Nothing ventured nothing gained

Thursday, 01 August 2002


    Is venture capital in this land of Oz managed by tin men, straw men and timid lions? Frank Downes* is scathing in his assessment of those who fail to live up to their promises.

    The overall level of venture capital generated in Australia awaiting "suitable investments" is at an all time high. However, unless someone takes issue with the fund managers, much of this capital will sit idle. The funds will underperform both the cash rate and the all ordinaries because too many fund managers don't appear to have either the intellect, courage or heart for new venture investing. I am reminded of the timid lions, tin men and straw men in the story of the Wizard of Oz. In that case everything worked out fine. When put to the test they found they could do the things they feared to do. Who then, can encourage and put to the test the fund managers in Oz(tralia) in order that they may do what they should be doing with the treasure they hold. In the period from 1997 to June 2001 many people with experience in the capital markets saw an opportunity to harvest a significant amount of the speculative risk capital that was becoming available. This capital was flowing into the sector as investors became less risk-averse and more ready to back their fellow Australians in ventures that would create jobs, wealth and hopefully some super profits.

    Savvy players in capital markets quickly cashed in on the money flow and got away IPOs for venture capital funds which they then proceeded to appoint themselves to manage. It now appears as though many of these managers are treating the funds as their private sinecure. They seem to believe that, provided they take no risks with the money it will see them through to retirement. Perhaps they hope that by the time they retire it won't matter if their investors are less than happy with the performance of the funds they managed. Some fund managers reassure themselves they are doing the right thing by preserving investor capital by not taking risks. This is the "protect your ass" strategy. Others will use the funds collected for new venture investing to play the stock markets in the same way as managed funds or they will invest in cash markets, comforting themselves that they will at least earn something for their shareholders. But what of the poor entrepreneurs the funds were originally intended to help? What will they get out of it all? Very little it seems.

    It would not be going too far to say that many managers of so-called venture capital funds are actually averse to risk. The evidence for this may be found by looking at the paltry number of deals being done in early stage investment in entrepreneurial business development. Why have so many fund managers been so slow to put to work the funds they have raised? It has been my personal observation that far too many fund managers are from traditional big-end-of-town capital market backgrounds, with little or no understanding of or empathy for entrepreneurs from the small end of town. Too many lack courage and do not have the fortitude for long-term investment in growing business. They are all looking at venture investment as a way to make a quick killing rather than as an investment to create something that will mature over a period of five to seven years. It has become a time-wasting exercise to try to get venture capital players to look at any new venture until it is ready to go global and has an identified target market in which sales are in excess of $US500 million a year. If all of the money locked up in venture capital funds is going to sit around waiting for enough of this type of deal to come along, then it is going to sit for a long time. This means that the money targeted towards new venture investment has been sucked out of the system and frozen.

    Because the focus of managers is on a quick result, the fund managers are only looking at deals at or near IPO stage which require amounts in excess of $2 million. The catchcry of fund managers evading real entrepreneurial endeavour is "the cost of due diligence is too high for deals under $2 million". The outcome for entrepreneurs at the early stage of development is that unless you have a money tree in the backyard to pay all of the fees to "connected" consultants you will be unlikely to get the attention of any of the venture capital managers. It seems that unless you are "connected" and prepared to pay high fees and to remove all risk from an investment before you even go to a venture capital fund manager then you should forget about it. Entrepreneurs with business opportunities requiring early stage venture capital in the order of from $100,000 to $500,000 are no better served today than they were before the boom in accumulation of venture funds. In fact, as the total amount of funds accumulated has grown it has become harder than ever to get money for early stage ventures. As the average venture fund has grown (a "respectable" fund is considered to be at least $50 million) so too has the minimum investment threshold level any fund manager will even deign to look at.

    No one doubts the work necessary to successfully manage venture capital investment. At seminar after seminar for the benefit, or entertainment, of people in the venture capital industry experts make it clear that the secret to success is that you have to roll up your sleeves and get involved. But the fact is that this is not what you will find the average venture capital fund manager doing. Firstly, they do not want to roll up their sleeves and do anything, because that takes work and commitment – and too many of them would rather take four-hour lunches than commit themselves to engaging in real business. One could be unkind and suggest that they could be seen as being more interested in protecting (and growing) their asses than in growing assets. Secondly, those few who may be prepared to evaluate opportunities and make investments are often not willing to get involved at board level and into management. Perhaps they are afraid they may put their careers at risk if the venture they are backing does not succeed.

    So, what needs to be done? It appears that apart from funds established under the PDF legislation, venture capital funds that have raised money for the express purpose of making venture capital investments are not subject to any form of censure or restriction by either the ASX or the ASIC – and individual shareholders are usually not in a position to call managers to account. Managers who raise funds specifically for venture investing and who then sit on them or who do not use them for the purpose for which they were raised need to be called to account by someone. Like mining companies that have specific reporting requirements not applicable to industrial companies, venture capital funds should be required by the ASX and or the ASIC to report on their investment plans and prospects on a quarterly basis. If they do not actually make venture investments in accordance with those plans they should then be subject to some form of censure. It is widely believed that there is now an accumulated surplus of funds earmarked for venture capital investment in Australia. However, for the poor, struggling entrepreneur there appears to be a drought of funds, with hurdles to funding set way too high.

    What is needed is for fund managers to stop looking for the quick kill some of them made in the period of dotcom mania. Fund managers must realise that venture investing is a long-term business. Many investments will start small and require work and several rounds of investment before they provide the ideal exit strategy and the big pay off. The fact is that venture capital investing is risky. You will have some failures, but in the long run, if you take some risk, work with your investments, get hands on and work in the businesses you will make abnormal returns on the total investment portfolio. It takes intellect, courage and heart.

    In the Wizard of Oz the Lion, Tin Man and Straw Man all found what they lacked when they were put to the test. Is it too much to hope that the same can happen for the venture capital fund managers. If the venture capital that is locked away in under performing funds can be freed up and put to work in new venture businesses it will go a long way toward keeping the land of Oz the wonderful, innovative and clever country we all know it is and can continue to be.

    * Frank Downes is convener, Queensland Entrepreneurs, and chairman of the Institute of Business Leaders. He may be reached on 07 5546 6458 or e-mail


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