Value Capital 2009 Report (1)

8/15/2019 Value Capital 2009 Report (1)

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Value CapitalTHE EVOLUTION OF VENTURE CAPITAL

AND PRIVATE EQUITY IN AUSTRALIA


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MESSAGE FROM THE CHIEF EXECUTIVE 2

EXECUTIVE SUMMARY 3

REPORT SPONSORS 4

THE ACHIEVEMENTS OF VENTURE CAPITAL AND PRIVATE EQUITY

The achievements of venture capital and private equity 6 Venture capital and private equity’s role in the economy 9 Venture capital case studies: Seek and Pharmaxis 13 Private equity case studies: Bradken and Pacic Brands 14

EVOLUTION OF THE AUSTRALIAN VENTURE CAPITAL AND PRIVATE EQUITY INDUSTRY

Venture Capital– The early days 16

– The 1990s 17 – The 2000s 19 – Outlook 20

Private Equity – Birth, boom and beyond 22 – The eco-system develops 23 – The boom and beyond 25 – Outlook 28

APPENDIX: WHAT ARE VENTURE CAPITAL AND PRIVATE EQUITY?

What are venture capital and private equity? 30 The difference between venture capital and private equity 30 The VC and PE lifecycle 30 – Fund raise 31 – Identify and develop new technology 31

– Commercialise and build sales 32 – Investments 32 – Improving the investee 33 – Realising the value – the exit process 33 – Capital return to investors 33 Fees 34

ACKNOWLEDGEMENTS 36

CONTENTS Value CapitalTHE EVOLUTION OF VENTURE CAPITAL

AND PRIVATE EQUITY IN AUSTRALIA


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Venture Capital (VC) and Private Equity (PE) in Australia todayare multi-billion dollar industries with participation from theworld’s most signicant investors and practitioners. They areindustries that have, over the last couple of decades, supportedthe growth and development of some of Australia’s greatestinnovations, and have invested in and strengthened many of the country’s best companies. They have a signicant impacton Australia’s productivity capacity.

Early stage VC gets new companies off the ground, providing afoundation for ideas and innovation that might not otherwiseget a chance. VC is the enabler of tomorrow’s economy. Australiacan no longer afford to be simply a beach, farm and quarry. TheAustralian economy needs to participate in the world of tomorrow,and VC has a central role to play in this vision of our future.

Australian VC has a core of consistent performers whoseinvestment returns are comparable with those available anywherein the world. Many in the industry are realistic about the currentbusiness cycle, recognising it as an inevitable part of economiclife. Meanwhile, the country’s advantages as a centre for science

and technology, its stable business and economic environment,and its attraction as a destination for talented people from acrossthe globe will remain strong competitive characteristics into thefuture. Nonetheless, early stage VC is facing its own challenges,with the current economic climate adding a layer of complexity to the business of raising and deploying funds and exitingbusinesses protably.

Later stage PE transforms existing companies with its own brandof management innovation. It is about providing a particular formof capital and management insight to particular companies in aparticular time in their lifecycle. It brings management disciplineto the country’s boardrooms, and is widely recognised as having astrongly positive impact on the way Australian business operates.

PE saw an unparalleled boom between 2005 and 2007. It waspropelled from relative obscurity to the front pages. Today, it should

be seen as just another sector of the economy: just one of a numberof sources of investment capital, management know-how, andstrategic expertise available to companies in a particular time andplace in their evolution.

As the economy faces the uncertainty of a prolonged downturn,PE will be a valuable source of investment capital in markets whereit has become increasingly difcult to access. Many are optimisticthat the times may suit PE. Irrespective of short term challenges,the fundamental foundation of the industry – its ability to identifyan investment proposition and develop and extract value – willremain compelling into the future, and the industry will continue

to be a crucial resource for the Australian economy.

Both the VC and PE industries are an integral part of Australia’seconomy. They provide unparalleled innovative capacity, avaluable source of investment capital for business, and muchneeded management expertise. These factors will ensure thatVC and PE remain equally important to Australia’s futureeconomy as they have been in the last decade.

I’d like to thank Ernst & Young for their nancial support andintellectual input into the production of this review.

