Yet another well-meaning government initiative is going to have negative side effects for the Aussie startup and venture capital community. I want to make sure the right people in the government know about it and to do that I need your help.
In July of this year superannuation funds will need to start disclosing all of their investments down to the root company level. The new law, passed by the previous government, is an attempt to make super more transparent to fund members.
This is a good thing, which I fully support, however it is one of those well intended regulations which may work for the broader market, but will have negative side effects on the Australian startup and venture capital community.
Under this new law, superannuation funds will have to disclose (on a public website) every asset and ‘final’ investment on a look through basis. This means that if a super fund invests in an Australian venture capital fund, they must disclose each company in which the venture capital fund invests. That’s probably not a big deal. The issue is that they must also disclose the value at which they hold each of these investments.
So as an Australian startup, if you take (or have already taken) capital from an Australian venture capital fund which is backed by super funds, the value at which they hold their investment in your company will be on a public website. I predict this disclosure data will soon become a key source of information on the health of venture-backed startup companies.
So what, you say? Well imagine your startup is working flat out to land an enterprise customer that will make your whole year’s plan. But one of your investors has written down their investment and your customer sees this? Think you’ll get the sale? Ditto if you’re trying to attract great employees, advisors or investors.
What if you’re in acquisition talks with Google and they are able to see the history of your investors’ valuations to craft their offer?
My point is that at these and many other times in a startup’s life, your investors’ valuation is not the best indicator of your success, or you are at a disadvantage if it’s made public.
Remember that you have no control over the valuation that a super fund puts on their investment. They are subject to a number of regulations and codes of practice. In some cases a change in valuation may be only because of a currency fluctuation. However, when these regulations come into force this valuation will be one of the first indicators people look at to judge your business.
The disclosure requirements are also an issue for the venture capital community. They mean the best Aussie startups will probably not want to take capital from an Australian venture capital fund that is backed by Australian super, or at least they will prefer to take capital from offshore sources that don’t have this obligation.
This will shut out Australian venture capital funds, and our superannuation pool from many of the best startups in Australia. This is an obstacle we don’t need, at a time when we’re trying to rebuild the Australian venture capital industry to fill a big gap in the funding base for Australian startups. It will also shut off our Australian super funds from most of the best venture funds globally – something that is not good for super fund members.
I fully support more transparency for the superannuation industry, but a blanket rule will cause unintended side effects for our venture capital and startup sector. A simple solution would be to make an exception based on materiality (a typical venture investment would be less than 0.05% of a typical superannuation fund’s assets) and/or confidentiality for venture capital investments.
This would not take away from the goal of the regulations. In fact I would argue that by eliminating the long tail of tiny investments we are making disclosure more useful to superannuation fund members.
It’s quite late in the process, but I believe the current government may be reviewing this right now, before it comes into force in July. My sources tell me that they may make some changes to the original requirements, including some exceptions to the blanket disclosure rule, but that the decision could go either way.
We know the government is supportive of the startup community, but it would be great to reinforce this by writing a short email to the Minister for Finance, Mathias Cormann, email@example.com and the Minister for Industry, Ian Macfarlane, Ian.Macfarlane.MP@aph.gov.au to let them know how about the unintended side effect of these regulations (and if you happen to be in the government team that’s working on this, I would love the opportunity to talk directly, you can get me at firstname.lastname@example.org).
By the way, Blackbird Ventures does not have any superannuation funds as investors, but we hope to someday.
I’ve set out the situation in detail below, for those with more time to read:
A little background: New regulation comes at just the wrong time
Firstly a little background for those of you who are not involved day-to-day in Aussie startups. I want you to know about the momentum which is building in the Australian tech startup space. I wrote a blog about this last year which explains what’s driving this, and why we should all be excited. As a community we are building something brick-by-brick which in 10-20 years could be a powerhouse of our economy.
There remains one big gap in the startup ecosystem here, and that’s a lack of local capital. The main reason for this is that the Australian superannuation funds are not investing any money into local venture capital. This is because the local venture capital industry has, on the whole, not delivered satisfactory returns.
However, the Aussie venture community is rebuilding itself. There are a bunch of new funds such as Blackbird Ventures (which I co-founded) and Square Peg Capital, new seed stage funds such as TankStream Ventures and those backed by Artesian Capital, a whole bunch of angel syndicates, incubators and accelerators, and some of the existing players are re-grouping. We have a real opportunity to build a fresh new start for Australian venture capital.
It’s the common goal of all of these people to earn back the trust of the superannuation funds over the next five-10 years. This is a really important long-term goal as venture capital is the only conduit for our national superannuation savings to trickle down into our technology sector.
New superannuation disclosure regulations and side effects
As part of the review of superannuation, the previous government enacted a new law to require all registered superannuation funds to publicly disclose all of their investments.
Sounds like a good idea, right, and I am all for more transparency. At Blackbird, we’re going to be transparent about everything so long as it doesn’t harm our portfolio companies and founders. But blanket-enforced disclosure is a problem.
Super funds will soon have to disclose (on a public website) every asset and ‘final’ investment on a look through basis. This means that if a super fund invests in an Australian venture capital fund, they must disclose each company in which the venture capital fund invests. That’s probably not a big deal. The real killer is that they must also disclose the value at which they hold each investment.
