Value Capital
THE EVOLUTION OF VENTURE CAPITAL
AND PRIVATE EQUITY IN AUSTRALIA
Value Capital
CONTENTS
THE EVOLUTION OF VENTURE CAPITAL
AND PRIVATE EQUITY IN AUSTRALIA
MESSAGE FROM THE CHIEF EXECUTIVE
2
EXECUTIVE SUMMARY
3
REPORT SPONSORS
4
THE ACHIEVEMENTS OF VENTURE CAPITAL
AND PRIVATE EQUITY
The achievements of venture capital and private equity
Venture capital and private equity’s role in the economy
Venture capital case studies: Seek and Pharmaxis
Private equity case studies: Bradken and Pacific Brands
6
9
13
14
EVOLUTION OF THE AUSTRALIAN VENTURE CAPITAL
AND PRIVATE EQUITY INDUSTRY
Venture Capital
– The early days
– The 1990s
– The 2000s
– Outlook
Private Equity
– Birth, boom and beyond
– The eco-system develops
– The boom and beyond
– Outlook
16
17
19
20
22
23
25
28
What are venture capital and private equity?
The difference between venture capital and private equity
The VC and PE lifecycle
– Fund raise
– Identify and develop new technology
– Commercialise and build sales
– Investments
– Improving the investee
– Realising the value – the exit process
– Capital return to investors
Fees
30
30
30
31
31
32
32
33
33
33
34
ACKNOWLEDGEMENTS
36
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APPENDIX: WHAT ARE VENTURE CAPITAL AND PRIVATE EQUITY?
1
MESSAGE FROM THE CHIEF EXECUTIVE
Venture Capital (VC) and Private Equity (PE) in Australia today
are multi-billion dollar industries with participation from the
world’s most significant investors and practitioners. They are
industries that have, over the last couple of decades, supported
the growth and development of some of Australia’s greatest
innovations, and have invested in and strengthened many of
the country’s best companies. They have a significant impact
on Australia’s productivity capacity.
Early stage VC gets new companies off the ground, providing a
foundation for ideas and innovation that might not otherwise
get a chance. VC is the enabler of tomorrow’s economy. Australia
can no longer afford to be simply a beach, farm and quarry. The
Australian economy needs to participate in the world of tomorrow,
and VC has a central role to play in this vision of our future.
Australian VC has a core of consistent performers whose
investment returns are comparable with those available anywhere
in the world. Many in the industry are realistic about the current
business cycle, recognising it as an inevitable part of economic
life. Meanwhile, the country’s advantages as a centre for science
and technology, its stable business and economic environment,
and its attraction as a destination for talented people from across
the globe will remain strong competitive characteristics into the
future. Nonetheless, early stage VC is facing its own challenges,
with the current economic climate adding a layer of complexity
to the business of raising and deploying funds and exiting
businesses profitably.
Later stage PE transforms existing companies with its own brand
of management innovation. It is about providing a particular form
of capital and management insight to particular companies in a
particular time in their lifecycle. It brings management discipline
to the country’s boardrooms, and is widely recognised as having a
strongly positive impact on the way Australian business operates.
PE saw an unparalleled boom between 2005 and 2007. It was
propelled from relative obscurity to the front pages. Today, it should
be seen as just another sector of the economy: just one of a number
of sources of investment capital, management know-how, and
strategic expertise available to companies in a particular time and
place in their evolution.
As the economy faces the uncertainty of a prolonged downturn,
PE will be a valuable source of investment capital in markets where
it has become increasingly difficult to access. Many are optimistic
that the times may suit PE. Irrespective of short term challenges,
the fundamental foundation of the industry – its ability to identify
an investment proposition and develop and extract value – will
remain compelling into the future, and the industry will continue
to be a crucial resource for the Australian economy.
Both the VC and PE industries are an integral part of Australia’s
economy. They provide unparalleled innovative capacity, a
valuable source of investment capital for business, and much
needed management expertise. These factors will ensure that
VC and PE remain equally important to Australia’s future
economy as they have been in the last decade.
I’d like to thank Ernst & Young for their financial support and
intellectual input into the production of this review.
Value Capital
katherine woodthorpe
Chief Executive, AVCAL
April 2009
2
EXECUTIVE SUMMARY
Both VC and PE have deployed more than $10.6 billion (excluding leverage), across some 1,135
companies, as at 30 June 2008. These investments have been spread broadly across the country’s
geographies and industries.
Venture Capital
Private Equity
• Australian VC has been responsible for many of the country’s
greatest innovative leaps over the past decade. Companies such
as Resmed, Cochlear, LookSmart and Seek were backed by VC
and today improve the daily lives of millions of people.
• The industry boosts the value of its enterprises at double the rate
of its peers in the public markets, with Australian PE amongst
the best in the world at improving the value of its investments.
• Australian VC has benefitted from a series of Government
initiatives designed to improve the industry’s capacity to raise
capital over the past two and a half decades. Despite this, a
Government review in 2008 (the Cutler Review) declared that
the country’s innovation system was in need of an overhaul.
• VC, along with many other industries, will continue to be
impacted by the global financial crisis. But the foundation
of success in the industry is the commercialisation of sound
research and innovation, and this will continue.
• Innovation is a key opportunity to ‘improve the way things are
done’ in a downturn and needs to be encouraged for Australia
to recover more strongly.
• Buyout and later stage PE creates exceptional value for its investors,
with funds formed between 1985 and 2007 producing a positive
pooled internal rate of return (IRR) of 9.9% as at 30 June 2008.
Upper quartile funds had returns of 14.4% or better.
• Later stage PE boosts value through fundamental strategic
innovation, investing in the businesses it buys and creating value.
• PE’s unique way of doing business bolsters Australia’s productivity,
growth, employment, innovation, level of opportunity and
economic stability.
• Australia’s PE industry was examined closely by every national
regulatory body in the financial markets and the Senate in 2007,
and pronounced positive and healthy for the Australian economy.
• The Australian PE industry grew steadily through the first years
of the decade, on the back of several years of business development
by a core group of professionals. The last few years have seen the
industry experience a significant boom in fundraising while deal
sizes and volumes also grew markedly.
• Much of this activity has come to a halt as the result of the credit
crunch and financial crisis but the industry is working its way
through the crisis. It is an industry made up of highly skilled,
adaptable and flexible professionals who are well equipped to deal
with the consequences of the changing economic circumstances.
• The Australian PE industry still has significant amounts of capital
to deploy on investments where there is value yet to be realised.
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• Australian VC competes with the best in the world. The country
is a leading player in the health and biotech industries, in
communications and media, and cleantech is becoming an
increasingly important area.
3
REPORT SPONSORS
AUSTRALIAN PRIVATE EQUITY AND VENTURE CAPITAL ASSOCIATION LIMITED (AVCAL)
AVCAL was established in 1992 as a forum for participants in the private equity and venture capital
industry. AVCAL is the central voice of the Australian industry and its membership includes almost
all the domestic, regional and global private equity and venture capital firms active in Australia.
Value Capital
ERNST & YOUNG
Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our
130,000 people are united by our shared values and an unwavering commitment to quality. We have
a dedicated team of professionals committed to helping our private equity clients and their investee
companies achieve their potential. Ernst & Young will address your investment, transaction and
portfolio needs to help deliver the returns your stakeholders expect.
4
THE ACHIEVEMENTS OF VENTURE CAPITAL
AND PRIVATE EQUITY
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PRIVATE EQUITY COMPANIES
EMPLOY MORE THAN 100,000 PEOPLE
PRIVATE EQUITY COMPANIES
INCREASE EARNINGS 2.5 TIMES FASTER
THAN PUBLIC COMPANIES
VENTURE CAPITAL
IS A FUNDAMENTAL CONSTITUENT
OF AUSTRALIAN INNOVATION
VENTURE CAPITAL COMPANIES
HAVE DEVELOPED TECHNOLOGIES
THAT HAVE MADE LIFE BETTER FOR
COUNTLESS PEOPLE ACROSS THE GLOBE AND
CREATED JOBS AND INCOME FOR THOUSANDS
OF EMPLOYEES AND INVESTORS
5
THE ACHIEVEMENTS OF VC & PE
The achievements of VC and PE
Australian VC and PE has grown from a nascent industry with its roots in small, early stage investments
into a vibrant and significant sector of the economy. In fiscal 2008, Australian VC and PE invested $2.4b
in new and follow-on company investments both domestically and overseas before leverage. Of this
amount, 28% of capital was deployed by VC and early expansion funds and 72% by PE investors.
The industry is a major employer, with the investee companies of 10 of the largest PE firms alone
employing more than 100,000 people in fiscal 2008.