Chief Executive, AVCALApril 2009

MESSAGE FROM THE CHIEF EXECUTIVE


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EXECUTIVE SUMMARY

Venture Capital • Australian VC has been responsible for many of the country’s

greatest innovative leaps over the past decade. Companies suchas Resmed, Cochlear, LookSmart and Seek were backed by VCand today improve the daily lives of millions of people.

• Australian VC competes with the best in the world. The countryis a leading player in the health and biotech industries, incommunications and media, and cleantech is becoming anincreasingly important area.

• Australian VC has benetted from a series of Governmentinitiatives designed to improve the industry’s capacity to raisecapital over the past two and a half decades. Despite this, aGovernment review in 2008 (the Cutler Review) declared thatthe country’s innovation system was in need of an overhaul.

• VC, along with many other industries, will continue to beimpacted by the global nancial crisis. But the foundationof success in the industry is the commercialisation of soundresearch and innovation, and this will continue.

• Innovation is a key opportunity to ‘improve the way things aredone’ in a downturn and needs to be encouraged for Australiato recover more strongly.

Private Equity• The industry boosts the value of its enterprises at double the rate

of its peers in the public markets, with Australian PE amongstthe best in the world at improving the value of its investments.

• Buyout and later stage PE creates exceptional value for its investors,with funds formed between 1985 and 2007 producing a positivepooled internal rate of return (IRR) of 9.9% as at 30 June 2008.Upper quartile funds had returns of 14.4% or better.

• Later stage PE boosts value through fundamental strategicinnovation, investing in the businesses it buys and creating value.

• PE’s unique way of doing business bolsters Australia’s productivity,growth, employment, innovation, level of opportunity andeconomic stability.

• Australia’s PE industry was examined closely by every national

regulatory body in the nancial markets and the Senate in 2007,and pronounced positive and healthy for the Australian economy.

• The Australian PE industry grew steadily through the rst yearsof the decade, on the back of several years of business developmentby a core group of professionals. The last few years have seen theindustry experience a signicant boom in fundraising while dealsizes and volumes also grew markedly.

• Much of this activity has come to a halt as the result of the creditcrunch and nancial crisis but the industry is working its waythrough the crisis. It is an industry made up of highly skilled,adaptable and exible professionals who are well equipped to deal

with the consequences of the changing economic circumstances.• The Australian PE industry still has signicant amounts of capital

to deploy on investments where there is value yet to be realised.

Both VC and PE have deployed more than $10.6 billion (excluding leverage), across some 1,135companies, as at 30 June 2008. These investments have been spread broadly across the country’sgeographies and industries.


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AUSTRALIAN PRIVATE EQUITY AND VENTURE CAPITAL ASSOCIATION LIMITED (AVCAL)AVCAL was established in 1992 as a forum for participants in the private equity and venture capitalindustry. AVCAL is the central voice of the Australian industry and its membership includes almostall the domestic, regional and global private equity and venture capital rms active in Australia.

ERNST & YOUNGErnst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our130,000 people are united by our shared values and an unwavering commitment to quality. We havea dedicated team of professionals committed to helping our private equity clients and their investeecompanies achieve their potential. Ernst & Young will address your investment, transaction andportfolio needs to help deliver the returns your stakeholders expect.

REPORT SPONSORS


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THE ACHIEVEMENTS OF VENTURE CAPITALAND PRIVATE EQUITY

PRIVATE EQUITY COMPANIESEMPLOY MORE THAN 100,000 PEOPLEPRIVATE EQUITY COMPANIESINCREASE EARNINGS 2.5 TIMES FASTER

THAN PUBLIC COMPANIESVENTURE CAPITALIS A FUNDAMENTAL CONSTITUENTOF AUSTRALIAN INNOVATIONVENTURE CAPITAL COMPANIESHAVE DEVELOPED TECHNOLOGIES

THAT HAVE MADE LIFE BETTER FORCOUNTLESS PEOPLE ACROSS THE GLOBE ANDCREATED JOBS AND INCOME FOR THOUSANDSOF EMPLOYEES AND INVESTORS


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The achievements of VC and PEAustralian VC and PE has grown from a nascent industry with its roots in small, early stage investmentsinto a vibrant and signicant sector of the economy. In scal 2008, Australian VC and PE invested $2.4bin new and follow-on company investments both domestically and overseas before leverage. Of thisamount, 28% of capital was deployed by VC and early expansion funds and 72% by PE investors.

