How Much is Enough?

Earlier this week I wrote that the Australian venture capital industry is still undersized. Australian venture capital funds have raised around $900m in the last two years, with some more to come. But when you take into account capital already invested and overseas allocations, dry powder directed at Aussie startups is much lower at around $440m. I think this is still low compared to the market opportunity.

A bunch of people asked the obvious next question — how much is enough? There’s no right answer to this. My gut feel is that we could happily double and perhaps triple the amount of dry powder in the ecosystem and still generate the types of returns we’re hoping for from venture capital.

This comes from our own experience in the market. Examining the opportunity from a bottom up analysis, we invested in 20 companies from our first Blackbird fund. These companies have in the last 4 years raised over A$700m — significantly more than the total dry powder in the current Australian venture system. Blackbird invested just 15% of this from our funds including from our more recent Follow-on Fund. The rest was funded largely from offshore sources.

Had we had more capital, I’m confident we could have invested at least double the amount of capital into these companies and perhaps more. This would still have allowed plenty of room for other Aussie VCs and those from overseas.

@JohnHenderson rightly suggested that we should think about how much capital needs to be returned to create good returns for the asset class and work backward from there.

So looking at the opportunity from a top down perspective, let’s take the midpoint of my 2–3x current dry powder, a round $1b. Assume the following return profile for the venture industry, which is the reality of venture around the world:

• Top quartile of funds make 3x capital on average (the few should do much better than this)
• Second quartile makes 1.5x
• Third and fourth quartile on average makes your money back and of course some will lose your money

Assuming a 15% shareholding at time of exit, we need to see about $10b of market capitalisation from companies formed every three years to create the returns from the industry quartiles listed above.

How would you get to this figure? My rough maths tells me that to make this happen we’d need one Atlassian, three Aconex-es and five Freelancers to be formed over the whole Australian startup industry in a three year investment cycle. This feels OK to me, especially as the ecosystem continues to mature. Of course Atlassian is the power outlier, contributing most of that value. Throughout the history of venture, it’s the outliers that make it all worthwhile. You’ve got to believe in them to believe in the asset class.

So what?

This just goes back to my point that there is plenty of scope for the Australian venture industry to continue to double and maybe triple in a sustainable fashion. We’ve had a really good start, but we’ve still got a lot of growing to go.