This investment and employment is broadly spread across the country and the economy, with investee
companies located in all States, and across all industries:
Figure 1: Number of investee companies by location FY08
Source: Australian Bureau of Statistics
1
19
%
17
4
34
6%
4%
67
45
69
6%
%
30
New South Wales
Victoria
Queensland
Western Australia
13
%
15
1
South Australia
24%
268
Tasmania, Australian Capital Territory,
Northern Territory
Overseas
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For much of the past decade, PE investment has contributed significantly to wealth creation by improving
the value of investee companies through strategic insight, clarity of management objectives and
incentives, long-term focus and the provision of investment capital.
6
THE ACHIEVEMENTS OF VC & PE
A survey of thirteen Australian PE exits in 2007 showed that PE invested companies increased their
enterprise value by 21% (or, if two exceedingly successful outliers are included, 32%). This enterprise
value is close to twice that achieved by publicly listed companies, and comparable to the best in the world
(see Figure 2).
Figure 2: Enterprise value (EV) growth in Australia 2007 (calendar year)
Source: Ernst & Young study 2008 “How do private equity investors create value?”
%
35
Weighted EV CAGR
30
EV CAGR
Weighted EV CAGR (including outliers)
32
25
20
15
21
10
11
5
0
Public Benchmark
Private Equity
Figure 3: Enterprise value (EV) by country 2007 (calendar year)
Source: Ernst & Young study 2008 “How do private equity investors create value?”
%
32
35
29
29
29
Public company benchmarks
30
24
7
25
18
13
21
20
20
12
14
17
15
22
10
5
PE out-performance
24
12
11
Total
Australia
16
9
2
20
12
7
0
-2
Germany
France
Southern
Europe
USA
Northern
Europe
UK
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Australian PE invested firms earnings grew more than 2.5 times faster than public company benchmarks
in 2007, with the majority of this improvement coming from organic growth or successful acquisition
rather than cost cutting or financial engineering. The PE model enables growth in profitability that
contributes to sustainable and repeatable above market performance.
7
THE ACHIEVEMENTS OF VC & PE
Figure 4: EBITDA growth in Australia 2007
Source: Ernst & Young study 2008 “How do private equity investors create value?”
%
40
9%
20%
36
43%
EBITDA CAGR
30
20
20
10
8
28
%
0
Public Benchmark
Private Equity
PE EBITDA Contribution
PE and VC have created and transformed some of Australia’s greatest companies and highest profile
businesses. On the VC side, companies such as Resmed, Cochlear, Seek, and LookSmart have developed
technologies that have made life better for countless people across the globe, and created jobs and
income for thousands of employees and investors. Later stage PE has transformed the fortunes of
companies as diverse as the Myer chain of department stores, Hoyts cinemas, Pacific Brands, and heavy
engineer Bradken, amongst dozens of others. Improving their performance has secured thousands of
careers, created new jobs and preserved a significant piece of the country’s commercial heritage.
Australian PE creates exceptional value for its investors. Australian buyout and other later stage PE funds
formed between 1985 and 2007 had a positive pooled IRR at the end of June 2008 of 9.9%. Upper quartile
buyout and other later stage PE funds had returns of 14.4% or better, compared to 3.3% or better for
upper quartile VC funds. On balance, combined PE funds have seen an annualised pooled return of 8.4%
to date1 (see Figure 5). The overall twenty-year horizon IRR was 8.5% for all PE funds (see Figure 6).
Figure 5: Investment returns – Australian VC and PE benchmarks
Source: Thomson/AVCAL Yearbook 2008
STAGE
NO.
AVERAGE
POOLED
UPPER
MEDIAN
LOWER
VC
37
-5.4
PE
101
5.8
-1.4
3.3
-0.6
-14.8
9.9
14.4
5.4
-2.5
All VC + PE
138
2.8
8.4
11.5
2.1
-4.3
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Cumulative annualised IRR since
inception of each individual fund.
Overall results as at June 30, 2008
Funds formed 1985 – 2007.
8
1
Pooled average: this calculation includes treating all funds as a single “fund” by summing the monthly cashflows together.
This cashflow is then used to calculate a rate of return.
THE ACHIEVEMENTS OF VC & PE
Figure 6: Horizon IRR results as of June 30, 2008
Source: Thomson/AVCAL Yearbook 2008
1 YEAR
3 YEAR
5 YEAR
10 YEAR
20 YEAR
VC
STAGE
-0.6
2.7
3.9
-1.4
-1.4
PE
0.8
8.1
14.2
9.3
10.0
All VC + PE
0.6
7.3
12.4
7.5
8.5
The fundamental strength of VC and PE’s value proposition means that, at a time when many other
sources of capital are significantly constrained and investment opportunities are difficult to fund,
PE still has plenty of capacity to invest, with unspent funds totalling $6.5 billion as at 30 June 2008
(see Figure 7).
Figure 7: Cumulative committed capital, amount drawn down and unused funds (combined VC and PE funds)
Source: Australian Bureau of Statistics
$m
17,133
18,000
15,148
16,000
14,000
12,348
12,000
6,000
4,648
4,000
2,182
2,000
4,999
7,983
8,000
5,322
1,865
6,218
2,288
6,871
2,528
Unused funds
5,991
10,048
10,000
Drawdowns
6,520
4,595
3,391
9,157
2,466
3,457
3,930
4,343
4,592
5,453
FY00
FY01
FY02
FY03
FY04
FY05
10,613
7,349
0
FY06
FY07
FY08
VC and PE’s role in the economy
Strong VC and PE sectors bring significant benefits to a broad section of Australian society and the
economy as a whole. Their unique way of doing business bolsters the country’s productivity, growth,
employment, innovation, level of opportunity and economic activity.
Innovation and opportunity
VC is a fundamental constituent of Australia’s innovation system. It provides capital and commercialisation
skill to the country’s top scientific, technical and entrepreneurial brains, providing essential funding
and business skill to make Australian innovation a reality. Without a thriving VC industry, Australian
inventors – from biotechnologists through to software developers, industrialists and financial innovators
– would be unable to bring their innovations to life.
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The importance of innovation to Australian wellbeing cannot be understated. The Cutler Review of
Australia’s Innovation System undertaken in 2008 stated that the VC industry embodies a spirit of
entrepreneurialism and risk-taking that should be fostered in all Australians. VC provides the foundation
for innovative growth and productivity enhancement that will be necessary to maintain the country’s
competitiveness into the twenty-first century.
9
THE ACHIEVEMENTS OF VC & PE
Business discipline
Because VC and PE bring rigorous analysis and business discipline to the market and provide an
alternative to other forms of ownership, they have a broad and positive impact on the business
environment as a whole.
Numerous studies from across the globe have shown that PE makes the bulk of its returns from
proactively growing the core businesses of its portfolio companies. It does this by applying significant
strategic know-how and management expertise with financial discipline. It aligns the interests
of management with that of owners, working closely with executive teams, getting involved with
the businesses it owns and bringing a flexible approach to strategy and business success. Quality
management teams in Australia underpin success; PE firms in Australia tend to retain existing
management and invest time and energy to support and drive them to achieve their strategic financial
objective. The success of PE is intimately bound up with its ability to exit its businesses, which means
providing value for the buyers – whether they are public market investors, a public company, a strategic
investor or another PE firm.
Because of the stringent discipline it brings to the business table, PE has a significant impact on the
broader business environment as a whole. Public company boards are forced to revisit their strategies
and adopt a number of the successful PE business strategies to assist them deliver better returns to
shareholders. The Reserve Bank of Australia puts it this way: “PE can play an important role in ensuring
an efficient and dynamic business sector. The threat of a takeover by a PE fund or another group of
investors is an important element in helping to ensure that the existing managers of firms have a strong
incentive to manage the assets under their control as efficiently as possible.” 2
Australian business thinks so too. A survey conducted by the Economist Intelligence Unit of nearly
300 Australian executives in December 2007 found that over 75% thought that PE was a positive thing
for Australian business.3
Productivity and employment growth
VC and PE provide a boost to both Australia’s employment levels and productivity.
PE-backed businesses invest in additional employees at a significantly faster rate than comparable
companies. This is because they are actively managed, supported with new capital and increase their
employee numbers more quickly than less dynamic businesses.
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PE makes businesses more efficient. An independent study commissioned by AVCAL in 2004 indicated
that the labour productivity of PE-backed firms increased over a period of two years by 6.3%, almost
double the comparable national figure of 3.4%.4
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2
3
4
Reserve Bank of Australia, “Private Equity in Australia”, Financial Stability Review, March 2007.
“Private equity moves in: the impact on business in Australia”, Economist Intelligence Unit, 2008.
Meyrick & Associates, Labour Productivity Study, June 2004.