The industry is a major employer, with the investee companies of 10 of the largest PE rms aloneemploying more than 100,000 people in scal 2008.

This investment and employment is broadly spread across the country and the economy, with investeecompanies located in all States, and across all industries:

Figure 1: Number of investee companies by location FY08Source: Australian Bureau of Statistics

For much of the past decade, PE investment has contributed signicantly to wealth creation by improving

the value of investee companies through strategic insight, clarity of management objectives andincentives, long-term focus and the provision of investment capital.

THE ACHIEVEMENTS OF VC & PE

New South Wales

Victoria

Queensland

Western Australia

South Australia

Tasmania, Australian Capital Territory,Northern Territory

Overseas

3 4 4

1 9 1

6 7

4 5

6 9 6

%

4

7

2 6 8 2 4 %

1 5 1

1 3 %


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A survey of thirteen Australian PE exits in 2007 showed that PE invested companies increased theirenterprise value by 21% (or, if two exceedingly successful outliers are included, 32%). This enterprisevalue is close to twice that achieved by publicly listed companies, and comparable to the best in the world(see Figure 2).

Figure 2: Enterprise value (EV) growth in Australia 2007 (calendar year)Source: Ernst & Young study 2008 “How do private equity investors create value?”

Figure 3: Enterprise value (EV) by country 2007 (calendar year)Source: Ernst & Young study 2008 “How do private equity investors create value?”

Australian PE invested rms earnings grew more than 2.5 times faster than public company benchmarksin 2007, with the majority of this improvement coming from organic growth or successful acquisitionrather than cost cutting or nancial engineering. The PE model enables growth in protability thatcontributes to sustainable and repeatable above market performance.

Public Benchmark Private Equity

E V C A G R

%35

30

20

10

25

15

5

0

32

11

21

Weighted EV CAGR

Weighted EV CAGR (including outliers)

0

5

10

15

20

25

30

35%

Australia Germany France Southern

Europe

USA Northern

Europe

UKTotal

12

24

12

11

32

21

9

29

20

16

29

13

22

29

7

7

24

17

20

18

-2

12

14

2

Public company benchmarks

PE out-performance



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Figure 4: EBITDA growth in Australia 2007Source: Ernst & Young study 2008 “How do private equity investors create value?”

PE and VC have created and transformed some of Australia’s greatest companies and highest prolebusinesses. On the VC side, companies such as Resmed, Cochlear, Seek, and LookSmart have developedtechnologies that have made life better for countless people across the globe, and created jobs andincome for thousands of employees and investors. Later stage PE has transformed the fortunes ofcompanies as diverse as the Myer chain of department stores, Hoyts cinemas, Pacic Brands, and heavy engineer Bradken, amongst dozens of others. Improving their performance has secured thousands ofcareers, created new jobs and preserved a signicant piece of the country’s commercial heritage.

Australian PE creates exceptional value for its investors. Australian buyout and other later stage PE fundsformed between 1985 and 2007 had a positive pooled IRR at the end of June 2008 of 9.9%. Upper quartilebuyout and other later stage PE funds had returns of 14.4% or better, compared to 3.3% or better forupper quartile VC funds. On balance, combined PE funds have seen an annualised pooled return of 8.4%to date 1 (see Figure 5). The overall twenty-year horizon IRR was 8.5% for all PE funds (see Figure 6).

Figure 5: Investment returns – Australian VC and PE benchmarksSource: Thomson/AVCAL Yearbook 2008

E B I T D A C A G R

%40

30

20

10

0

Public Benchmark

8

Private Equity

36

20

9 %

2 0 %

4 3 %

2 8 %

PE EBITDA Contribution

Cumulative annualised IRR sinceinception of each individual fund.Overall results as at June 30, 2008Funds formed 1985 – 2007.

STAGE NO. AVERAGE POOLED UPPER MEDIAN LOWER

VC 37 -5.4 -1.4 3.3 -0.6 -14.8PE 101 5.8 9.9 14.4 5.4 -2.5

All VC + PE 138 2.8 8.4 11.5 2.1 -4.3

1 Pooled average : this calculation includes treating all funds as a single “fund” by summing the monthly cashows together.This cashow is then used to calculate a rate of return.