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This means that if, as a startup founder, you take capital from a venture capital fund that has an Australian superannuation fund as an investor, their investment and their valuation of that investment in your company will be open for the world to see.
You might think this is a storm in a tea cup. Who will really look at these disclosure websites anyway? Lots of people. In the private equity industry they already do it with the data from the US public pension funds (which only have to disclose to the fund level – a far more realistic requirement).
As soon as these websites pop up, people will start screen shotting them to build a store of data on companies, especially unlisted private companies and startups. I predict that this data source will become a standard way of judging the health of a startup for prospective investors, acquirers, customers and employees.
This can have some very real side effects for your business. Remember that you have no control over how your venture investor or super fund values your company on their own books. They have valuation policies that are set and enforced by other regulations and codes of conduct and are subject to the opinions of their auditors. In some cases the revaluation may be solely due to currency movements as super funds often hold venture investments denominated in other currencies which flow back into Australia.
Imagine any of the following:
- You are trying to raise a new funding round at a reasonable valuation, but your venture capital investors or indirect superannuation fund investors have for some external reason decided to write down the value of their investment in your company. It’s going to be hard to raise that next round if this data is a starting point for every investor (US and Australia) to judge your company.
- Ditto when you are trying to sell the company.
- Your company is really starting to grow and you have a chance to raise a big funding round from an amazing Silicon Valley-based VC firm, but they decide not to do it because one of your existing Aussie indirect investors needs to disclose the progress of your company.
- Imagine you’re a struggling enterprise software business, working hard to close that sale with a large corporate, but it’s taking a bit longer, and money is tight (anyone been in this situation?). That may well trigger a write down by your investors. Normally this wouldn’t matter – who cares how they value your company right now if you just can close that sale. But in this case, your potential customer is looking at the superannuation disclosure data, and seeing that you’ve just been subject to a write down in value. Think you’ll close that sale?
- Ditto when you’re trying to build a team, attract that stellar a board member, or generally build the profile of your business.
- It also works against you on the upside. When everything works out spectacularly for you, do you want everyone being able to calculate what the company sold for? Does the buyer want this disclosed? Could it be a reason someone doesn’t end up buying you, or isn’t willing to pay such a high price?
At these and many other times in a startup’s life, your investors’ valuation is not the best indicator of success and should not be public. But under these new laws it will probably be one of the first things people look up about your company. At other times, it puts you at a disadvantage if your investors’ valuations are made public.
So as a founder of the next big global tech company, do you want to take money from an Aussie venture capital fund that has Australian superannuation investors? More importantly if you had a choice between an offshore venture capital fund (without these obligations) and an Aussie one, which would you pick? If you are lucky enough to be a hot tech company and you’re pulling together a stellar investor syndicate for one of your rounds, do you want to let that Aussie venture fund in for a slice? My guess is probably not.
So the logical conclusion of this is that Aussie venture capital funds that are funded by Aussie super funds will be shut out of many of the best Australian investments. This in turn means that we’re stuck where we are now … with almost no superannuation funding getting into Aussie startups. And US pension funds reaping the rewards of Australian innovation, as they have done for years.
Another logical conclusion of the disclosure requirement is that the Aussie superannuation industry is effectively shut out from the best investments in the global venture capital (and part of the private equity) asset classes. I know from my friends in the industry that this is already happening.1
A simple solution
Firstly, let me emphasise that I think the concept of super funds being more transparent is a good idea. Surely we can come up with something that works without seriously inhibiting the growth of our venture and startup ecosystem.
Here’s a simple exception based solution in two parts:2
1. Create an exception based on materiality: Most of these investments will be a tiny portion of any superannuation fund’s assets. Take an average small super fund of $5 billion, say it makes an average investment of $20m in a $200m venture fund and the venture fund makes a $2m investment in a company. The indirect holding in a typical venture backed company for the super fund is 0.04% of the super fund. In many other cases it may be as little as 0.01%. This is immaterial for super fund members.
2. Create an exemption based on confidentiality for venture capital investments: It seems crazy that we would create a regulation that kills the ability of Australian super to invest in a certain asset class. If there is a real need for confidentiality then the disclosure regulations should not apply.
While I think that either condition should remove the need to disclose, an exception requiring both materiality and confidentiality would also be workable. Due to the asset allocation of all superannuation funds, these exceptions wouldn’t have a material effect on the benefits of disclosure. Some would argue that by limiting a long tail list of tiny investments, we are in fact making the disclosure information more valuable to super fund members.
In any case the startup and venture community needs to jump on this and make sure the current government knows the unintended side effects it will have on our nascent, but rapidly growing sector.
(1) I used to be responsible for venture investing at one of Australia’s largest superannuation fund managers.
(2) I can’t take much credit for this – it has already been suggested by many within the private equity and venture capital industry. I think it works and hopefully can help by articulating it in a clear fashion.
Rick Barker is a managing director at Blackbird Ventures. This post originally appeared on the Blackbird Ventures blog.
This article first appeared on StartupSmart.