The US economy has been taking big steps forward in economic growth over the past few years, but of course the nature of economic cycles suggests it’s also one step closer to a period of economic recession. Just what impact a downturn in the world’s largest economy will have on Australia is a question that is increasingly being asked by some inside and outside the VC sector.
After struggling for several years in the wake of the tech-wreck, Australia’s VC sector has blossomed as a technological wave of innovation has surged around the world.
Total assets under management by venture firms has more than doubled since 2015, reaching
$6.9 billion at December 2017, according to the latest Preqin data published in AVCAL’s 2018 Yearbook. Alongside that growth in funds under management has been record-breaking levels of investment activity, which reached a record $962 million across 135 deals in 2017. Aggregate investment activity in 2018 is likely to break yet more records, based on current indications.
And while records are being broken with the depth and breadth of investment activity over recent years, the quality of early stage innovation and investment strategies being used by managers is being laid bare in the profile of returns for investors into venture capital in Australia.
Over the 12 months ended March 2018, VC funds tracked by Cambridge Associates quoted pooled returns to investors (net of fees, expenses and carried interest) of 26%, according to the latest data compiled from the Australian market. Impressive after-fee returns for three and five-year periods as well.
When the inevitable period of economic slowdown hits the United States, a look back at history can give some indication about what to expect next time around. The 2008-09 global financial crisis began in the US and quickly spread like contagion to many markets around the world. It used to be the case that economic shifts in the US had a profound and almost immediate impact on Australia, but the global financial crisis saw a different playbook for Australia.
Australia’s economic and trade relationship with China is widely acknowledged as being the major point of difference. The Chinese economy continued to grow, underpinned by its own massive stimulus package, which in turn drove significant ongoing demand for Australian commodities during the GFC. While the US remains an important strategic partner, and many US-based VC funds invest in Australian start-ups, the internationalisation of the open-market Australian economy has accelerated significantly over recent years.
While the GFC was one of the largest and most dispersed downturns in history, it had a significant impact on the US VC industry – more so than other VC markets around the world (measured by number of funding rounds and amounts raised), according to one study[1].
Of course that isn’t to say the Australian VC industry was unaffected.
Fewer new investments were made, the flow of funds into VC firms tightened and IPO exit opportunities diminished – all directly attributable to the economic slowdown and the focus on reducing exposure to risk.
Fast-forward a decade, and the Australian VC industry is as strong today as it ever has been in the past. And that’s precisely what you would expect – technology is reshaping whole industries, and business models are being permanently altered as a result of innovation and data.
Much is made of Australia’s geographic isolation, but that very same challenge presents unique opportunities to foster original ideas and innovation that then finds new markets and customers all over the world. A growing number of VC-backed businesses are generating profits while successful expats are routinely returning home to Australia and re-investing in other businesses, bringing the value of their experience to the table as part of that.
Meanwhile, major Australian institutional investors such as Hostplus and the Future Fund, as well as others, have been working to increase their allocation into the early stage investment ecosystem domestically and offshore for some time now. The fact that large sophisticated investors like these are adopting such strategies provides an insight into the opportunities presented by fast-growth businesses with new and emerging technologies.
So, while a likely US recession in coming years will have an impact on the Australian economy – the unique features of the domestic market will undoubtedly play a role in shielding us from some of the implications of a downturn. Only time will tell precisely how we navigate our way through when the moment comes.
[1] Venture Capital and the Financial Crisis: An Empirical Study Across Industries and Countries
D. Cumming (ed.), The Oxford Handbook of Venture Capital, Oxford University Press, pp. 37-61.