THE ACHIEVEMENTS OF VC & PE
PE represents another ownership form, more relevant to some industries and businesses at various
points of an economical cycle. PE’s ability to deploy significant amounts of capital quickly, and the
maturing nature of the PE firms in the Australian economy are important in creating a dynamic, high
performing business landscape. The ownership changes and competitive threat increases corporate
activity and offers investors alternative investment classes to diversify its own investment risks.
A core competence of VC and PE professionals is determining which deals are right for them. Figure 8
shows the number of proposals VC and PE have examined over the past three years, and the number
of actual investments. The low conversion rates underpin the investment thesis of the PE model and
highlights the breadth of businesses and assets analysed by PE as part of its disciplined approach to
investments.
FY06
FY07
FY08
Proposals viewed
6,896
8,792
8,497
Further analysis
787
1,039
963
New deals entered into
278
253
260
Conversion rate
4%
3%
3%
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Figure 8: VC and PE deal analysis
Source: Australian Bureau of Statistics
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THE PUBLIC INTEREST
QUESTION
Following the wave of high profile PE bids in 2006, every legislative and
regulatory body involved in Australia’s capital markets was formally examining the implications of
the PE boom. In February 2007 the Takeovers Panel, part of the Australian Securities & Investments
Commission (ASIC), published draft guidance notes on conflicts of interest. Also in February that
year, the Council of Financial Regulators, comprising the Reserve Bank of Australia, the Australian
Prudential Regulation Authority, ASIC and the Australian Treasury, formed a working group to
look at the issues raised by the strong growth in PE and leveraged buyout activity, and in particular,
whether there was excess leverage. In March, the RBA published a Financial Stability Review focused
on PE, and the Senate opened a parliamentary inquiry into PE and its effects on capital markets and
the Australian economy.
Each of these inquiries came to the conclusion that PE was a good thing for
Australian business. The Takeovers Panel concluded that conflicts of interest and insider trading
issues are more or less the same whether they involve PE or other types of M&A, and are dealt with
under the Corporations Act. As for market stability, the Reserve Bank of Australia said that with
PE transactions remaining a very small part of the overall financing taking place in the economy,
it was the central bank’s view that PE developments “posed absolutely no risk to the stability of the
financial sector or the economy more generally”.5 The Treasury and the Tax Office could not find
any conclusive evidence to show whether PE activity affects tax revenues one way or another:
“The general consensus was that the impact on revenue appears to be low and concerns about it
overstated,” reported the Senate.
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The conclusion of the Senate Inquiry,6 published in August 2007 was
unequivocal: “The committee does not consider that any convincing case has been made for any
further regulation of PE activity in Australia.”
12
5
6
Mr Ric Battellino, Deputy Governor, Reserve Bank of Australia, Official Committee Hansard of the Senate Standing Committee on Economics, 25 July 2007.
Private Equity in Australia – Submission to the Senate Standing Committee on Economics May 2007.
CASE STUDIES
The following case studies demonstrate how
VC investments play a vital role in the Australian
economy, by bridging the funding gap for the
commercialisation of new technologies by
early-stage companies.
SEEK
PHARMAXIS
Seek was formed in 1997 to match job seekers and employers over
the internet. It is Australia’s leading company in the online training
and employment market, serving SMEs, large corporations, and
government and recruitment agencies.
Pharmaxis is a specialist pharmaceutical company founded in 1998
that researches, develops and commercialises human therapeutic
products to treat chronic respiratory and autoimmune diseases.
The lead technology was developed by Dr Sandra Anderson at
the Royal Prince Alfred Hospital in Sydney. Founding investor
GBS Venture Partners provided support in identifying the lead
technology, building the board and management team, and
developing the strategy.
Seek was backed by a number of AVCAL members: CHAMP
Ventures, the Macquarie Technology Fund and Gresham AMCF.
These investors were there on day one – back in 1999, well before
any of Seek’s big name investors. They provided extensive strategic
input to the company, including active participation in market
analysis, fund raising and exit planning, as well as assistance in
budgeting, cost control and project selection.
Paul Bassat, Seek CEO, says: “Seek raised several rounds of early
stage capital, in order to fund our growth. The availability of this
capital was a key factor in enabling us to achieve our objectives.
Several of these investors provided important strategic input as
well as access to their networks. The growth of the VC industry
is an important ingredient for the ongoing health of early stage
businesses in Australia.”
Today, Seek is an immense success. It enjoys a formidable lead
over its nearest competitor in terms of both job ad and jobseeker
numbers. According to data from Nielsen/NetRatings, in
September 2008 Seek attracted over 2.79 million unique browsers
to its site, more than twice the number of individual visitors
received by its nearest competitor. Of the total time spent by
jobseekers on the three major Australian employment sites, 76%
of that time is spent on Seek. The total time spent on Seek is five
times its nearest competitor. Seek currently hosts about two thirds
of all online ads, and its site reach is 66% of the online jobseeker
market in Australia (Nielsen/NetRatings). In any given month,
approximately 200,000 job ads are posted on its Australian website,
which is more than double the number of job opportunities listed
by its nearest competitor.
Pharmaxis is headquartered in Sydney at its TGA-approved
manufacturing facilities. GBS first invested in Pharmaxis as a
start-up in 1999, prior to in-licensing what has become its core
technology and building the management team. In the following
eight years GBS led a syndicate of follow-on venture investors,
including CM Capital, through a number of private financing
rounds prior to listing on the ASX in 2003. Since raising $25m at
IPO in Q4 2003 Pharmaxis has gone from strength to strength,
raising a further $150m on the ASX and NASDAQ. Pharmaxis has
grown to become among Australia’s largest life sciences companies
with offices in the US, UK and China. The company currently
has 100 employees and is constructing a new 7,000 square metre
factory and headquarters in Frenchs Forest, Sydney.
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Seek has around 400 employees and is based in Victoria, with
branches in all Australian state capital cities, Auckland and
London.
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CASE STUDIES
The following case studies illustrate how PE firms
add sustainable value, transforming their investee
companies into more attractive assets for future
buyers through a combination of management
expertise, capital investment and strategic direction.
BRADKEN
PACIFIC BRANDS
Bradken has been a manufacturer of high quality consumables
for the mining industry since the 1920s. It is a heavy industrial
company making large equipment: rolling stock, spare parts
for huge mining vehicles, processing equipment. It was
purchased in December 2001, from the Smorgon Steel Group,
by a consortium of CHAMP Private Equity, US-based ESCO
Corporation and Bradken management. At the time of the
$185.5 million management buyout (MBO) the company had
a turnover of $300 million and staff of 1400. The consortium
funded the company with a total of about $200 million, 30%
of which came from equity held by management and CHAMP
and 70% from bank borrowings.
Pacific Brands came out of PE ownership some five years ago.
In 2009, the impact of the global crisis and negative publicity
surrounding the strategy of moving production offshore,
remains to be seen. Nevertheless, it is clear that the company
was comprehensively turned around in PE hands.
Bradken remained under private ownership for just under three
years. During this period, approximately $25 million of new capital
expenditure was invested for capturing growth opportunities
and cost reductions. Bradken’s EBITDA grew over 60% from
approximately $30 million per annum to $50 million per annum.
At the time of its successful public listing in August 2004, the
investment achieved an IRR of 49% and CHAMP retained a
10.1% stake in the company.
Bradken’s Managing Director Brian Hodges said that the
advantages of PE ownership included the capital injection into
the company that the previous owners could not make. Other
less obvious advantages included the reduction in non-value
adding work for senior managers. People became more focussed
and there was a reduction in reporting. “You do not do as much
filling out of monthly reports to send up through the levels of
an organisation; you are at the top of the organisation and you
talk directly to the people involved.”
Mr Hodges also says that as Bradken became a stand-alone entity
there was a period of three to five years with a clear plan and
targets to meet. He also found that the PE owner was significantly
closer to the business than previous owners, and challenged many
of the known norms.
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There was also an effect on employment levels. Prior to the PE
takeover a number of plants were shut down and people retrenched.
Although there was little capital expenditure, efficiencies were driven
through work practices and other changes. From 2002 onwards
staff levels increased. Currently the company employs around
3,000 people and there have been no further staff reductions.
14
The company, manufacturer of famous Australian clothing
brands such as Bonds and King Gee, was an unloved division
of conglomerate Pacific Dunlop when it was purchased by PE
firms CVC Asia Pacific and Catalyst Investment Managers in
November 2001. Over the next three years its new ownership
increased the speed of decision-making, boosted advertising
spend from $30 million to $70 million, increased staff training
budgets by 163%, improved working capital and shed $90 million
of low-margin product lines to concentrate on core brands.
Bought for $730 million, the company was floated on the
Australian Stock Exchange in April 2004 in an initial public
offering (IPO) that raised $1.25 billion. The PE investors made
more than five times their initial investment for an internal rate
of return of 105%. The company has continued to prosper in
public hands, with sales increasing from $1.3 billion in 2004,
the year of its IPO, to $2.1 billion in 2008 with EBITDA of $229
million that year.
