Anatomy of a Venture Capitalist
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SYDNEY -- How does a venture capitalist inspire market confidence so it can keep raising institutional backing over the years to provide seed money to emerging enterprises? The answer lies in baseball terminology. All you really need are one or two home runs.
Sydney-based Technology Venture Partners (TVP), believes its three successful portfolio company exits so far were a factor in enabling the VC to raise a robust $144.4 million for its third new fund, TVP3. Many investors from TVP2 followed onto TVP3.
Phillip Wing, executive director of TVP, says: "We've made 14 total investments as a manager and of that we've got four exits, including one write-off. So the ability to invest and exit and give a return back to investors is pretty crucial, I would have thought, to their decision on TVP3."
The new fund has a 10-year life and will seed up to a dozen new high-quality technology ventures which have impressive intellectual capital, a global business application and a good management team.
"We invest in companies we think are going to be pretty substantial and are going to be purchased by pretty substantial companies," Wing says.
We have to build $50 to $100 million revenue enterprises. There's no point backing a company that's going to be a $5 million revenue concern."
He says investors expect an average 20-25% return rate over the life of the TVP3 fund. "Over the whole portfolio, we expect to get our capital back to investors, plus," he says.
"In terms of this asset class, which is private equity, most investors are looking for returns of 20 to 25 per cent over the medium term. It's a risk reward issue and those are fairly common expected returns."
And what is prompting this optimism right now on the part of the institutional investors, given that technology stocks have been in the doldrums for a year?
It's the lure of the elusive but extremely lucrative home run.
"If you look at VC history, out of every 10 investments, you normally get one, which is called a home run in the industry," Wing says. "If you get that one out of 10 home run, you're pretty much assured of making your return on the fund."
Of the eight or nine remaining portfolio companies, Wing says one or two generally have to be written off as "dogs," then three or four where the investment is returned, plus a bit more and then the rest simply return the original investment and no more.
To the surprise of the TVP fund managers, given these blighted times for technology companies, the $144.4 capital-raising overshot its target, to create Australia's largest specialist technology venture capital fund to date.
"We went to the market expecting to raise $125 million, but we had such strong support that we took an oversubscription. We certainly didn't necessarily go in with that view though, because investors are pretty selective at the moment about who they choose as managers."
TVP, which is one of Australia's oldest independent venture capital firms and launched its first fund about six years ago, took six months to raise the capital for its new fund TVP3.
About 70% of the investors in TVP3 came from TVP2, a factor which Wing regards as a landmark development.
"This is significant, because for the first time in Australia, you've seen a major follow-through of professional investors saying: 'We've put our toes in the water, but now we're going to follow through with this.'
"We've now raised two purely institutional funds - TVP2 and TVP3 - and that's definitely a first for Australia."
A key factor is that all investors in TVP3 are superannuation funds, which are currently awash with cash in Australia and are looking for medium-term investments.
Follow-on investors from TVP2 include the Development Australia Fund, Commonwealth Superannuation Scheme (CSS), Public Sector Superannuation Scheme (PSS), Victorian Funds Management, Stevedoring Employees Retirement Fund (SERF), Australia Post Super and ING Private Capital.
New blue-chip investors in TVP3 include BHP Super, Telstra Super, Funds SA, the Macquarie Alternative Investment Trust, Goodman Fielder Super, SunSuper, Quay Partners I Fund and Singapore-based global investor, Temasek Holdings.
"The net inflows into super funds are very positive and they still have a lot of funds coming to them to manage. With that amount of money, they have to put it somewhere," says Wing.
"Alternative asset classes - for example private equity venture capital - have been a very small proportion of their investment portfolio to date and they're now increasing that weighting." Wing says this trend is global, with super funds overseas also increasing their weighting in this area and the market in Australia maturing in a flow-on effect.
The super funds are also starting to invest in cycles, which shows that their commitment to technology is stronger than before. "It's not a fad anymore, it's a very strong asset allocation decision," says Wing.
"Operationally, yes, it's hard for technology companies at the moment. But when we went and pitched to investors and said: 'We think the sector's still in its infancy and that there'll be dramatic growth over five to 10 years', they concurred.
"This is a 10-year fund, so my hypothesis is they believe in this sector over the medium-term. In addition, there are not that many specialist managers like us who just specialise in IT and communications."
In baseball parlance, TVP's batting average so far is not bad. Professing a strategy of avoiding dot.coms in general and e-tailers and B2B exchanges in particular, TVP has taken on technology companies with major potential offshore revenue-earning power.
"We have 10 active companies in our portfolio and eight have revenues offshore," Wing says. "Of those 10, five have significant operations in the US and one makes 80 per cent of its revenues offshore."
"Basically we are looking for Australian-founded companies with good global potential," he says. "They really have to be addressing a market need which is probably going to be outside Australia. And to be honest, that was one of the reasons we could never get interested in the dot.coms in Australia. Even if they dominated the Australian market, they would never be big enough for us to be interested."
About 1,000 approaches are made to TVP every year for funding, but only four to six get across the line. About 500 make it to interview stage or to having their business plan inspected. "There's a lot of culling in the opportunities we see," says Wing.
TVP says it is now targeting technologies involved in the successful rollout of communications infrastructure, such as broadband and wireless, and enterprise software that improves an organisation's ability to generate revenue or dramatically reduce cost structures.
In 1998, TVP scored an early big win by selling a $2.5 million stake in Internet security firm Security Domain to Britain's Zergo for a rumoured $11 million. Another $2 million was notched up when Zergo listed on the London Stock Exchange later that year.
Two more lucrative trade sales have since followed - ISD, a South Australian firm which specialises in infra-red tracking systems, was sold to a French company under terms which were not disclosed and SDS, a software gaming company, was sold to Victorian faming authority TABCorp.
The company which was written off "before the tech wreck for normal commercial reasons" was Three Dots, a specialist in internet-based workflow solutions.
The oldest fund, TVP1, which is one of Australia's most mature, still has three live companies. "In that fund, we've totally returned the capital," says Wing. "So every exit we have from here is a super-return on the fund, which is great."
Other investees include SME e-commerce service provider, Peakhour Pty Ltd, speech recognition software development company, Syrinx Speech Systems Pty Ltd, and provider of broadband and Internet access for business travellers, inter-touch Pty Ltd.
TVP was co-founded in 1997 by Allan Aaron and John Murray. Aaron is now based in Silicon Valley as part of a new permanent office aimed at assisting Australian companies in the US market.
"Because we have a lot of companies earning revenue overseas, we have set up the office to support them with due diligence from a US market perspective and help them raise capital overseas," Wing says.