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Figure 6: Horizon IRR results as of June 30, 2008Source: Thomson/AVCAL Yearbook 2008

The fundamental strength of VC and PE’s value proposition means that, at a time when many othersources of capital are signicantly constrained and investment opportunities are difcult to fund,PE still has plenty of capacity to invest, with unspent funds totalling $6.5 billion as at 30 June 2008(see Figure 7).

Figure 7: Cumulative committed capital, amount drawn down and unused funds (combined VC and PE funds)Source: Australian Bureau of Statistics

VC and PE’s role in the economyStrong VC and PE sectors bring signicant benets to a broad section of Australian society and theeconomy as a whole. Their unique way of doing business bolsters the country’s productivity, growth,employment, innovation, level of opportunity and economic activity.

Innovation and opportunity VC is a fundamental constituent of Australia’s innovation system. It provides capital and commercialisationskill to the country’s top scientic, technical and entrepreneurial brains, providing essential fundingand business skill to make Australian innovation a reality. Without a thriving VC industry, Australianinventors – from biotechnologists through to software developers, industrialists and nancial innovators– would be unable to bring their innovations to life.

The importance of innovation to Australian wellbeing cannot be understated. The Cutler Review of Australia’s Innovation System undertaken in 2008 stated that the VC industry embodies a spirit of entrepreneurialism and risk-taking that should be fostered in all Australians. VC provides the foundationfor innovative growth and productivity enhancement that will be necessary to maintain the country’s

competitiveness into the twenty-rst century.

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000$m

FY00

2,182

2,466

FY01

1,865

3,457

FY02

2,288

3,930

FY03

2,528

4,343

FY04

3,391

4,592

FY05

4,595

5,453

FY06

4,999

7,349

FY07

5,991

9,157

6,520

10,613

FY08

4,6485,322

6,2186,871 7,983

10,048

12,348

15,148

17,133

Drawdowns

Unused funds

STAGE 1 YEAR 3 YEAR 5 YEAR 10 YEAR 20 YEAR

VC -0.6 2.7 3.9 -1.4 -1.4

PE 0.8 8.1 14.2 9.3 10.0

All VC + PE 0.6 7.3 12.4 7.5 8.5


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Business disciplineBecause VC and PE bring rigorous analysis and business discipline to the market and provide analternative to other forms of ownership, they have a broad and positive impact on the businessenvironment as a whole.

Numerous studies from across the globe have shown that PE makes the bulk of its returns fromproactively growing the core businesses of its portfolio companies. It does this by applying signicantstrategic know-how and management expertise with nancial discipline. It aligns the interestsof management with that of owners, working closely with executive teams, getting involved with

the businesses it owns and bringing a exible approach to strategy and business success. Qualitymanagement teams in Australia underpin success; PE rms in Australia tend to retain existingmanagement and invest time and energy to support and drive them to achieve their strategic nancialobjective. The success of PE is intimately bound up with its ability to exit its businesses, which meansproviding value for the buyers – whether they are public market investors, a public company, a strategicinvestor or another PE rm.

Because of the stringent discipline it brings to the business table, PE has a signicant impact on thebroader business environment as a whole. Public company boards are forced to revisit their strategiesand adopt a number of the successful PE business strategies to assist them deliver better returns toshareholders. The Reserve Bank of Australia puts it this way: “PE can play an important role in ensuringan efcient and dynamic business sector. The threat of a takeover by a PE fund or another group of

investors is an important element in helping to ensure that the existing managers of rms have a strongincentive to manage the assets under their control as efciently as possible.” 2

Australian business thinks so too. A survey conducted by the Economist Intelligence Unit of nearly 300 Australian executives in December 2007 found that over 75% thought that PE was a positive thingfor Australian business. 3

Productivity and employment growthVC and PE provide a boost to both Australia’s employment levels and productivity.