A Brief History:
Significant milestones in the evolution
of venture capital and private equity.
THE EVOLUTION OF THE
AUSTRALIAN VENTURE CAPITAL
AND PRIVATE EQUITY INDUSTRY
1970
First VC fund formed:
International Venture Corporation
1984
Government launches MIC Program
creating vehicles for risk capital
1987
First PE Fund formed: AMIT and Byvest
1992
Arrival of large corporate investors
into risk capital sector
Government replaces MIC Program with
Pooled Development Funds
Government legislates compulsory
superannuation scheme
Creation of AVCAL with 17 funds
managing $507m
1993
Government forms Australian Technology Group
to invest in early stage technology
1997
Government launches Innovation
Investment Fund Program
1998
AVCAL records growth of VC and PE sector to 40
funds with $2.7bn in funds under management
Foreign capital invested in PEP’s first fund
1999
Government launches Commercialising
Emerging Technologies (COMET) Program
to provide $30m in funding for early stage
growth firms to commercialise their work
Government introduces major tax reform
on capital gains tax, roll-over relief and zero
taxation for US and certain Pension Funds
2000
Global dotcom market crash
2001
Government announces $2.9b innovation
action plan to fund new initiatives in
education and R&D
2002
Government legislates capital gains tax
exemptions or certain foreign investors
that invest in VC/PE limited partnerships
2003
AVCAL introduces standard reporting
guidelines for its members,
based on world’s best practice
Global PE Firms set up offices in Australia
2006
AVCAL adopts the International
VC & PE Valuation Guidelines
Mega PE deals:
CVC invests in PBL Media, KKR acquires
Brambles Cleanaway and Seven Network
2007
Senate Inquiry into Private Equity
PE bids on high profile Australian listed
companies such as Qantas, Flight Centre,
Orica and Coles
Sub-prime crisis hits
Australia has over US$1.68b of PE deals reported
despite the global financial crisis; higher than
China (US$1.13b) and Japan (US$999m)
2009
Government announces $83m
IIF Follow-on Fund
Value Capital
2008
Review of the National Innovation System
(the Cutler Review)
15
THE EVOLUTION OF THE AUSTRALIAN VC & PE INDUSTRY
Venture Capital
Australia competes with the best in the world and is a leading player in health, biotech, communications
media, and more recently cleantech. Australian VC has a passionate core of talented and experienced
investment professionals who have contributed to the successful commercialisation of science and
technology which has improved the everyday lives of countless people each day. Its funds are some of
the most professional and experienced investors in early-stage companies in the world.
A number of VC funds are now reaching their ten-year anniversaries, and those with significant track
records are competing on the global stage. A small number now have funds under management of over
$300 million. Successful venture-backed companies such as Resmed and Cochlear now have multi-billion
dollar market capitalisations and touch the lives of millions of customers each day.
As at 30 June 2008, Australian funds had $2.7b invested in 700 companies in the pre-seed, seed and
early stage expansion stages (not including leverage). Of this number, over half of these companies
were companies in the early expansion stage.
Figure 9: VC Investee Companies
Number of companies and value of investment ($m) at financial year-end, FY00 – FY08
Source: Australian Bureau of Statistics
3,000
800
2,000
500
400
1,500
300
1,000
200
Investment ($m) in VC
2,500
600
Number of deals
Number of deals
Investment ($m)
700
500
100
0
0
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
The early days
Many commentators would say that an important catalyst for the growth of the Australian VC industry
was the knowledge and experience that a small number of MBA graduates brought back to Australia in
the 1970s from the United States.
Value Capital
Although there was some venture activity in the country in the 1960s, the early 70’s credit crunch
effectively squashed the industry, which only recovered very slowly through the decade. In 1980,
Bill Ferris, a co-founder of Australian Mezzanine Investment Trust (AMIT), an early stage investment
firm, wrote an article outlining what he called the Small Business Investment Gap. He claimed that
there was little opportunity for venture-stage companies to attract investment capital, and urged the
Australian Government to rectify the situation.
16
THE EVOLUTION OF THE AUSTRALIAN VC & PE INDUSTRY
In 1983 the Australian Government appointed the Espie Committee to recommend ways to remedy
the problem, particularly to stimulate investment in high technology, which was booming offshore.
It recommended the creation of the Management and Investment Companies (MIC) Program. Under
the program, initiated in 1984, 11 MICs were licensed to raise venture capital from investors, who were
in turn allowed to claim 100% of their investments as a tax deduction. Over and above the 11 MICs, a
paper published in October 1988 counted some 47 VC organisations of different ownership structures
and investment preferences – although many of these were focussed on small scale expansion capital
investments – and calculated the industry’s capital base at $353 million.7 The MIC program did have
a catalytic effect on the market, boosting its growth significantly.
VC funds grew slowly through the late 1980s, but were hard hit by the recession in the early 1990s.
The stock market crash of October 1987 and the recession that followed made life very difficult for
existing players and discouraged new entrants to the industry. It was a brutal time for the investment
industry as a whole – commercial interest rates soared over 20% and two of the country’s banks were
brought to the brink of collapse – and VC suffered.
The 1990s
There were several initiatives in the early 1990s that helped get the industry back on its feet. In 1992,
the MIC programme was replaced with the creation of Pooled Development Funds (PDFs). Similar
in structure to the MICs but less driven by tax incentives, over the subsequent six years PDFs invested
$155 million in 147 companies. At the same time, the industry began organising itself more formally.
In 1992 AVCAL’s predecessor association, the Australian Development Capital Association Limited
(ADCAL) was formed with the first meeting chaired by Richard Gregson.
According to Geoff Brooke of GBS Ventures, there was minimal VC happening in Australia until the
mid-1990s. Later in the decade, however, with the first stirrings of the technology boom, there was
something of a revival – by 1998 Australia had 40 funds, mostly VC, with $2.7 billion in capital under
management. Although some years before the float of Netscape and other icons of Web 1.0, this was
the time when the internet was beginning to make an impact and optimism was yet again rife in the
technology industry.
Value Capital
Some of the VC deals done around this period are still considered the most successful in Australian
venture history. High profile cases include LookSmart, an AMIT-backed dotcom that was floated in
August 1999 generating a return of over 1,100%, and Cochlear, the Advent Private Equity-backed
commercialisation and globalisation of world-leading hearing implant technology developed in
Australia. There are numerous other success stories from the late 1990s across industries, from high
technology to mining services, medical equipment and financial services.
7
A Development of the Venture Capital Market in Australia, V. Wan, University of Wollongong.
17
THE EVOLUTION OF THE AUSTRALIAN VC & PE INDUSTRY
In 1997, the Australian Government introduced the Innovation Investment Fund (IIF), a federal program
still running today, that matched funds raised from the private sector up to a ratio of two to one.
The scheme has invested $221 million in rounds one and two of the program, and is investing some
$200 million in its third round.
Many of the companies that were awarded licences in the first rounds of the IIF were spin-offs from
earlier MICs. Rothschild, for instance, raised one of the first IIF venture funds that was a $42.5 million
fund: $27.5 million from government and $15 million from the private sector. Other venture funds
around this time were around the same order of magnitude, although a number were significantly larger.
Nanyang Ventures, for example, was funded in the second round of IIF, raising $140 million.
One of the first IIF funds was a joint venture between Australian Mezzanine Investment Trust and the
Walden Investment Fund out of San Francisco. It was a company that had some significant VC successes,
including LookSmart, Gecko Mining Systems, and seek.com, as well as a couple of others. It paid back
the entire investment of the Australian Government in the first round of IIF funds, helping to establish the
fact that you could make money in venture capital.
Most of the companies that were handed licences in the first round of the IIF scheme have gone on to
become institutional grade venture capitalists that now form the backbone of the Australian VC industry.
Figure 10: IIF licence companies
ROUND 1
ROUND 2
ROUND 3
Allen & Buckeridge
Foundation IIF /
Stone Ridge Ventures
Andover Venture Partners
AMWIN/CHAMP
Brandon Capital Management
CM Capital
Nanyang Ventures /
Four Hats Capital
Cleantech Ventures
GBS/Rothschild
Neo Technology Ventures
IB Australian Bioscience
Momentum Funds Management
Start-up Australia
Yuuwa Capital
Value Capital
In 1999, the industry began formally collecting data on its activities, with the Australian Bureau of
Statistics and Thomson Venture Economics both beginning regular surveys and reporting on the VC
industry. The Thomson/AVCAL yearbook reported that a record $A800 million flowed into the industry
during FY1999. A number of new funds were also established that year, with capital coming from both
Australian and offshore institutions. According to Thomson, at the end of 1999 AVCAL’s 35 investor
members had $3.5b in funds under management.
