Finding a smart use for 'dumb money'

On November 4, Australians will wager up to $1 billion on which of two dozen horses will complete a 2,300 metre course the fastest. As speculative investments go, the Melbourne Cup is at the extreme end of the risk curve, albeit with an entry cost that is easily affordable for many Australians. 

By comparison, Australian venture capital firms invested only $111m for the 2013 financial year, according to Australian Venture Capital and Private Equity Limited. So could Australia's love of a punt prove to be the saviour of the technology start-up sector?

A host of new equity crowdfunding services have commenced operating in Australia, each punting that Australian's appetite for risk will extend to backing our best and brightest start-up entrepreneurs.

Equity crowdfunding lets investors back unlisted early-stage companies with high growth potential. Investments can start from as little as $1,000, with the money pooled into a trust which is invested in return for equity.

This differs from reward-based crowdfunding services, such as KickStarter, Indiegogo and Pozible, where backers pre-purchase goods and services to effectively offset their development cost.

However, current Australian regulation restricts equity crowdfunding to sophisticated investors with gross income of $250,000 or more for the two previous years or who have net assets of at least $2.5m. It is estimated there are more than 200,000 sophisticated investors in Australia.

But this limitation was barely a stumbling block for the three-year-old taxi payment service ingogo, which recently raised $1.2m through VentureCrowd, an offshoot of Artesian Capital Management, as part of a $9.1m fundraising round.

Ingogo founder Hamish Petrie says he was "blown away" by the response.

“They literally raised the $1.2m in about three days,” Petrie says.

Petrie says it is important that start-ups consider every funding source that is out there, with ingogo also counting Artesian Ventures, UBS, and the Sydney Angel Sidecar Fund amongst its backers. While these add credibility, he says crowdfunding reaches a much wider group of investors.

“It's not humanly possible to have that number of one-on-one meetings with people and run your business at the same time,” Petrie says.

Artesian Venture Partners' chief operating officer Tim Heasley describes VentureCrowd as democratising access to early stage ventures.

“Traditional VC has been quite exclusive -- it has been something that has been the preserve of the rich and the very well connected,” he says.

Heasley says VentureCrowd is working to quickly bring more investment opportunities onto its platform, having forged alliances with incubators and groups such as Sydney Angels to provide qualified deal-flow. He says access to large numbers of ventures is essential to ensure good returns.

“Start-ups have a shocking attrition rate,” Heasley says. “50 per cent of them will fail, and you'll generate 90 percent of your cash returns from 10 percent across a diversified portfolio.”

The Israeli crowdfunding service OurCrowd has also launched in Australia, with US$10m from its total US$70m raised coming from sophisticated Australian investors.

Managing director Dan Bennett says OurCrowd provides a platform for Australians to invest in global venture capital from as little as $10,000. He says one of its investments, in the recently-listed exoskeleton suit maker ReWalk, delivered a ten-fold return for investors. Bennett says crowdfunding has advantages over VC funds as investors can choose to only invest in the deals they like. He says OurCrowd assesses up to 250 deals each month and directly invests between 5 and 10 per cent of the funds in each raising.

“So if it is not good enough for us then it is not good enough for our investors,” Bennett says.

While the limited Australian investment pool has not deterred OurCrowd and VentureCrowd, another would-be Australian crowdfunder, Equitise, has chosen to initially launch in New Zealand to take advantage of recent legislative changes that allows companies to raise up to $2m from the public in 12 months. Co-founder Chris Gilbert says Equitise has applied for a New Zealand licence, but is also working with Canberra legislators to see similar changes introduced in Australia.

“We've been very busy in New Zealand building a model which can actually operate commercially,” Gilbert says. “We think they (NZ) have done a very good job in putting the onus back on the intermediary to obviate the marketplace.”

Crowdfunding is not the only way of raising funds from the public. The Australian Small-Scale Offering Board enables companies to raise up to $2m from the public over 12 months, but from only 20 investors in each raising. Altogether it has raised $140m for 300 companies.

Australians can also contribute to projects through KickStarter, Indiegogo and the local crowdfunding service Pozible, which has raised $23m across more than 7,000 projects.

While that service has traditionally funded Australian-based creative projects such as books and albums, co-founder Rick Chen says Pozible is now taking on China with the opening of offices in Shanghai and Shenzhen.

“That market is a lot bigger than Australia, and we are focusing on hardware, which is a huge market,” Chen says. “We are positioning ourselves as the Asia-Pac platform. The Western platforms can't get in to China, and the local platforms have no knowledge of anyone outside of China.” 

The emergence of crowdfunding has been greeted with enthusiasm by Australian start-ups and investors, including the managing director of venture fund Blackbird Ventures, Niki Scevak. 

“Investors get the benefit of being able to access an investment they not normally would have been able to invest in, and can do so at a small enough amount that enables them to build a portfolio of investments over time,” says Scevak. He says the concept also allows angel investors to build scale in their portfolio quickly to help spread their risk.

The founder and president of Melbourne Angels Jordan Green is more cautious, saying, for the most part, crowdfunding delivers ‘dumb money', with investors paying fees but having no say in the management of the companies they invest in.

“Essentially it is like a very expensive version of the ASX, without the regulatory checks and balances,” Green says.

“For start-ups, I think there is a long way to go before there is a reliable and valuable model for funding a large volume of truly early-stage ventures. Favourable tax incentives and some certainty around light touch regulation will both be required to really drive success in this space.”

For Petrie, having quickly raised $1.2m, he sees potential for businesses like his to eventually raise complete funding rounds through crowdfunding. 

“Think about how many people go and punt money on sporting events,” Petrie says. “Instead, they could be putting money on great entrepreneurs that are going to build great businesses.

“That's really exciting for helping Australia develop new businesses.”