Why aren’t VC funds taking as many risks on startups?

Posted: 25 March 2019 12:49 pm
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Follow[the]Seed weighs in on the decline in growth rates of new investments made by VC funds across Australia.

Venture capital funds that don't fail with most of their investments aren't taking enough risk, says a founding partner of venture capital (VC) fund Follow[the]Seed Andrey Shirben. The VC fund was identified in a recent report into Early Stage Venture Capital Limited Partnerships (ESVCLP) as the most active fund in Australia having made 13 new investments in the 2018 financial year. The fund has made 19 startup investments in total.

The report, produced by The Department of Industry, Innovation and Science, found that there is a decline in growth rates by 5.5x of new investments made by VC funds across Australia. The four most active fund managers – Follow[the]Seed, AirTree Ventures, RightClick Capital and BlackBird Ventures – made 32% of total new investments in the 2018 financial year. The large majority of VC funds (73%) invested in fewer than five startups or did not invest in any startups at all while 20% invested in between 6 and 10 startups.

Shirben believes the declining growth rate in startup investment from VC funds is to do with risk aversion.

"There are only a handful of funds in Australia that are walking the walk," he said. "When a fund doesn't make any investments or makes very few of them, it means it either doesn't have sufficient funds or that it is not willing to take the risk, which defeats the purpose of starting an ESVCLP, to begin with."

The ESVCLP is a program which was established to stimulate investment in early stage companies. It offers tax benefits to fund managers and investors while also connecting investors with early stage businesses.

"I think the ESVCLP is a great program that helps shake some of the risk element off and encourage a shift in this paradigm," said Shirben. "But if you're there just for the tax benefits, you are not helping the innovation ecosystem at all. I sometimes feel like some people don't really understand what the "V" stands for, in the "VC" and focus only on the 'C'."

According to Startup Muster's 2018 report, 49.2% of startups listed themselves as currently trying to raise funds but 31.9% said they had raised $0. Seed investment came in third as what startups need most in the next 6 months, with 36.6% of startups listing this as a need. A further 28.8% said a round investment was needed in the next 6 months. The majority of startups surveyed (38.1%) only had a financial runway of between six and nine months.

The ESVCLP report identified $223.1 million capital invested for the 2018 financial year, the highest so far. However, Shirben believes more could be done to help the ecosystem.

"It's a risky business," Shirben said. "And the way I see it, if you don't fail with most of your investments, you simply didn't take enough risk."

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