18
THE EVOLUTION OF THE AUSTRALIAN VC & PE INDUSTRY
The 2000s
The venture end of the spectrum was hit hard by the dotcom bust. GBS Ventures (then Rothschild &
Sons) closed a $64.5 million fund just after the dotcom crash of March 2000. After this event fundraising
for cash-hungry high tech businesses was difficult for a number of years. High tech industries were
further hit when the global telecoms industry crashed just a year later.
From 2002, later stage PE experienced a fund-raising boom, attracting significant offshore investment
and increasing its domestic capital base. VC however was growing at a much slower pace. It has been
a frustrating time for those who have dedicated their careers to Australian technology innovation.
“The flow of investment dollars has not come from the institutions,” says GBS’s Brookes. “It is extremely
frustrating that many Australian super funds are willing to invest in US venture capital, even though
local venture produce returns that are absolutely comparable with those in Silicon Valley.”
The numbers back up this assertion: Australia’s best VC managers achieve returns comparable with
those seen in the US – a recent AVCAL survey showed that positive cash exits in the Australian VC sector
average 39.3% IRR with a 4. 1 multiple.8 Yet Australian super funds allocate less than 1% of their capital
to VC and PE investment in total (see Figure 11).
%
10,000
1.2
9,000
1.0
8,000
7,000
0.8
6,000
5,000
0.6
4,000
0.4
3,000
2,000
0.2
1,000
Super committed to PE as a % of total
superannuation assets
Superannuation funds committed to VC & PE ($m)
Figure 11: Superannuation funds committed to VC and PE in value and as a % of total assets of superannuation funds
Source: Australian Bureau of Statistics
Commitment to
VC and PE by
investors from
super funds
Percentage
0
0
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
Value Capital
One observer points to the relative stagnation in average fund size over the decade – the first funds
created by the IIF over ten years ago were in the order of $40 million. Aggregate fund raising levels
haven’t changed greatly since 1999. It is, say many commentators, a “chicken and egg” problem: investors
want more quality local investment managers, but without investment dollars the industry cannot grow.
“We have proven over the last ten years that Australian VC can create technologies, build companies,
create jobs and wealth,” says one industry veteran. Yet the industry has failed to attract the volume of
capital it needs to attain truly critical mass.
8
Dr. Mike Hirshorn and Tim Peters, “Positive cash-on-cash Exits”, Australian Venture Capital Journal, Oct 2008, pp. 23 – 25.
19
THE EVOLUTION OF THE AUSTRALIAN VC & PE INDUSTRY
What’s more, the relative lack of investment capital is frustrating for participants, because there have
always been more investment opportunities in Australia than there is funding. Australian innovation
is one of the most underfunded in the world: overall VC investment in Australia is just 0.05% of GDP,
less than half the OECD average.
Figure 12: VC and PE new and follow-on investments ($m)
Source: Australian Bureau of Statistics
$m
1,200
Investments in new deals – VC ($m)
289
2,500
350
2,000
Follow-on investment – VC ($m)
Investments in new deals – PE ($m)
Follow-on investment – PE ($m)
167
1,500
1,000
2106
185
500
0
1419
1248
140
227
157
256
492
FY06
FY07
FY08
Outlook
The credit crunch will have a significant impact on the ability of an Australian venture to attract new
capital. Nevertheless, there is still some – if now much more highly contested – capacity, in the market
for funding promising technologies.
“Since becoming established in 2001 we’ve raised close to $400 million of capital,” says John Dyson, now
a principal at Starfish Ventures. “The current market demise may slow us down a bit, but in the broader
picture we are just where we want to be. To a large degree the credit crisis doesn’t really affect us, because
our companies have next to no debt. What does affect us is sentiment; the ability for us to raise funds
and investors to take risk.”
Value Capital
The next few years are likely to see something of a “battening down the hatches”. That means making
decisions that will preserve remaining cash in the expectation that quick exits will not be easily come
by, and new funds will be more difficult to raise than they may have been in the past. Nonetheless, the
industry has been through lean times before and has good experience in waiting these out until the
growth cycle kicks in again. It is an industry made up of experienced professionals with a great depth
of experience. What’s needed now is for the industry to be bolstered by a new wave of fresh capital –
both financial and human.
20
THE CUTLER REVIEW
The Rudd Government commissioned a formal review of Australia’s
innovation system early in its first term. Delivered in September 2008, the report found that the systems
Australia uses to support its capacity to innovate have been suffering from neglect for over a decade.
The proportion of Government spending on innovation fell markedly over the past 10 years, education
spending fell below the OECD average, and productivity growth has flattened in recent years.
Value Capital
The report recommended a complete overhaul of the country’s innovation
system, from the establishment of new bodies to specifically promote Australian innovation and
human capital, to a revision of the tax benefits that accrue to research and development. The report
recommended that the IIF program be maintained and extended, with a fourth round after 2012.
It also recommended a raft of other initiatives to support Australian VC and to attract offshore
venture funds to Australia.
21
THE EVOLUTION OF THE AUSTRALIAN VC & PE INDUSTRY
Private Equity
Birth, boom and beyond
In the late 1980s, the PE industry was embryonic but it supported a core group of professionals. The
early practitioners are today seen as the pioneers of the industry. Notable players in the industry at
the time included John Grant from Hambro-Grantham (then later Colonial First State Private Equity),
Bill Ferris and Joseph Skrzynski from Australian Mezzanine Investment Trust (now CHAMP Private
Equity), Andrew Rothery, Doug Bartlett and Ross Grant at Byvest, Alex Varley, Ian Lansdowne, Geoff
Berry, and Gordon Windeyer at Catalyst, and a number of captive operations within the investment
banking community, including Peter Chapman and Bill Robinson at Citicorp Capital Investors, and
Sandy Lockhart at Macquarie Bank’s Bond Street Investments.
The first institutionally subscribed PE funds in the country had been raised in 1987. They were the $30
million fund raised by AMIT and a $95.5 million fund raised by Byvest. According to CHAMP partner
Bill Ferris, one aspect of the industry hasn’t changed for twenty years: “The size of our first fund was just
$30 million, and everyone said to us in those days ‘How on earth are you going to find ways to deploy
those funds?’ and it’s true to say that every fund since then including the last one, which was a $1 billion,
has attracted the same response.”
Figure 13: Average PE fund size FY99 – FY08
Source: Thomson Reuters/AVCAL Yearbook 2008
$m
1,400
1,200
1,000
800
600
400
200
0
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
In the interim, there have been many significant developments in the industry. According to Peter Wiggs
of Archer Capital: “Going back pre-2000, the whole idea of buyouts dominating the space would’ve been
very foreign to 90% of the participants.
Value Capital
“In terms of people employed, funds under management and deals done, the vast majority were venture
capital or growth capital in nature with very few controlled acquisition deals. We were not big users of
debt because these were all companies that were net importers of cash rather than producing cash so
they couldn’t support debt. So the standard deal was a $5 or $10 million equity cheque into a promising
if somewhat embryonic company.”
22
THE EVOLUTION OF THE AUSTRALIAN VC & PE INDUSTRY
The eco-system develops – PE comes of age in late 90s
The introduction of compulsory superannuation in the early 1990s radically increased the amount of
investment capital available from the domestic market. With increasing sums of investment capital to
manage, conservative Australian investment managers were looking for ways to diversify their holdings
away from traditional fixed income and equity investments. Allocations to “alternative assets” such as
VC and PE increased accordingly.
“All this activity meant that PE companies, which had been the poor cousins to the investment banks and
others in the financial services industry, could now raise large enough funds to hire well qualified people
to manage their money,” says Ironbridge’s Julian Knights. “By 2001 there were a number of $200 – $300
million funds that could compensate four or five people with reasonably competitive salaries. It’s true to
say that after 1998 the number and quality of people in the industry grew in leaps and bounds.”
At the beginning of 1998, there were few lawyers, accountants or other transaction support services
with dedicated PE expertise. Local institutional investors were both sceptical and conservative, and
investment from offshore was unknown. What private investment activity there was generally focussed
on early-stage investment, with public to private and other later stage buyouts unfamiliar to the market.
In fact, a number of observers note that, at the time, PE was considered a buyer of last resort. Vendors
were reluctant to talk with the industry because they felt PE wouldn’t be able to raise the capital to pay
an appropriate price, and many in the legal fraternity felt that a management buyout created a conflict
of interest for management.
The late 1990s saw a series of events that laid the foundation for the success of the industry for the
following decade. One was the establishment of several significant PE finds, including AMP Development
Capital, the Development Capital of Australia Fund, GS Private Equity (the successor to Byvest), and
the formation of CHAMP Private Equity.
