Where to find venture capital

When a car crash destroyed Rod Saunders’s hearing, he agreed to join a trial for a new hearing aid. This wasn’t any old trial: Saunders had to agree to have the new aid surgically implanted. The year was 1979, and it took eight hours of surgery to fit the new device.

But it was successful.

That implant, developed by Dr Graeme Clarke from the University of Melbourne, went on to revolutionise the hearing aid market. In 2015 alone, Cochlear – the company that makes the implants – recorded a profit of $941.9 million.

New hurdles

Australians have a good track record when it comes to these sorts of game-changing inventions: the aviation black box, the electric drill, the cure for ulcers and the electronic pacemaker, to name just a few. It probably stems from being an isolated and harsh country, where people have to use their wits. But coming up with good ideas is the easiest part of the process – without money to commercialise the invention, it can sink without trace.

The Cochlear implant only made history because Dr Clarke was able to raise finance.

The company he approached, Telectronics, employed Dr Michael Hirshorn to evaluate new products. Dr Hirshorn – interviewed by Fast Thinking several weeks before his death in 2011 – said he and a colleague had been very excited by the implant, sensing that it was a “real product that could make a difference”.

In 1981, $1.6 million of capital was raised from the Australian government to help move from a prototype to through to clinical trials. Hirshorn himself went on to have a distinguished career in venture capital. But by the time he died in 2011, the financial landscape had changed. Today, innovators looking for finance have significant hurdles in front of them.

What interests investors

Before approaching potential investors, it’s important to identify the type of funding required, suggests Dr Allan O’Connor from the Entrepreneurship Commercialisation and Innovation Centre at the University of Adelaide. “In terms of people trying to fire up a venture, their ambitions might not match what a venture capitalist is looking for.”

The next question is whether the technology or process being commercialised is likely to be of interest to an investor at all. “To be of interest, it needs to be protectable. Can they own the intellectual property, so it won’t be in dispute, and can they keep the rights to it for a substantial period of time, so they can use it to exploit it for a return?” The more protectable the product or process, said Dr O’Connor, the more likely it is to attract interest.

Another crucial question: is there really a market potential for the product? And how will it get to market? “Will it be a direct sell, or will it be pushed through someone else? Do you need a supplier and are they going to dictate demand?” Dr O’Connor said the product itself and the ambitions of the entrepreneur behind it can’t be separated. “The ambition may not be very high and the market may only be local anyway, and maybe the demand isn’t there, so you wouldn’t need venture capital and you wouldn’t attract it.”

Paradoxically, the more you can develop the enterprise to the point where it doesn’t need funding, the more likely it is to attract equity. “The more ammunition you’ve got on your side, the better,” advised Dr O’Connor. “You’re playing a negotiation game, so the more you need the money, the weaker your bargaining position.” Do as much market research as possible, including the patent searches. “A venture capitalist will say ‘you’re going to need me and therefore I’m going to control it’,” he said. “The more you can bring to the table, the better your bargaining position.”

Dr Hirshorn said the technology itself is what’s crucial in attracting funding. “Number one is technology, number two management, number three the business plan – which includes the revenue model – and number four, the ability to raise finance,” he said and added that the business plan needs a “punchy executive summary, as a calling card”. If, after all that, it appears the technology has a chance of success, then a typical venture capitalist “would write a shareholder agreement with you for a certain amount of money, for a certain percentage of the company, and provide a member to your board of directors” and “be involved in a hands-on way in the company”.

The marriage

But due diligence has to be done by both parties. “As an entrepreneur, you’ve got to recognise that if you get into a relationship, you’re going to have to live with them,” said Dr O’Connor. Don’t agree to do business with just anybody, even if they come bearing wads of cash. “Does the firm have the appropriate networks, the appropriate connections, and the access to markets and technologies that are going to be of benefit in the long run?”

Grappling with these issues can be difficult for inventors. “In the beginning, the company is very happy just to have raised the money,” cautioned Dr Hirshorn. “Some companies feel, ‘we’ve got the money now, so go away, we know what we’ve got to do’,” whereas the reality is the company has signed up for an ongoing partnership, where the venture capitalists may making sweeping managerial changes, in order “to build the company, sell it at a profit and return the money to our funds. It can take three to five years or, in the case of biotech, five to seven years.” If the project takes longer than it was projected, the company may be sold before the technology becomes viable. “There are companies that haven’t been successful at all and have to be wound up, or there are times where there are mergers with other technologies to make the companies more powerful.”

Dr Hirshorn said people should ask themselves if they really want to deal with this. “Most scientists in their heart want to be scientists, and most technologists want to be technologists,” he said. “They don’t really want to be a businessman – so why do it?”