PE-backed businesses invest in additional employees at a signicantly faster rate than comparablecompanies. This is because they are actively managed, supported with new capital and increase their

employee numbers more quickly than less dynamic businesses.PE makes businesses more efcient. An independent study commissioned by AVCAL in 2004 indicatedthat the labour productivity of PE-backed rms increased over a period of two years by 6.3%, almostdouble the comparable national gure of 3.4%. 4


2 Reserve Bank of Australia, “Private Equity in Australia”, Financial Stability Review, March 2007.3 “Private equity moves in: the impact on business in Australia”, Economist Intelligence Unit, 2008.4 Meyrick & Associates, Labour Productivity Study, June 2004.


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PE represents another ownership form, more relevant to some industries and businesses at variouspoints of an economical cycle. PE’s ability to deploy signicant amounts of capital quickly, and thematuring nature of the PE rms in the Australian economy are important in creating a dynamic, highperforming business landscape. The ownership changes and competitive threat increases corporateactivity and offers investors alternative investment classes to diversify its own investment risks.

A core competence of VC and PE professionals is determining which deals are right for them. Figure 8shows the number of proposals VC and PE have examined over the past three years, and the numberof actual investments. The low conversion rates underpin the investment thesis of the PE model and

highlights the breadth of businesses and assets analysed by PE as part of its disciplined approach toinvestments.

Figure 8: VC and PE deal analysisSource: Australian Bureau of Statistics

FY06 FY07 FY08

Proposals viewed 6,896 8,792 8,497

Further analysis 787 1,039 963

New deals entered into 278 253 260

Conversion rate 4% 3% 3%


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12 5 Mr Ric Battell ino, Deputy Governor, Reserve Bank of Australia , Ofcial Committee Hansard of the Senate Standing Committee on Economics, 25 July 2007.6 Private Equity in Australia – Submission to the Senate Standing Committee on Economics May 2007.

THE PUBLIC INTEREST QUESTION

Following the wave of high prole PE bids in 2006, every legislative andregulatory body involved in Australia’s capital markets was formally examining the implications ofthe PE boom. In February 2007 the Takeovers Panel, part of the Australian Securities & InvestmentsCommission (ASIC), published draft guidance notes on conicts of interest. Also in February that year, the Council of Financial Regulators, comprising the Reserve Bank of Australia, the AustralianPrudential Regulation Authority, ASIC and the Australian Treasury, formed a working group tolook at the issues raised by the strong growth in PE and leveraged buyout activity, and in particular,whether there was excess leverage. In March, the RBA published a Financial Stability Review focusedon PE, and the Senate opened a parliamentary inquiry into PE and its effects on capital markets andthe Australian economy.

Each of these inquiries came to the conclusion that PE was a good thing for Australian business. The Takeovers Panel concluded that conicts of interest and insider tradingissues are more or less the same whether they involve PE or other types of M&A, and are dealt withunder the Corporations Act. As for market stability, the Reserve Bank of Australia said that withPE transactions remaining a very small part of the overall nancing taking place in the economy,it was the central bank’s view that PE developments “posed absolutely no risk to the stability of the nancial sector or the economy more generally”.5 The Treasury and the Tax Ofce could not nd any conclusive evidence to show whether PE activity affects tax revenues one way or another:“The general consensus was that the impact on revenue appears to be low and concerns about it

overstated,” reported the Senate.The conclusion of the Senate Inquiry,6 published in August 2007 was

unequivocal: “The committee does not consider that any convincing case has been made for any further regulation of PE activity in Australia.”


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SEEK

Seek was formed in 1997 to match job seekers and employers overthe internet. It is Australia’s leading company in the online trainingand employment market, serving SMEs, large corporations, andgovernment and recruitment agencies.

Seek was backed by a number of AVCAL members: CHAMPVentures, the Macquarie Technology Fund and Gresham AMCF.

These investors were there on day one – back in 1999, well beforeany of Seek’s big name investors. They provided extensive strategicinput to the company, including active participation in marketanalysis, fund raising and exit planning, as well as assistance inbudgeting, cost control and project selection.