A further important development was the success of local funds in attracting capital from foreign investors
for the first time. In 1998 a team of professionals from Bain & Co. set up Pacific Equity Partners, now one of
the country’s largest PE funds, raising its first fund with 90% of its capital sourced from overseas investors.
Although this fund may have been the first significant foreign invested fund in the country, its success
had been built on the back of a decade’s work pioneers had put into increasing Australia’s profile amongst
the international investment community. “Getting US investors’ interest has been a long haul,” says
Andrew Rothery (then of Byvest). Senior partners of international fund managers such as Harbourvest
(the world’s largest fund manager) and other foreign investors visited Australia and met the Treasurer
and local companies right through the 1990s, before initial investments in Australia were made.
At the same time, the banking market was developing its leveraged finance resources. Domestically,
BT boosted its acquisition finance team, and offshore competitors such as the Royal Bank of Scotland,
HBOS, Société Générale and Crédit Agricole sent fresh teams to provide the burgeoning industry with
the leverage it would need to grow over the next decade. Meanwhile, the global professional services
firms were setting up dedicated PE teams in Australia to service the growing number of active funds.
Value Capital
The new funds looking for larger deals concentrated on opportunities created by the strategic restructuring
of conglomerates, while others in the market completed significant smaller deals that used the new PE
infrastructure to provide know-how and capital to Australia’s small and medium enterprises.
23
THE EVOLUTION OF THE AUSTRALIAN VC & PE INDUSTRY
In March 1998, CVC Capital Partners acquired Amatek, an Australian building products group from
UK conglomerate BTR for $1.625 billion. For many the arrival on the scene of a significant global player,
purchasing a major local business for a significant sum of money, marked the beginning of a new phase
for Australia’s PE industry. But there was something of a hiatus after this deal, during which funds were
raised, but big deals were not getting done.
The dam was broken with the $730 million purchase in 2001 of the Pacific Brands division of Pacific
Dunlop by CVC Asia Pacific and Catalyst. This was the first of the country’s dozen or so public-toprivate deals that have happened to date. It was a classic PE play that took an unloved division of a large
conglomerate, turned the business around, and reaped the reward. The business was boosted through
initiatives such as an increased advertising spend, a 163% increase in staff training expenditure and a
strong focus on working capital. The company was floated in April 2004, achieving an IRR of 141%.
According to the Thomson/AVCAL yearbook, in fiscal 2000, 42 new funds were formed, nearly doubling
the number of funds formed the previous year – a historic high.
Figure 14: Amount of funds raised by fiscal year (in A$ millions)
Source: Thomson/AVCAL Yearbook 2008
YEAR
VENTURE CAPITAL
PRIVATE EQUITY
TOTAL
1999
411.60
1,182.00
1,593.50
2000
338.60
1,153.40
1,492.00
2001
385.50
969.90
1,355.40
2002
115.50
821.60
937.20
2003
203.20
467.90
671.10
2004
152.60
1,079.20
1,231.80
2005
82.80
3,572.90
3,655.00
2006
184.70
3,210.90
3,395.60
2007
398.10
10,359.30
10,757.50
2008
174.30
6,134.30
6,308.50
Meanwhile, at the smaller end of the market, PE was completing a number of high profile deals – some
of the country’s best known brands, such as Repco, Just Jeans and JB Hi-Fi were transformed by PE
over this period, and drew the attention not only of the local press and business community but also
of international capital and competitors in the PE market.
Value Capital
“I think we were all true believers,” says Archer’s Peter Wiggs. “There was no reason, given Australia is a
mature industrialised economy with a deep debt capital markets, that you wouldn’t expect a strong and
vibrant leverage buyout industry to be present. And I think we’d been surprised that a buy-out industry
in Australia hadn’t been a part of the local PE and M&A scene. I think for a few of us, this was what we
had intended to happen and it was just finally happening. We weren’t feeling like this was amazing, we
were feeling like this was preordained.”
24
THE EVOLUTION OF THE AUSTRALIAN VC & PE INDUSTRY
In the 2002 AVCAL Yearbook, then chief executive Andrew Green wrote that Australia was top of mind
with global investors for five reasons: a sophisticated PE infrastructure; integrity; transparency; a critical
mass of funds under management; and world class entrepreneurship skills. The deals done around this
time boosted Australia into the top ranks of global PE markets, delivering some of the strongest returns
in the world. Over the next few years, the world’s largest PE houses set up shop in Australia. These were
often part of their Asian businesses, looking to invest a portion of the significant amounts of capital
that had been drawn to PE in Asia during this period.
“This was the age of the frustrated Pan-Asian fund,” says Tim Sims of Pacific Equity Partners. “Large
amounts of money were flowing into Asia, but the Asian deal markets were proving to be more granular
and less developed than the perhaps optimistic international investors had hoped. There was a large
volume of investment funds in Hong Kong, there was some activity in Korea, there were early growth
capital businesses in China and other places, but the really hard-core LBO activity that the international
players were looking for didn’t really present itself in Asia. The result was you saw increasingly large
efforts being made by offshore PE in Australia.”
With interest from offshore investors, high profile PE houses setting up shop, and local and international
banks offering significant leverage, the foundations of Australia’s PE boom were in place.
The boom and beyond
In 2006 a number of significant deals were consummated, indicating that Australian PE was following
the rest of the world. Global capital flocked to take advantage of the country’s transparent and wellregulated markets, a perception of undervalued equity markets, and opportunities for significant
strategic transformation and value realisation.
Not only did the number and size of deals accelerate, PE was becoming the owner of some of the
country’s highest profile companies and brands. In February 2006, TPG bought Myer, one of the
country’s two major department store chains for $1.4 billion. In June, KKR bought Cleanaway and
Brambles Industrial Services from Brambles for $1.83 billion. When the country’s media ownership
laws changed in October 2006, PE quickly partnered with Australia’s largest media owners. KKR
bought a 50% stake of the Seven Network from the Stokes family, and CVC Asia Pacific purchased
half of PBL Media, which included the Nine Network and other media assets. Each deal totalled over
$2 billion.
In addition to the high profile brand names, PE funds were also involved in a number of important
health and pharmaceutical deals. CVC Asia Pacific and Ironbridge bought Affinity Health from Mayne
for $813 million. Public to private deal DCA Group by CVC Asia Pacific for $2.7 billion, and Archer
and Ironbridge purchase of iNova for $450m. Proving that the business expertise of PE ownership can
apply to a breadth of specialised industries.
Value Capital
The excitement these deals created generated a powerful buzz around the investment community,
and provided a real stimulant to asset prices – both public and private companies were trading at
significantly increased earnings multiples than they had been just 12 months earlier. With large pools
of PE capital backed up by affordable and accessible leverage finance, PE could afford to pay good
prices. But as 2006 turned into 2007 there were signs that these prices were finding their limits.
25
THE EVOLUTION OF THE AUSTRALIAN VC & PE INDUSTRY
Figure 15: PE Investee companies
Number of companies and value of investment ($m) at financial year-end, FY00 – FY08
Source: Australian Bureau of Statistics
600
6,000
500
5,000
400
4,000
300
3,000
200
2,000
100
1,000
Number of deals
Investment ($m) in PE
Number of deals
Investment ($m)
0
0
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
Early 2007 saw a number of high profile public-to-private deals in which PE made offers that were
spurned by boards of directors and shareholders. These deals included Flight Centre, Orica, Coles,
APN News & Media and Qantas. “Even before the credit crunch slowed international leveraged buyout
activity, mega-deals in Australia found themselves struggling against the strength of the Australian
equities market,” wrote the Economist Intelligence Unit in a report published in March 2008.9
In August 2007 the global sub-prime led credit crunch hit, and with it a notable deceleration in the
number and size of PE offers hitting the boardrooms of Australia’s companies (see Figure 16).
Figure 16: PE new and follow-on investments ($m vs number of deals)
Source: Australian Bureau of Statistics
$m
140
2,500
Investments in new deals – PE ($m)
Follow-on investment – PE ($m)
Investments in new deals – PE (no.)
120
2,000
Follow-on investment – PE (no.)
Number of deals
100
1,500
80
60
1,000
40
500
20
0
0
FY07
FY08
Value Capital
FY06
26
9
“Private equity moves in: the impact on business in Australia” Economist Intelligence Unit, 2008.
MINING CAPITAL
PE is a global industry, as is mining. Australia is a centre of mining excellence,
and as such it is in the early stages of developing its own PE eco-system for investment in the global
mining industry. It is small, but Australia’s growing mining equity industry leads the world.
Traditionally, early stage mining firms are listed on the stock exchange, raising
modest capital sums of $3 – $5 million to fund claim development and drilling. There are some 400
junior mining firms on the ASX, many of which will fail in the process of proving their claims.
