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Australasian Biotechnology (backfiles)
AusBiotech
ISSN: 1036-7128
Vol. 8, Num. 5, 1998
Business Forum Australasian Biotechnology,
Volume 8 Number 5, September/October 1998, pp. 296-298

Business Forum

"Too little science or too little money?"

George Jessup ,

Managing Director, Start-up Australia Pty Limited
(Presentation to the BioBusiness Forum in Sydney, 26 May 1998)

Code Number:AU98037
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Reflecting on this question, I was reminded of my university days where a number of well known techniques were frequently used (by other students) when dealing with difficult questions.

The first technique was to complain. My complaint is that in Australia this is a very relevant question. If we were having this meeting in an office in San Francisco right now, a more relevant question would be "Too little science or too much money" or even "Too much money for too little science". In the US at the moment, there is a weight of money for technology based ventures which is at times overwhelming and produces asset values that are unlikely to be sustained long term.

Another useful technique was to argue the validity of the question. The question seems to imply the equation money + science = more money. However, in my experience, a more accurate equation is money + science = no money. The missing factor is the application of business skills to the money and the science. This is one of the reasons for the success of venture capital in the US. Money and science need to be put together in the context of an appropriate business strategy, skills and other resources. This is (or should be) the role of venture capital.

The final technique, and the one I will use, is to answer a different question, namely the issue of funding for technology based companies and how that funding level can be increased through venture capital.

Availability of Funds

The availability of money depends on the stage of development of a company. Companies with some sales (e.g. $5 million) and strong growth prospects (i.e. expansion stage) are likely to be able to find funding. In fact, there is likely to be competition for investing in such deals. However, available funds for seed and start-up funding is minimal. We are yet to see if the IIF funds will increase this availability. Numerous reasons are given for this poor availability of funding.

Poor Corporate History

Australia has few good examples of successful venture backed companies. The ASX has a startling lack of high growth technology based companies. To some degree, this void is filled by the mining sector. Australia has yet to discover how to extract value out of its science anywhere near as well as it extracts value out of the ground.

Poor Management

The blame is often placed at the feet of management. I agree there are too few entrepreneurs who are able to build companies in Australia. We have a plentiful supply of financial engineers but few skilled managers who can build value. The irony is that there are large numbers of expatriate managers who are in fact building value in senior overseas positions. One must have some sympathy for the budding entrepreneur, for who would be an entrepreneur in Australia with such poor prospects of financial support for start-ups?

Cultural Incompatibility

Australians are often regarded as having a fear of failure and a lack of hunger for success. Anyone who has lived for some time in the US will be aware of the almost overwhelming affirmation of initiative and effort, from the earliest age and extending through the education, scientific and business communities. This creates a society where almost anything is possible. If failure occurs, success may be just around the corner. This creates a willingness to take risks and is a key component to creating a high growth technology sector.

Uncommercial Research Institutions

Research institutions are often criticised as being uncommercial in two areas: choice of research priorities and willingness to structure commercial deals. Our experience with research institutions with a few notable exceptions, has been excellent. Start-up Australia has invested in a number of companies which were created as spin-outs from research institutions. I do not expect, nor do I want research priorities to be commercially justified in the early stages. The major conceptual breakthroughs will be ahead of the market. The one area of concern is that some research institutions regard licensing to a multinational as a first option even where a smaller Australian company makes a strong proposal. It seems to me there is a role for the thinking that because a large percentage of the funding for research comes from the Australian public one way or another, Australian entities deserve a first look at breakthrough technologies and favourable consideration from research groups.

Market Failure

In the age of economic rationalism, the case for government intervention is frequently dressed up using the rationale of "market failure". There clearly is a failure, but I am not convinced there is a failure of markets as opposed to failure of people; researchers, entrepreneurs and investors. One cannot expect institutional investors to support early stage investment unless it can be shown that the financial rewards are in line with the risk. It will only take a relatively small number of successes to change attitudes to this sector dramatically.

Tax

This is often a vague complaint which I have trouble understanding. Like most people, I find our tax system complex and full of anomalies. Of particular recent interest is the argument that Pension Funds in the US won't invest in Australian venture capital since they would have to pay capital gains in Australia at a higher rate than they would in the US. This may be true, but we have a substantial Superannuation Fund industry in Australia which could easily double its commitment to venture capital in Australia without going above 5% of their funds under management. However, until there are sufficient venture capitalists in Australia with a good track record they will avoid this sector or invest overseas.

These arguments may all have some validity but are in most cases self serving and circular in nature. Some success stories are needed to encourage the supply of funds as well as improve the environment for future success. Start-up Australia is focussed on achieving success stories and securing more funding for this sector.

Since a healthy venture capital sector is critical, it is worth considering the factors critical for the success of venture capital: deal flow, institutional investors and adding value.