Paul Bassat, Seek CEO, says: “Seek raised several rounds of earlystage capital, in order to fund our growth. The availability of thiscapital was a key factor in enabling us to achieve our objectives.Several of these investors provided important strategic input aswell as access to their networks. The growth of the VC industryis an important ingredient for the ongoing health of early stage

businesses in Australia.”Today, Seek is an immense success. It enjoys a formidable leadover its nearest competitor in terms of both job ad and jobseekernumbers. According to data from Nielsen/NetRatings, inSeptember 2008 Seek attracted over 2.79 million unique browsersto its site, more than twice the number of individual visitorsreceived by its nearest competitor. Of the total time spent by jobseekers on the three major Australian employment sites, 76%of that time is spent on Seek. The total time spent on Seek is vetimes its nearest competitor. Seek currently hosts about two thirdsof all online ads, and its site reach is 66% of the online jobseekermarket in Australia (Nielsen/NetRatings). In any given month,approximately 200,000 job ads are posted on its Australian website,which is more than double the number of job opportunities listedby its nearest competitor.

Seek has around 400 employees and is based in Victoria, withbranches in all Australian state capital cities, Auckland andLondon.

PHARMAXIS

Pharmaxis is a specialist pharmaceutical company founded in 1998that researches, develops and commercialises human therapeuticproducts to treat chronic respiratory and autoimmune diseases.The lead technology was developed by Dr Sandra Anderson atthe Royal Prince Alfred Hospital in Sydney. Founding investorGBS Venture Partners provided support in identifying the leadtechnology, building the board and management team, anddeveloping the strategy.

Pharmaxis is headquartered in Sydney at its TGA-approvedmanufacturing facilities. GBS rst invested in Pharmaxis as astart-up in 1999, prior to in-licensing what has become its coretechnology and building the management team. In the followingeight years GBS led a syndicate of follow-on venture investors,including CM Capital, through a number of private nancingrounds prior to listing on the ASX in 2003. Since raising $25m atIPO in Q4 2003 Pharmaxis has gone from strength to strength,raising a further $150m on the ASX and NASDAQ. Pharmaxis hasgrown to become among Australia’s largest life sciences companies

with ofces in the US, UK and China. The company currentlyhas 100 employees and is constructing a new 7,000 square metrefactory and headquarters in Frenchs Forest, Sydney.

The following case studies demonstrate how VC investments play a vital role in the Australianeconomy, by bridging the funding gap for thecommercialisation of new technologies by early-stage companies.

CASE STUDIES


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CASE STUDIES

BRADKEN

Bradken has been a manufacturer of high quality consumablesfor the mining industry since the 1920s. It is a heavy industrialcompany making large equipment: rolling stock, spare partsfor huge mining vehicles, processing equipment. It waspurchased in December 2001, from the Smorgon Steel Group,by a consortium of CHAMP Private Equity, US-based ESCOCorporation and Bradken management. At the time of the$185.5 million management buyout (MBO) the company hada turnover of $300 million and staff of 1400. The consortiumfunded the company with a total of about $200 million, 30%of which came from equity held by management and CHAMPand 70% from bank borrowings.

Bradken remained under private ownership for just under threeyears. During this period, approximately $25 million of new capitalexpenditure was invested for capturing growth opportunitiesand cost reductions. Bradken’s EBITDA grew over 60% fromapproximately $30 million per annum to $50 million per annum.At the time of its successful public listing in August 2004, the

investment achieved an IRR of 49% and CHAMP retained a10.1% stake in the company.

Bradken’s Managing Director Brian Hodges said that theadvantages of PE ownership included the capital injection intothe company that the previous owners could not make. Otherless obvious advantages included the reduction in non-valueadding work for senior managers. People became more focussedand there was a reduction in reporting. “You do not do as muchlling out of monthly reports to send up through the levels of an organisation; you are at the top of the organisation and youtalk directly to the people involved.”

Mr Hodges also says that as Bradken became a stand-alone entitythere was a period of three to ve years with a clear plan andtargets to meet. He also found that the PE owner was signicantlycloser to the business than previous owners, and challenged manyof the known norms.

There was also an effect on employment levels. Prior to the PEtakeover a number of plants were shut down and people retrenched.Although there was little capital expenditure, efciencies were driventhrough work practices and other changes. From 2002 onwardsstaff levels increased. Currently the company employs around3,000 people and there have been no further staff reductions.

PACIFIC BRANDS

Pacic Brands came out of PE ownership some ve years ago.In 2009, the impact of the global crisis and negative publicitysurrounding the strategy of moving production offshore,remains to be seen. Nevertheless, it is clear that the company was comprehensively turned around in PE hands.