Specialist PE companies are an alternative form of funding for companies at
this stage of their development. Companies such as Pacific Road Capital Management, based in Sydney,
Resource Capital Funds in Perth, and the Sentient Group provide development capital to mining
ventures across the globe. These three groups specialise in early stage exploration and development,
seeking exits once projects become cash flow positive.
Value Capital
“Traditional PE is very comfortable in the mining services area,” says Louis
Rozman, a director of Pacific Road Capital. “But the difficulty for people not familiar with the early
stage development character of this business is how to manage the risks. We’ve been in mining all
our working lives and understand how the models work. The industry needs people who can run
businesses in a different way, and PE provides a different form of capital to the public markets that
brings its own benefits.”
27
THE EVOLUTION OF THE AUSTRALIAN VC & PE INDUSTRY
Outlook
PE, like all industries, suffers during a downturn in the economic cycle. But the industry has a
fundamentally strong and sustainable business model. Australian PE has historically been amongst
the best performing in the world. There is no reason why that is likely to change in the future.
In the current economic environment Australian PE, in common with its competitors around the world,
faces significant challenges. The global financial crisis has severely restricted credit for most economic
activity. Economic commentators expect the amount of leverage available across the globe to contract
at least tenfold from 2007 levels. Still, it is likely that loans will be available for those deals where value
capital will add significantly to the prospects of a business through its strategic business focus and
innovative management capability.
Over the last few years, the Australian superannuation industry has been investing significantly in
alternative assets including PE. But the market dislocation has reduced the absolute value of investment
pools, as well as the risk appetite of a generally conservative investor base. Raising fresh funds will be
challenging for the foreseeable future. Australian PE firms raised $11 billion in fiscal 2007. By fiscal 2008
that number had fallen to $6 billion (see Figure 14).
Investment funds are likely to restrict allocation to PE, but the industry will continue to attract capital
from other sources including sovereign wealth funds and high net worth individuals.
PE funds currently have around $6.5 billion of unused commitments available for investment in
Australian businesses over the next two to three years (see Figure 7). This is likely to be an attractive source
of capital for liquidity-constrained corporates as they look for investment partners in coming years.
With the consumer and industrial markets suffering in the downturn, PE is likely to consider new
opportunities for investment. Areas such as property – delisted property trusts, for instance – as well as
distressed assets that require competent management attention. But at the same time, PE will scrutinise
its investment opportunities closely.
Indeed the current market conditions provide an opportunity for Australian PE firms to invest in and
consolidate their existing portfolios, to ensure that when conditions improve their companies will
maximise exit values.
Value Capital
Australian PE practitioners remain optimistic. In relative terms Australia remains a healthy market for
private investing. It is stable and well regulated. Its capital markets are sophisticated and, even amidst
significant turmoil, relatively deep. It presents a pool of well-developed businesses, many looking for
succession strategies. Its proximity to the relative strength of the developing markets of Asia puts the
country in a prime position to prosper from one of the world’s most dynamic set of economies.
Short-term complications aside, many in the industry are excited about the future and look forward
to the progress the next decade will undoubtedly bring.
28
WHAT ARE VENTURE CAPITAL
AND PRIVATE EQUITY?
Value Capital
APPENDIX:
29
WHAT ARE VC & PE?
What are Venture Capital and Private Equity?
VC and PE are two of many different ways for investment capital to find profitable ways to be employed.
Like other forms of investment management, it has advantages and disadvantages, and is appropriate for
some companies, investors and investment managers, but not for others.
In its broadest sense, PE is equity investment in a business not quoted on a public exchange. All private
companies have equity investors, including family companies and other small businesses. The term PE
more often refers to the practice of investing in an unlisted company with the aim of improving the
business over a period of years, and selling it for an optimal price.
The difference between VC and PE
PE firms come in all shapes and sizes, and invest in businesses at all stages of their development – from
pre-seed capital technologies seeking research and development funds to the outright purchase of
publicly-listed companies.
Firms that invest in early stage companies are known as venture capitalists, while expansion and later
stage buyout companies are termed private equity.
Stages of VC and PE
VENTURE CAPITAL
Seed
Early Stage
PRIVATE EQUITY
Expansion
Buyouts
The VC and PE lifecycle
VC and PE capital flow and activity follow a cycle. Each stage of the cycle is described in more
detail below:
VENTURE CAPITAL
STAGE 1
STAGE 2
STAGE 3
STAGE 4
STAGE 5
Fund raise
Identify and
develop
new technology
Commercialise
and build sales
Realise capital
Remit return to
investors
STAGE 1
STAGE 2
STAGE 3
STAGE 4
STAGE 5
Fund raise
Invest
Improve the
investee
Realise capital
Remit return to
investors
Value Capital
PRIVATE EQUITY
30
WHAT ARE VC & PE?
Fund raise
The standard VC or PE firm is structured as an investment fund. The managers of the fund are known
as General Partners (GPs) – they are responsible for the fund’s legal debts and obligations. Investors in
the fund are known as Limited Partners (LPs), because their liability is limited to the amount of their
investment. LPs are usually sophisticated investors – superannuation funds, for instance, will often have
a manager dedicated to investing in PE. Other investors include insurance companies, banks, university
endowments and high net worth individuals who understand the commitments they are taking on.
More recently, sovereign wealth funds have also invested capital in PE.
Figure 17: Source of funds FY08
Source: Australian Bureau of Statistics
81
2,0
Non-residents
1 1%
Pension funds
6
Authorised deposit-taking institutions
Trading enterprises
Governments in Australia
Life insurance offices
5%
850
2%
36
0
4%
70
12%
1,89
1
Trusts
7%
4%
577
1,249
Other residents
%
55
9 ,4
20
VC and PE funds are generally limited in their lifespan. A particular fund, for instance, will state that
its objective is to have all its capital invested investments exited, with all its funds returned to investors
within 10 to 12 years from the date of fundraising.
Identify and develop new technology
In VC, the amounts invested are predominantly at the seed and early expansion stages. In the seed stage,
the business concept exists with R&D being carried out but commercial operations are not yet fully
established.
Value Capital
A major aspect of the venture investment life cycle is identifying the beginning of an industry, or unique
technology, that probably has few competitors, high IP protectability, that cannot be replicated easily and
has the potential to be commercialised on a sufficiently lucrative scale. Investment at this stage addresses
the gap between promising R&D and commercialisation. VC funding therefore provides the funding
needed to support the fledgling business during this vital gestation period.
31
WHAT ARE VC & PE?
Investment opportunities actively sought by VCs predominantly relate to new intellectual property in
areas such as IT, life sciences and cleantech that can be commercialised to meet a global need.
As these are higher risk investments, VCs manage their risk by only investing in businesses after having
completed extensive due diligence. Given the highly technical nature of the market for new innovations,
VC professionals also tend to hold specialist qualifications and experience in the high-technology
sectors they invest in.
Commercialise and build sales
At this stage, the business is product-ready and may have registered some initial sales. This is a capitalintensive period for businesses where revenues may exist but with minimal profits, with capital injected
to help the business grow. Much of this capital is usually directed towards product development and
initial marketing, manufacturing and sales.
It is also at this stage that the business’ management team particularly benefits from the VC’s management
expertise, networks and mentoring, which helps to build up the entrepreneurial skills of researchers and
build links with the finance and business community.
Investments
In PE, the managers of the fund will identify companies that they believe to be promising, determine
what they believe a company is worth in its current form, and how they believe they may be able to add
value if they were successful in buying it. They will do detailed due diligence to determine the strengths
and weaknesses of the business.
PE will finance its purchase of companies with a combination of equity – money provided to the fund
by the limited partners – and debt – loans from banks and other financial organisations. The proportion
of debt to equity will be determined by the price and availability of debt. In a normal market, a typical
buyout of a mature company would use perhaps 50% equity and 50% debt (in 2009 we would expect
to see much higher proportions of equity due to a lack of readily available credit), but this will be
determined very much by the nature of the company in question – its maturity, cash flow strength, the
amount of investment it will need, and its general ability to service loans. As early stage firms are often
not yet revenue positive, they do not have sufficient cash flow to service debt.
Later stage PE uses debt for two reasons. First, by using debt rather than capital from the fund, they
can make more investments from the fund as a whole. Secondly, using debt can increase the returns
to the equity used in each transaction, and investors can make a greater return on their funds. When
interest rates are low, and debt is a relatively cheap form of financing, PE is able to finance more purchases
or pay relatively higher prices for the companies that they buy. Lower interest rates mean that companies
are more easily able to service their debts.