The money trail

Given that Australian venture capital is hard to find, would it be better for local entrepreneurs to seek overseas money? Dr O’Connor said it’s important to look for capital close to where most of the business activity will happen.

The website of AVCAL, the Australian Private Equity & Venture Capital Association, is a good place to start, because it gives details about its members. Do not, however, call AVCAL itself, as then-CEO Katherine Woodthorpe said they “don’t have much bandwidth to help people”.

She stressed that venture capitalists aren’t looking to invest in someone with an idea, and that the person seeking capital must have a comprehensive business plan that “sets out that opportunity and how they’re going to address that opportunity”.

She said that people in life sciences will find it easiest to raise money –– “Australia has a very deep life sciences market in terms of research and development” – with information and communication technologies second, and clean technology last. However, the chance of anyone raising capital is quite small at the moment, because those operating in the venture capital market have either invested their funds or a “reserving funds for companies they’re interested in, so there’s not a lot of new money”.

This situation is partly because venture capital results to date have been “pretty ordinary,” as Woodthorpe put it. There’s also a structural problem at work; venture capital mostly comes from the superannuation industry and as the super funds get bigger, they paradoxically find it harder to invest comparatively small amounts of money. “A company might be looking for $5 million,” said Woodthorpe, “but the superannuation funds don’t write cheques that small.”

Once they do transfer money, however, they prefer not to own too much of the company. A venture capitalist wouldn’t,Woodthorpe said, take more than 40%, because they want to founders to have “skin in the game”. Then as the company grows and “goes for second and third rounds of funding, a larger range of venture capital funds might be involved.” She said an overseas fund might be brought in as a co-investor, in which case the founders’ share will be diluted even further.

Woodthorpe said to bear in mind that securing finance is not like applying for a grant, and it can take a long time. “The venture funds managers are very conscious of whose money they’re investing,” she said. “It’s not just money from rich people – it’s coming from superannuants and pensioners who need the money to retire.”

Other options

Doron Ben-Meir, CEO of Commercialisation Australia, said that Australia can be a great place for innovators. His organisation is a federal project, offering a number of different grants for different stages of business maturity. There’s a skills and knowledge grant, for example, worth up to $50,000 in grant money, as long as applicants can put up $12,500 of their own. “That’s for a very early stage, maybe an inventor in a garage who can show something works, but needs a commercialisation strategy,” explains Ben-Meir. There’s a ‘proof of concept’ grant worth up to $250,000, which is appropriate for people about to launch into the marketplace. Then there’s a grant for the early stages of commercialisation, worth up to $2 million.

Commercialisation Australia recognises that many inventors and innovators are not good at business. “Rather than say ‘send us your business plan’, we cut to the chase and ask questions in plain English,” said Ben-Meir. The primary thing is that “there has to be an element of novelty about the business. If someone wants to set up an accountancy practice, they don’t come to us,” he explains, “but if they come up with a new way to deliver accountancy practice that hasn’t been done, they would come to us.”

He said that innovation often arises from people who have been working in an area for a while and who see something that needs doing. “The entrepreneurial personality is inclined to seize the opportunity.” But the bigger the opportunity, the more difficult it will be to commercialise it successfully. “That’s why the opportunity was there in the first place. If it was so easy to do, it would have been done.”

Interestingly, Ben-Meir said that money is often the last thing innovators need. “Anyone who has built a business knows that money is essential, but insufficient to get you to where you want,” he said. “What we’re spending a lot of time and effort on is building skills to complement the financial assistance.”

One problem many first time entrepreneurs have, he said, is they think they’ve created something the world needs. “What they fail to understand is the difference between their perception of need and the customer reality of desire,” he said. Engineers are particularly prone to this trap, because “they assume people think logically and rationally – which is completely unlike a human being.” So they fail to consider position and packaging.

Commercialisation Australia offers case managers with experience in business building – Ben-Meir himself has started six businesses. “The case managers’ role is not to tell participants how to run their business – that would be patronising – but to say ‘that’s your plan – how can I help you achieve that quicker’? The challenge is to get to your goal before the money runs out.”

Ben-Meir said a number of companies have benefited from this approach, from a business that grew out of useful introductions made by the case manager, to another that learned to stop underselling itself. Then he lets fly with a stream of innovations going on around Australia, from new protocols for high speed wireless, to new chip designs, to “very clever designs for barbed wire fences that completely changed the way that fences are constructed”. And, perhaps best of all: “a new braking system for garbage trucks”. As anyone who has been woken up by the unpleasant sound knows, garbage trucks squeak a lot. The new system can apparently extend the brake lifetime by a factor of four, while significantly cutting down on the noise. Which, in its own way, will be another great Australian contribution to hearing.

Felicity Carter