Lots has been written about the shortage of early-stage capital in Australia.
There is no doubt that our per capita spend on early stage investments is still well below our friends in the US and UK. However, I believe this is slowly improving, driven by a number of factors.
Companies are staying private for longer, encouraging more capital to invest in non traditional asset classes.
We have more home-grown technology success stories, which not only creates FOMO among the rich, but seeds new generations of successful founders and early employees who are keen to give back to the sector.
And, perhaps less obviously, we have the rise of syndicates in Australia. Syndication is where a group of investors come together to pool their funds and invest as a single entry on the cap table. They can benefit founders who are unable to secure much-needed capital at their earliest stages and angel investors who may not be able to access the cap table directly.
It’s a win-win, clearly. But despite this, Australian syndicates are far from as common or easy to navigate as they should be.
Syndicates can take the form of a number of legal structures — trust, company, managed investment scheme. We’ve actually seen some real innovation around structuring in Australia (although I can appreciate this is at the less sexy side of the innovation spectrum, for most).
In the US the most common structure is an SPV which allows for a special purpose company to be easily established with minimal regulation. Sadly, no such structure exists in Australia.
In Australia, most early-stage investment syndicates fall broadly into either commercial or club models.
A commercial model operates in a highly regulated environment with a professional manager and fees charged to the investor (usually a combination of management and performance fees). The professional manager means they have the ability to move quickly and can often access the same quality deal flow as a leading VC. The downside, of course, is that participating investors have to pay for the manager — and the cost of maintaining an AFSL and insurance is around $100K per year.
A club model usually operates without an AFSL, doesn’t receive fees from investors and relies on its members to do a lot of the investment work. These can be wonderful when you have a group of committed, experienced investors, working together with a clear process. The issue is that sometimes life gets in the way. Angels — almost by definition — are successful and busy. It can sometimes be hard for them to bring the singular focus of a commercial syndicate. Cheque certainty can also be an issue as they don’t have visibility on how much their members are keen to invest.
At Flying Fox Ventures, we operate a commercial syndicate that is more akin to a rolling fund. We bring together a cohort of angel investors and help them deploy capital into 10 startups, selected by our investment committee.
The cohort model means we can offer cheque certainty to founders who are looking to partner with us. The angels get to see ‘under the hood’ of our due diligence and deal structuring process, and lean in and help companies that could benefit from their skills and experience.
Angels emerge from a cohort with a diversified portfolio of at least 10 startups, and hopefully the confidence to go out and start investing on their own. Most of our investors really value the flexibility offered by our model — to lean in when it suits them, but ‘set and forget’ when life gets in the way.
Regulatory differences between the US and Australia mean that we have different applications of the rolling fund model. In the simplest sense, it’s almost akin to a subscription model, for investing. It means that a fund manager can start deploying capital on day 1, rather than chasing a minimum closing target for the fund. It allows investors to come in at various points (quarterly or annually), rather than waiting for a new fund to be raised in ~3 years.
For example, at Flying Fox, we structure our intakes around cohorts, rather than being time-based. If the market is hot (like now!) we will deploy more quickly. If things slow down, so will we.
We really value this flexibility as it allows us to invest based upon prevailing market conditions and opportunities as they present, and doesn’t force investments within a set period.
The single line entry on the cap table is important. In Australia, a company can only have 50 shareholders before it becomes a ‘public company’ — meaning it is subject to more regulation and, importantly, the takeovers provisions in the Corporations Act.
Using a syndicate means that founders can access a large brains trust of super angels — without filling up their cap tables.
It also means that when they need to chase up shareholder signatures for corporate approvals, they only need to deal with the syndicate lead. Chasing busy people for signatures is not fun.
Syndicates can also be far more flexible than a fund. Funds are governed by investment strategies that are detailed in IMs and essentially set in stone for 10 years. On the flip side, most syndicates are established on a ‘deal by deal’ basis; they aren’t limited by the usual fund dynamics.
The key benefit is access. When investors come together via a syndicate, they collectively have more power.
Being able to invest more money usually makes an investor more attractive to founders.
The truth is, founders just don’t have the time to spend hours with every person who wants to give them $10K. However, if 20 people come together in a syndicate to invest $200K, they are not only able to get better access, but they will often have the ability to negotiate terms.
Also helpful is having someone handle the deal mechanics — the legal documentation, the cap table math, the pre completion conditions. Even if individual angels have the skills to do this work, a lot of them will not have the capacity to do it well, for a relatively small investment.
Investing with people is fun too. It’s great to learn from the mistakes of others, rather than having to make every mistake for yourself.
At Flying Fox, in addition to generating great returns for our investors, we are driven by a supplementary mission of helping to mint new angels.
We know there is a gap in early stage funding in Australia. By creating more angels who are excited about the asset class and confident enough to navigate all the uncertainty that comes with it, we are helping to reduce that gap.
There’s nothing quite like the feeling of ponying up your own hard-earned cash.
The venture model is set up to accommodate power returns; they are looking for investments that have the ability to return the fund. It doesn’t matter if they incur some losses along the way.
Angels definitely feel those losses more acutely! Whereas a return of 1-3x is usually seen as a failure in venture, as an angel I can tell you that getting my money back, even with a relatively small uplift, is always better than it going to zero.
Losses are inevitable in this space, which is why diversification is the only angel strategy that works.
Even so, founders who work hard to responsibly manage a modest exit (after the GBHAS* has failed) are some of the unsung heroes of the ecosystem.
Angels have the freedom to break all the rules. Two of our core values at Flying Fox are discipline and fun. To be a great angel, you need an abundance of each. You need to be disciplined around your process and diversification strategy — but you need to have fun along the way.
Angel investing is an enormous privilege and if you can’t align it to your personal values at least some of the time, what’s the point? One of my early syndications at Eleanor Venture was into a consumer genetic counselling service called Eugene. It didn’t fit into any of the frameworks I had developed at that time. However, my youngest son was born with a genetic anomaly and I had experienced first hand the problem at Eugene’s core. It was beyond personal to me.
I explained to my syndicate investors that I was biased beyond belief and investing because I simply had to. It felt good. It was a smaller syndicate than what we usually raised, but so what? It made me feel great and I’m proud of it. Looks like it’s going to bring some great returns too, which is also rather pleasing.
*Great big hairy-assed scheme.