Value Capital
Fund managers receive a management fee based on the size of the fund and also receive a share in the
capital gains delivered to the fund’s investors. The management fee is usually calculated as a percentage
of the funds originally invested in the fund. The percentage is negotiated between the investors and the
manager at the time the funds are raised. An indicative figure is 2 to 2.5% p.a. for smaller VC funds and
1 to 2% for larger PE funds. This figure covers the overheads of the business including salaries and the
costs of conducting due diligence on investments.
32
WHAT ARE VC & PE?
Improving the investee
There are many ways to add value to a company – PE may be able to provide investment capital, knowhow, contacts, management competence and strategic insight. PE’s greatest successes are achieved with
companies that are not getting enough management attention, strategic direction or investment capital.
If a PE firm is successful in buying a company, it will usually put one or more directors on the board
and become actively involved in the management of the company and its strategic progress.
According to a 2008 study of 13 Australian PE exits, the greatest gains in enterprise value were achieved
by proactively growing the core business, with the smallest gains coming from financial engineering
and investing in growth sectors or opportunities.
Figure 18: Primary investment rationale in Australia
Source: Ernst & Young study 2008 “How do private equity investors create value?”
EV
Compound Annual
Growth Rate
%
% of total deals by investment rationale
100
Buy and build
25%
76.4%
60
Accelerate growth from the core business
Invest in growth sector/opportunity
80
33%
92.2%
42%
8.4%
40
20
0
Proportion of Deals
Realising value – the exit process
There are four main paths that PE investors can choose to realise value from an investment: sale to
a strategic buyer (such as a publicly listed company or another firm with presence in the company’s
market), sale to another PE investor (known as a secondary buyout), initial public offering (flotation
on the public markets) or a share buyback (under which an existing shareholder will buyout the PE
firms stake in the company). Part or all of the PE fund’s investment may be realised.
Value Capital
As shown in Figure 19, in recent years the vast majority of exits have been realised through sales to
strategic buyers or through public floats.
33
WHAT ARE VC & PE?
Figure 19: Exits and other decreases during the year ($m)
Source: Australian Bureau of Statistics
$m
1,200
Other (includes secondary buyouts)
1,000
Write-offs
Buybacks
800
Initial public offers
600
Trade sales
400
200
0
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
Capital returns to investors
Figure 20: PE and VC returns – periods to end June 2008
Source: Thomson Financial, Standard & Poors
STAGE
1 YEAR
(IRR P.A)
3 YEAR
(IRR P.A)
5 YEAR
(IRR P.A)
Australia Private Equity
0.8
8.1
14.2
Australia Private Equity and Venture Capital
0.6
7.3
12.4
S&P/ASX 300 (price index)
-17.1
7.1
11.4
S&P/ASX 300 (accumulation index)
-13.7
11.4
16.2
Fees
The manager’s share of capital gains is around 20% in most funds globally and is calculated after all
fees and expenses paid by the fund have been returned to the investors. The VC and PE manager only
receives a share in capital gains if the fund has delivered a minimum return known as the ‘preferred
return’. If the capital gains do not exceed the preferred return then the manager receives no share in
capital gains. The preferred return is usually similar to the long-term bond rate.
Value Capital
The bottom line is that if VC and PE funds do not perform by adding value to the companies they buy,
they will not earn performance fees. The interests of the managers of the fund are aligned with those
of the management of the investee companies. It is the unique structure of the industry that provides it
with its powerful value creation incentives and makes it such a valuable part of the Australian economy.
34
HOW DOES PRIVATE EQUITY
ADD VALUE?
Because improving company value is at the core of their business, PE funds
ensure that the investments they make have the following characteristics:
Alignment of interest
The foundation of PE’s ability to add value is the alignment of interest between owners and management.
Each has a genuine stake in the business and is firmly focused on increasing its value. Often in a buyout,
senior management will participate in the equity structure of the company, giving it a huge incentive
to act in the interests of all shareholders. “We were encouraged to act as if we owned the company,” says
Brian Hodges, CEO of Bradken, talking about the value PE firm CHAMP brought to the company.
Long-term focus
Because PE invests over a term of three to five years, it is not focussed on short-term results at the
expense of long-term success. PE-backed companies are able to invest in new products, new businesses
and new employees without being overly concerned about short-term profitability. The public company
sector, on the other hand, is under constant pressure to provide ever increasing short-term profitability
gains. 28% of ASX investors divest their shares within 12 months, and 51% between two to five years.10
Only a fifth of investors potentially hold their stocks for a longer period than PE firms. Many firms taken
into private ownership benefit from having a “time out” from the publicity circus of public ownership.
Private ownership can give management a breather in which to make investments or take risks that the
public markets might respond unfavourably.
Detailed due diligence
Prior to investing in a business, a PE manager conducts thorough analysis to gain a detailed insight into
the strengths and weaknesses of the business, its growth potential and the prerequisites for achieving
this growth. This level of due diligence provides the foundation for a detailed strategy for the company’s
future. PE will not proceed unless it has a clear idea of how it can add value to the business.
Flexibility to plan for growth
The insight from due diligence allows the PE fund, as new owners of the business, to develop with
management a comprehensive and coherent long-term plan to increase the value of the business.
This plan will typically:
– Stress the importance of sales growth as well as cost efficiency;
– Emphasise cash as much as earnings;
– Focus on a small number of essential performance metrics;
– Include a training and development program for employees; and
– Include a capital expenditure program to ensure that the business has the plant and equipment
necessary to meet its growth targets.
Performance metrics and progress against targets are monitored closely so that any remedial measures
can be implemented promptly. Decisions are made swiftly without the bureaucracy and complexity of
public company management. Plans and strategies are constantly reassessed to address changing market
conditions. Importantly, PE adds value to businesses by facilitating the introduction of lower-cost
capital structure, operational change, manager incentives and exit (investment realisation) options
necessary to take the company forward.11 A study commissioned by AVCAL in 2006 found that the main
reasons for seeking PE investment were the expert advice and guidance that accompanies it, and greater
flexibility relating to the funding structures available and the relative simplicity of the process, compared
to raising PE.12
Value Capital
Active stewardship and
clear performance targets
10
11
12
ASX Australian Share Ownership Study, 2006.
Blundell-Wignall, The Private Equity Boom: Causes and Policy Issues, OECD Report, 2007.
PriceWaterhouseCoopers/AVCAL, Economic Impact of Private Equity and Venture Capital in Australia, 2006.
35
ACKNOWLEDGEMENTS
AVCAL would like to acknowledge and thank the following people
for their time and assistance in developing this publication:
Geoff Brooke
Roger Buckeridge
John Dyson
Bill Ferris
Chris Golis
Mike Hirshorn
Julian Knights
Kon Mellos
Andrew Rothery
Louis Rozman
Tim Sims
Greg Smith
Judith Smith
Peter Wiggs
Christopher Witt
Bryan Zekulich
THE AUSTRALIAN BUREAU OF STATISTICS (ABS)
The ABS is Australia’s official national statistical agency and
provides statistics on a wide range of economic, social and
environmental matters, covering government, business and
the community. It also has an important coordination function
with respect to the statistical activities of other official bodies,
both in Australia and overseas.
About the Australian Bureau of Statistics research
Australian Bureau of Statistics (ABS) undertook the first survey of
Australian VC and PE firms in FY1999 and has since undertaken
this survey annually at the request of, and with the financial support
of, the Department of Innovation, Industry, Science and Research.
The ABS sourced graphs contained in this report have been
created to demonstrate trends of the industry between the period
of FY2000 and FY2008.
As the Australian VC and PE industry has grown and evolved
over time, so too have the definitions and classifications of VC and
PE. In FY2006 the ABS changed its classifications of the different
investment stages of VC and PE, to more clearly distinguish
between different stages of investment. Prior to that the stages
were classified as seed, early, expansion, turnaround, late and LBO/
MBO/MBI stages. From FY2006 the stages were classified as preseed, seed, start-up, early expansion, late expansion, turnaround
and LBO/MBO/MBO stages.
References to VC and PE investee companies in Figures 9 and
15 refer to investee companies which were, at the time of survey
submission, in the pre-seed to early expansion stages (classified
in Figure 9 as VC), and in the late expansion to LBO/MBO/MBO
stages (classified in Figure 15 as PE).
Value Capital
References to VC and PE new and follow-on investments in
Figures 12 and 16 refer to investments by funds whose preferred
stages of investment were in the pre-seed to early expansion stages
(classified in these figures as VC), and by funds whose preferred
stages of investment were in the late expansion to LBO/MBO/
MBO stages (classified in these figures as PE).
36
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Value Capital
THE EVOLUTION OF VENTURE CAPITAL
AND PRIVATE EQUITY IN AUSTRALIA
Level 41, Gateway Building
1 Macquarie Place
Sydney NSW 2000
Tel + 61 2 8243 7000
Fax + 61 2 9251 3808
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