the Global Entrepreneurship and Development Index ranked Australia the second best environment for female entrepreneurs, behind the US, but male entrepreneurs outnumber females four to one.


Statistics from the global entrepreneurship group Entrepreneurs’ Organisation show males represent more than 85% of members. President of the Melbourne EO chapter, David Barnes, told SmartCompany that this is despite efforts to grow the number of females in the organisation.


“Sydney and New Zealand seem to be able to attract more female entrepreneurs, in New Zealand females account for around 40% of the members, but we’ve always struggled in Melbourne and Perth.


“Since we’ve had more females come on board we’ve started attracting other quality female entrepreneurs, but there are still a lot more males,” he says.


Despite efforts from organisations such as EO, the OECD survey shows little has changed globally since 2000.


“Women remain substantially underrepresented as entrepreneurs. Men are two to three times more likely to own businesses with employees than women,” the report stated.


“Online in a few countries the gap has significantly narrowed, namely Chile, Korea and Mexico.”


The OECD average shows women make up approximately 23% of the entrepreneurs in each country.


Once again Australia was behind the average, with females accounting for roughly 18% of the entrepreneurial community, although Australia was ranked ahead of the US, Israel and the UK. Greece was leading the way, with females making up more than 40% of the entrepreneurial population.


Alarmingly, the OECD found overall that self-employed women earned “much less than men” and in all countries the gender gap in earnings from self-employment was greater than the wage gap.


Zekulich says while Australia has a small female entrepreneurial representation, this is partly due to social factors.


“We find overwhelmingly female entrepreneurs reach a level of revenue which they are comfortable with and remain there,” he says.


“For whatever reason, they are savvier about risk taking and they consider risk a whole lot more than their male counterparts, which makes them less inclined to take risks their male counterparts will.”


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In terms of business growth, Sewell says Australian entrepreneurs, in general, frequently make the decision not to grow their businesses over a certain point.


“Often Australian business owners who are making $200,000, $300,000 or $400,000 a year decide they’re happy with it and they don’t have an incentive to scale the business,” he says.


“People make lifestyle choices that we don’t necessarily understand either. I think, why don’t you try to grow the business to $10 million or $20 million, because many could do that with what they’ve got, but they’re happy.”


Sewell says business owners find once the business exceeds 15 or 20 people “the game changes”.


“People decide they don’t like it past 20, it’s a different game. This is possibly a lifestyle choice or a business size choice,” he says.


“You make the decision at $5 million that that’s as big as you want to be. But the market changes and if you have a profitable niche today and haven’t capitalised on it, then someone will either compete with you, or the market will change and leave you behind.”


Sewell says too few business owners realise it’s better to change the business structure and become an investor, rather than an operator, allowing a professional management firm to run it, than to fail to adapt and grow.


Attitude to growth isn’t the only way Australian businesses differ to their US counterparts. Sewell says the Australian approach to failure limits the entrepreneurial environment.


“We don’t accept failure, if a business person fails here, that’s it, they’re done. But in reality you have to fail, it’s a part of life,” he says.


“You’ve got to work with your customers and sometimes your customers don’t even know what they want, so you invest in the wrong things and you fail.”


Co-founder and lead investor of AngelCube, Adrian Stone, told SmartCompany the US’s big advantage is their embrace of business failure.


“Failure isn’t seen the way it is here. In Israel too, a country which has the greatest number of start-ups per capita and the second largest in the world, failure is actually a badge of honour.”


Stone says in order for entrepreneurial communities to work, fundamentally the drive has to come from the entrepreneurs themselves. Changing this attitude to failure, he says, is crucial to Australia’s entrepreneurial capacity.


“We need to get to this point, but it’s a cultural thing. Maybe we can talk about our failures more often. It’s moving this way in tech start-ups, there is a move toward the lean start-up and it’s all about failing often and failing fast,” he says.


Barnes says there is now a negative stigma around business failure.


“The media publishes things when businesses go into voluntary administration and say they’ve collapsed. But going into administration is a normal business process.


“There are other people which have had four, five or six successful businesses, and going into administration or “failing” is the realisation you’re not going to hit your goals.”


