This article was written by Robert Wright and Austin Chen.
Australia currently ranks 19th on the 2016 Global Innovation Index, behind countries such as the UK, the US, Singapore and Germany – slipping two places from 2015. This index is an important indicator because innovation is a key factor for competitiveness and growth, particularly in developed countries. In fact, the OECD estimates that innovation activities may account for up to 50% of long-term economic growth in its member countries.
Access to funds is commonly considered to be a key barrier to innovation – restricting entrepreneurs from developing and commercialising their ideas especially during early stages of innovation. As part of its National Innovation and Science Agenda (Innovation Agenda) the Australian Federal Government has committed to invest $1.1 billion over 4 years and recently introduced the Tax Laws Amendment (Tax Incentives for Innovation) Act 2016 (Cth), which is intended to provide certain tax benefits and relaxed compliance requirements for Venture Capital Limited Partnerships (VCLP) and Early Stage Venture Capital Limited Partnerships (ESVCLP) investing in Australia. In addition, the new tax reforms provide a number of incentives to investors in qualifying early stage innovation companies (ESIC).
While these reforms are still gaining traction, in this update we track which sectors VCLP and ESVCLP funds are investing in and the key drivers for investment in these sectors.
VCLP and ESVCLP investment trends
According to the December 2016 ESVCLP and VCLP public registration lists, the Department of Industry, Innovation and Science (Department) had recorded 24 registered ESVCLPs and 32 conditionally registered ESVCLPs, as well as 47 registered VCLPs and 15 conditionally registered VCLPs up to calendar year end.
The sectors targeted by the limited partnership investors (as disclosed by the Department) are set out below.
Take up between ESVCLP and VCLP structures are relatively evenly split (as set out below) and a number of venture capital firms have registered funds in both categories. There are a number of differences between the two classifications, most notably, VCLPs typically have access to a higher investment threshold, whereas, ESVCLPs benefit from lower compliance requirements and further tax benefits with effect from 1 July 2016.
Technology and Healthcare sector investment focus
The emphasis on investment in the TMET and Healthcare sectors will come as no surprise to investors.
Historically, venture capital investments in these sectors have also consistently generated higher returns within shorter time periods and the median investment size is typically lower than in other sectors (particularly in the technology sub-sector) according to industry sources and KWM DealTrends Reports.
Venture capital investment in these sectors is also consistent with growth across the broader Australian services industry. According to the 2017 Australian Trade and Investment Commission Benchmark Report released this month, Australia's services sector has expanded by an average of 3.4% p.a. driven largely by Information Media and Telecommunications, Financial and Insurance Services, Professional, Scientific and Technical Services and Health Care and Social Assistance.
Anecdotally, venture capital investment in 2016 focused on technology innovations across a range of sectors (including fin-tech, health-tech, insure-tech and other technology based sub-sectors).
Although one of the aims of the recent reforms is to encourage investments across a range of sectors (outside the technology focussed areas), the government has not to date introduced new sector specific incentives for ESICs. It is anticipated that government departments will be closely monitoring whether the additional incentives for ESVCLPs included in the 1 July 2016 reforms will attract more investors to invest in ESICs and whether other sectors will receive much needed funding through these initiatives.
Fintech a feature within technology investment
Investment in the fintech sub-sector is expected to continue its growth trajectory in Australia – from an approximately $250 million industry in 2015 to $4.2 billion by 2020, according to a study by Frost & Sullivan.
The Australian Federal Government (and State Governments) have continued support for investment in this sector and most recently, the NSW Government has partially underwritten a $4 million loan from Investec to H2 Ventures. Under the guarantee, if H2 Ventures cannot repay its loan from Investec, Investec can claim 50% of any losses from the NSW government. H2 Ventures runs the Startup Accelerator program that provides funding to start-ups in fintech related sectors.
Industry commentators say this is a step in the right direction in order to attract global fintech talent from current tech-hubs such as Silicon Valley, New York, London and Tel Aviv. The development of globally respected co-working spaces like Tyro and Stone & Chalk as well as quality accelerator programs go some way to lift the Australian fintech profile.
Segments within the Healthcare sector likely to benefit
Recent venture capital investments within the broader Healthcare sector has covered a range of innovative products and services, including, for example:
- Medical devices innovations – OneVentures ESVCLP fund's (among other funds') investment in Vaxxas – pioneering a next-generation vaccine delivery platform that enables robust immune system activation;
- Heath tech – Future Health Ventures' investment in HeathEngine, RemoteConsult, Popfossa and CalorieStory – health resources connecting patients and health practitioners as well as other industry based online solutions; and
- Biopharmaceutical developments – Brandon Capital's investment in Cardiora – developing a new oral medicine for the treatment of end stage heart failure, currently undergoing phase 1b clinical trials.
Historically, early stage investment in the biotech sub-sector has often been overlooked by Australian investors and fund managers in favour of other "known quantities", especially when compared with investors in other more active markets like the US. The Innovation Agenda includes initiatives to convert Australia's world leading health and medical research capabilities "out of the laboratory and into the marketplace". To tackle this challenge, the government has established the Biomedical Translation Fund with more than $500 million ($250 million of Commonwealth funding that has been matched by private sector investors) to be used to invest in commercialising promising biomedical discoveries – "helping to bring the next great Australian biomedical discoveries, like the Gardasil cancer vaccine or cochlear medical device".
While the Healthcare sector looks set to benefit under these initiatives, early stage Australian biotechnology companies (particularly those requiring prolonged periods of research and commercialisation) will be carefully monitoring the impact of the Biomedical Translation Fund and whether further initiatives could potentially be on the agenda in 2017.
In addition to funding, management education is equally important in achieving growth for early stage companies as highlighted by ANZ's Chair in Business Growth. Managers need to know what to do with investment funds and how to implement an optimal growth strategy. But overall, initiatives put forward by the government to attract funds and investors in early stage investment opportunities is welcomed across industries as an important step in ensuring that Australia maintains its global competitiveness.