Given the popularity of crowdfunding platforms and the potential for early-stage companies to accelerate the Australian labour market, investing in high-growth early-stage companies is an increasingly attractive option for investors, Benjamin Chong writes.
High-growth, early-stage companies are set to accelerate Australia’s labour market, driving jobs growth and economic prosperity, according to the Australian Venture Capital and Private Equity Association (AVCAL). With the popularity of crowdfunding platforms and the Australian government’s new tax incentives, it’s increasingly attractive for private investors to seek out the high risk-adjusted returns in an otherwise low interest rate environment.
What defines a great investment opportunity?
As with all successful businesses, a strong founding team is a key indicator of a great investment opportunity. Great founding teams often strike the perfect balance between business, domain and technical experience, allowing them to create a sustainable competitive advantage with their new and differentiated product or service.
Founders who have their sights set on chasing global markets are also key. Given the size of our domestic market, investors should look out for founding teams who demonstrate market momentum, and have the potential to scale their businesses. For earlier stage startups, high customer acquisition rates and a solid pipeline of deals in negotiation are also key indicators.
How do you start investing?
You can gain exposure to high-growth early-stage technology businesses by being an angel investor, crowd-sourced equity funding investor, or through a venture capital fund:
Angel investing
Angel investors, typically affluent individuals, provide capital to early-stage businesses in exchange for equity. Since the introduction of the Australian government’s National Innovation and Science Agenda reforms in July 2016, such investors can benefit from a 10-year capital gains tax exemption and a 20 per cent non-refundable carry-forward tax offset on investments.
Investors can be eligible for these incentives by meeting the “sophisticated investor” test under the Corporations Act, or have total investments in qualifying companies under $50,000 for that income year. Under the scheme, eligible companies must be non-listed and have been incorporated within the last three income years with total assets not exceeding $50 million.
They must also have less than $1 million in business expenses and income under $200,000. Further criteria require they have demonstrated potential for high growth and scalability, and address a large market with a significant competitive advantage.
While angel investing requires a greater level of involvement, the advantages include having greater control over capital and the ability to practically support founders. As an angel investor, the investment process involves sourcing, assessing, negotiating, conducting due diligence and ongoing management of deals. Additionally, angels also provide support through coaching and mentorship in their areas of expertise.
Joining an angel group (like Sydney Angels and Melbourne Angels) is a great way to source deals through connecting with founders, and seeking advice from an experienced network of angel investors. Subscribing to Right Click Capital’s publishing arm, Internet DealBook, also keeps you in the loop on angel, VC and private-equity investment, and M&A activity in Internet and technology-related companies.
Crowd-sourced funding platforms
This year, crowd-sourced equity funding (CSEF) is a new method of investing in early-stage technology businesses backed by the Australian government. CSEF platforms allow investors to invest capital into early-stage private enterprises similar to how they would invest on the ASX, by buying shares in startups and SMEs.
Federal parliament recently passed legislation allowing unlisted public companies to advertise their campaigns on licensed crowdfunding portals and raise up to $5 million a year. Retail investors — those earning less than $250,000 a year and owning less than $2.5 million in assets — would be limited to investing $10,000 per company per year.
In September 2017, Treasurer Scott Morrison introduced new CSEF legislation into parliament, allowing CSEF platforms to advertise offers from private proprietary companies. In turn, gives the public more opportunities to invest across a broader range of businesses. Private companies will soon be able to raise up to $3 million through CSEF platforms before requiring an annual audit of their financial statements. These investments must be made through ASIC-licensed crowdsourcing platforms that can be accessed by both retail and wholesale investors.
The investment process for CSEF investments is similar to angel investments. It involves assessing the prospects of available deals on CSEF platforms, determining if you wish to participate on the published terms, and making the investment.
Indirectly investing through a venture capital fund
If you’re looking to invest in early-stage businesses but don’t have the time to be an angel or CSEF investor, you can invest through a venture capital fund. Reputable funds will follow a structured process similar to the one outlined above. When assessing potential funds, consider the background of the fund’s principals, the value proposition to both investee businesses and investors, and the fund’s history and track record.
Screening the principals of a VC firm is a crucial step before committing to an investment. If the fund focuses on specific sectors, you should note whether the principals have relevant technical knowledge to review potential deals, and can add value to their investments. Some VCs have a founder background, with extensive startup and operational experience, while others have a financial management or investment banking background. Either way, you will want to make sure the VC you choose has personal experience in building or leading their own businesses along with the ability to provide critical feedback to investee companies.
While prior accomplishments don’t guarantee future success, screening a VC firm should also involve reviewing the firm’s track record and historical investments, all of which can provide an indication of future performance.
Whether you choose to invest directly or through a fund, by asking the right questions at every step of the investment journey, you will have a greater chance of success.
Benjamin Chong is a partner at venture capital firm Right Click Capital, investors in high-growth technology businesses.
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