‘Let’s move overseas’ attitude


Motivated by the ease of attracting funding in the US, including its extensive entrepreneurial environment and positive start-up culture, a goal of many Australian entrepreneurs is to shift their business to the US.


Chief executive of the world’s largest outsourcing platform Freelancer.com.au Matt Barrie told SmartCompany the venture capital model in Australia is “completely and utterly broken”, with the exception of groups such as Blackbird and AngelCube, and this is driving entrepreneurs away.


“The traditional model of Australian venture capital is they’ll finance you early on if you can find someone, everyone will write you a cheque for $20,000 or $50,000 and maybe $100,000, but that first $1 million to $5 million is very difficult,” he says.


“Even if you manage to attract $1 million or $2 million in funding, the venture capitalist will do all the hard work with you and then tell you to go to the US for further funding.”


At this point after a round of funding the Australian tech start-up might have won $5 million to $10 million in funding, and Barrie says the Australian company will be under pressure to move to the US.


“The US team then says you need a US chief executive and the team partially moves to the US, and then comes a US management team. This eventually dilutes all the Australian shareholders. Then they say the company is undercapitalised, which it is, you need to raise $20 million,” says Barrie.


“Then the Aussie venture capitalist runs out of money gets kicked off the board and the US CEO then has a US management and US shareholders, but an offshore development team. When the Australian dollar is 60 cents or 70 cents it might make sense to have an offshore development team, but when the Australian dollar was $1.05, it was more expensive to hire a Sydney graduate than a Stanford graduate.”


The net result, Barrie says, is that the Australian company’s operations are eventually moved to a cheaper location and the business becomes effectively another American company.


Barrie says to counter this problem the Australian Securities Exchange needs to be “built up” as a route for financing technology companies and arousing liquidity.


“We do it in mining tremendously well. You can have a PowerPoint presentation, not even a drill hole in the ground, and raise $20 million on the ASX.


“The Australian mining industry is a world powerhouse and we need to do it with technology because mining is running out. There has been more money raised on the ASX in the past five years than NASDAQ, so it’s one of the biggest financial markets in the world and we need to be doing this for start-ups,” he says.


Government action


The experts were unanimous that the push for change needs to come from the entrepreneurial community, rather than government action, but all agreed there are a number of policies which could be altered to better the entrepreneurial environment.


Barnes says payroll tax is harming the small business community.


“Payroll tax is just a joke – no business owner likes paying payroll tax,” he says.


“Businesses are going to move their staff offshore so they can lower the costs of doing business. It seems unfair to incur a 4-5% payroll tax for employing people when we’re also paying the superannuation increase. It’s another 7-8% on top of the base wage just to employ people.”


Sewell says the government would also be able to restructure its tax system to better favour investment.


“The tax deductibility of losses and capital losses, you could change the way they are treated to encourage investment. The system now is that you quarantine your losses against particular assets, but there would be a more effective tax structure because at the moment it’s not conducive to investments,” he says.


Stone says the government needs to “chip in and put their money where their mouth is” to help fund Australian businesses.


“Commercialisation Australia does a lot to help entrepreneurs, but they need to take their lead from Singapore, UK, and Israel where they give loans to match those of investors,” he says.


“The government needs to recognise that it’s worthy of investment. The way it works is it provides a loan which is repayable, almost all the loans get paid back and this goes a long way to fostering the community.”


Stone says the education system also needs to be changed to better encourage entrepreneurialism from a young age.


“I’d like to see all kids to try and start an online business and I think the support of doing this would help them a lot. My son started his first business when he was 12 and he’s now onto his third business and earning enough to support himself.


“For me entrepreneurship, I believe it’s learning by doing. You can do university courses, but it needs to be like vocational training almost. Start a business and then get right. It might succeed or fail, but it doesn’t matter.”


Ultimately, Stone says it’s about encouraging more people to have a go.


“Be willing to have a go and withstand the consequences. Don’t be results driven, do something you love and don’t be hung up on your result good bad or indifferent,” he says.


This story first appeared on SmartCompany.