The company, manufacturer of famous Australian clothing

brands such as Bonds and King Gee, was an unloved divisionof conglomerate Pacic Dunlop when it was purchased by PErms CVC Asia Pacic and Catalyst Investment Managers inNovember 2001. Over the next three years its new ownershipincreased the speed of decision-making, boosted advertisingspend from $30 million to $70 million, increased staff trainingbudgets by 163%, improved working capital and shed $90 millionof low-margin product lines to concentrate on core brands.

Bought for $730 million, the company was oated on theAustralian Stock Exchange in April 2004 in an initial publicoffering (IPO) that raised $1.25 billion. The PE investors made

more than ve times their initial investment for an internal rateof return of 105%. The company has continued to prosper inpublic hands, with sales increasing from $1.3 billion in 2004,the year of its IPO, to $2.1 billion in 2008 with EBITDA of $229million that year.

The following case studies illustrate how PE rmsadd sustainable value, transforming their investeecompanies into more attractive assets for futurebuyers through a combination of managementexpertise, capital investment and strategic direction.


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1970 First VC fund formed:

International Venture Corporation

1984 Government launches MIC Program creating vehicles for risk capital

1987 First PE Fund formed: AMIT and Byvest

1992 Arrival of large corporate investors into risk capital sector

Government replaces MIC Program with Pooled Development Funds

Government legislates compulsory superannuation scheme

Creation of AVCAL with 17 funds managing $507m

1993 Government forms Australian Technology Group to invest in early stage technology

1997 Government launches Innovation

Investment Fund Program

1998 AVCAL records growth of VC and PE sector to 40 funds with $2.7bn in funds under management

Foreign capital invested in PEP’s rst fund

1999 Government launches Commercialising Emerging Technologies (COMET) Program to provide $30m in funding for early stage growth rms to commercialise their work

Government introduces major tax reform on capital gains tax, roll-over relief and zero taxation for US and certain Pension Funds

2000 Global dotcom market crash

2001 Government announces $2.9b innovation action plan to fund new initiatives in education and R&D

2002 Government legislates capital gains tax exemptions or certain foreign investors that invest in VC/PE limited partnerships

2003 AVCAL introduces standard reporting guidelines for its members, based on world’s best practice

Global PE Firms set up ofces in Australia

2006 AVCAL adopts the International VC & PE Valuation Guidelines

Mega PE deals: CVC invests in PBL Media, KKR acquires Brambles Cleanaway and Seven Network

2007 Senate Inquiry into Private Equity

PE bids on high prole Australian listed companies such as Qantas, Flight Centre, Orica and Coles

Sub-prime crisis hits

2008 Review of the National Innovation System (the Cutler Review)

Australia has over US$1.68b of PE deals reporteddespite the global nancial crisis; higher than China (US$1.13b) and Japan (US$999m)

2009 Government announces $83m IIF Follow-on Fund

THE EVOLUTION OF THEAUSTRALIAN VENTURE CAPITALAND PRIVATE EQUITY INDUSTRY

A Brief History:Signicant milestones in the evolutionof venture capital and private equity.


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THE EVOLUTION OF THE AUSTRALIAN VC & PE INDUSTRY

Venture CapitalAustralia competes with the best in the world and is a leading player in health, biotech, communicationsmedia, and more recently cleantech. Australian VC has a passionate core of talented and experiencedinvestment professionals who have contributed to the successful commercialisation of science andtechnology which has improved the everyday lives of countless people each day. Its funds are some of the most professional and experienced investors in early-stage companies in the world.

A number of VC funds are now reaching their ten-year anniversaries, and those with signicant track

records are competing on the global stage. A small number now have funds under management of over$300 million. Successful venture-backed companies such as Resmed and Cochlear now have multi-billiondollar market capitalisations and touch the lives of millions of customers each day.

As at 30 June 2008, Australian funds had $2.7b invested in 700 companies in the pre-seed, seed andearly stage expansion stages (not including leverage). Of this number, over half of these companieswere companies in the early expansion stage.