Deal Flow

Science is the lifeblood of the venture capitalist who invests in the life sciences. It is therefore in our interest that there be a high level of grant and other funding programs provided by governments. I would like to see as much science funded by public money as possible. It may surprise many here that I would like to see the emphasis placed on basic research. Most publicly funded research should not have to be justified by specific product based market projections or by collaboration with commercial partners. It is basic research that results in the creation of new platform technologies which can be of "blockbuster" value. This research should be unencumbered and available to the entrepreneur or technology company who can then add commercial value to the science. A healthy venture capital sector is thus reliant long term on government funded research programs. Grant programs supporting commercial research will assist specific companies and are also important. However, they will not provide the initial deal flow required to create successful new ventures in the first place. It is of concern to me that so many of these commercial grants go to large companies which have profits and can claim a tax deduction on R&D expenditure at concessional rates.

Another critical component of deal flow is the entrepreneur. In Australia we are short of entrepreneurs. Scientists and business people have yet to catch on to the excitement and rewards of creating a new company and participating in its rapid growth. This is starting to change. We are seeing an increasing number of spin-out companies from research institutions.

The Institutional Investor

In order to invest, the venture capitalist must first raise capital. The largest source of capital is from institutions such as superannuation funds. The trustees of these funds have a responsibility to produce returns for their members within an acceptable risk profile. They allocate assets within different asset classes, each of which has a different risk and return profile. Venture capital falls within the "alternative asset" class. If we exclude infrastructure, funds in Australia will invest up to 5% or less in this category. Typically a venture capital fund is a 10 year closed end fund. The investor must be prepared to wait up to 10 years for all the returns from the fund. Thus it is a relatively illiquid investment. In order to be attractive, venture funds must produce a return significantly above the stock exchange indexes.

In order to produce these returns, the venture fund must invest over the first 5 years of the fund and make exits in a 5-7 year time frame (typically through a trade sale or following a float on a public Business Forum stock exchange). The venture capitalist needs to see a plan which will provide for rapid increase in value and a viable exit within this time frame. In many case, there is no product actually for sale at the time of exit, but the product has advanced and there are commercial relationships in place which have resulted in an increase in value of the business. The focus is on capital gains, not on an ongoing dividend stream or royalty.

Adding Value

I mentioned previously that money will not guarantee success in a venture. The role of the venture investor is to work the money invested so that returns are above that of a passive investor. In order to illustrate this process, I will use a live example, Technico Pty Limited. When we made the first investment in Technico Pty Limited, on behalf of the Australian Technology Group, there were no employees. We were approached by two inventors who had come up with a laboratory scale process for the rapid propagation of potato seed. This is a huge market (potatoes are $150 billion and potato seed $15 billion). This investment has increased in value through focussing on the 5 P's.

People

The key inventors were either hired or retained as consultants and continue to be associated with the technology. In addition, an excellent CEO was recruited along with a technical and manufacturing team who are acknowledged as leaders in the industry in Australia and arguably the world. An employee share option scheme was put in place to provide incentive and to "lock in" key staff.

Product

The process was scaled up from a small laboratory process to a large factory scale and the process was modified to be applicable to a large range of potato varieties. A number of technologies were added to further improve the process. Field trials have been conducted on the seed with great success in most states in Australia as well as the US, India, Indonesia and Thailand.

Protection

The business has to have some protection of its competitive advantage. The Technico technology is complex and novel. It is protected under trade secrecy and would be extremely difficult to replicate, requiring substantial investment and many years research. Technico is also rapidly moving forward to retain its lead in rapid propagation of seed. The brand name is protected as a registered trade mark and is becoming a well known brand name in the industry.

Partner

A license and supply agreement was signed with PepsiCo shortly after our investment. PepsiCo is the dominant US player in crisps and recently acquired Smiths. They have built a factory in the US and in Mexico. This agreement provides Technico with credibility and a powerful ally. In addition, Technico has supply contracts with Simplot and McCains in Australia and intends to extend these in the future.

Plan

The business plan has been modified over time to be increasingly aggressive and expansive. The company will become a global supplier of potato seed. This plan requires further investment but will create a substantial industry player.

The result of these developments has been a substantial increase in the value of Technico. It is worth noting that this value is unrealised and the venture investor can only return profits to the investors in the fund when it realises this value through a private sale or following a stock exchange listing. This demonstrates the patience required to secure value from early stage investing.

Future Prospects

Australia cannot afford to fail in developing a vibrant early stage venture sector. It is no use complaining about the unwillingness of investors to support early stage technology based ventures. Institutional investors have a responsibility to produce adequate financial returns. In order to attract funding for this sector, venture fund managers, researchers and entrepreneurs will need to get on with the job of adding value to a small number of early stage technology based ventures and show a substantial financial return. This will attract investors. Once a track record can be demonstrated, funding will be available on an ongoing basis and allow Australia to secure more financial return from its science as well as create interesting, high value jobs.

Start-up Australia is a venture capital company which invests in technology based companies in the life sciences sector. We specialise in early stage ventures and are heavily involved in bringing science and money together in order to create high growth companies.
george@start-up.com.au ; http://www.start-up.com.au

Copyright 1998 Australian Biotechnology Association Ltd.

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