Figure 9: VC Investee CompaniesNumber of companies and value of investment ($m) at nancial year-end, FY00 – FY08Source: Australian Bureau of Statistics

The early daysMany commentators would say that an important catalyst for the growth of the Australian VC industrywas the knowledge and experience that a small number of MBA graduates brought back to Australia inthe 1970s from the United States.

Although there was some venture activity in the country in the 1960s, the early 70’s credit cruncheffectively squashed the industry, which only recovered very slowly through the decade. In 1980,Bill Ferris, a co-founder of Australian Mezzanine Investment Trust (AMIT), an early stage investmentrm, wrote an article outlining what he called the Small Business Investment Gap. He claimed thatthere was little opportunity for venture-stage companies to attract investment capital, and urged theAustralian Government to rectify the situation.

Number of deals

Investment ($m)

FY07 FY08FY00 FY01 FY02 FY03 FY04 FY05 FY06

N u m

b e r o f

d e a

l s

I n v e s t m e n

t ( $ m

) i n V C

500

0

1,000

1,500

2,000

2,500

3,000

100

200

0

300

400

500

600700

800


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In 1983 the Australian Government appointed the Espie Committee to recommend ways to remedy the problem, particularly to stimulate investment in high technology, which was booming offshore.It recommended the creation of the Management and Investment Companies (MIC) Program. Underthe program, initiated in 1984, 11 MICs were licensed to raise venture capital from investors, who werein turn allowed to claim 100% of their investments as a tax deduction. Over and above the 11 MICs, apaper published in October 1988 counted some 47 VC organisations of different ownership structuresand investment preferences – although many of these were focussed on small scale expansion capitalinvestments – and calculated the industry’s capital base at $353 million. 7 The MIC program did havea catalytic effect on the market, boosting its growth signicantly.

VC funds grew slowly through the late 1980s, but were hard hit by the recession in the early 1990s.The stock market crash of October 1987 and the recession that followed made life very difcult forexisting players and discouraged new entrants to the industry. It was a brutal time for the investmentindustry as a whole – commercial interest rates soared over 20% and two of the country’s banks werebrought to the brink of collapse – and VC suffered.

The 1990sThere were several initiatives in the early 1990s that helped get the industry back on its feet. In 1992,the MIC programme was replaced with the creation of Pooled Development Funds (PDFs). Similar

in structure to the MICs but less driven by tax incentives, over the subsequent six years PDFs invested$155 million in 147 companies. At the same time, the industry began organising itself more formally.In 1992 AVCAL’s predecessor association, the Australian Development Capital Association Limited(ADCAL) was formed with the rst meeting chaired by Richard Gregson.

According to Geoff Brooke of GBS Ventures, there was minimal VC happening in Australia until themid-1990s. Later in the decade, however, with the rst stirrings of the technology boom, there wassomething of a revival – by 1998 Australia had 40 funds, mostly VC, with $2.7 billion in capital undermanagement. Although some years before the oat of Netscape and other icons of Web 1.0, this wasthe time when the internet was beginning to make an impact and optimism was yet again rife in thetechnology industry.

Some of the VC deals done around this period are still considered the most successful in Australianventure history. High prole cases include LookSmart, an AMIT-backed dotcom that was oated inAugust 1999 generating a return of over 1,100%, and Cochlear, the Advent Private Equity-backedcommercialisation and globalisation of world-leading hearing implant technology developed inAustralia. There are numerous other success stories from the late 1990s across industries, from hightechnology to mining services, medical equipment and nancial services.

7 A Development of the Venture Capital Market in Australia, V. Wan, University of Wollongong.



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In 1997, the Australian Government introduced the Innovation Investment Fund (IIF), a federal programstill running today, that matched funds raised from the private sector up to a ratio of two to one.The scheme has invested $221 million in rounds one and two of the program, and is investing some$200 million in its third round.

Many of the companies that were awarded licences in the rst rounds of the IIF were spin-offs fromearlier MICs. Rothschild, for instance, raised one of the rst IIF venture funds that was a $42.5 millionfund: $27.5 million from government and $15 million from the private sector. Other venture fundsaround this time were around the same order of magnitude, although a number were signicantly larger.

Nanyang Ventures, for example, was funded in the second round of IIF, raising $140 million.

One of the rst IIF funds was a joint venture between Australian Mezzanine Investment Trust and theWalden Investment Fund out of San Francisco. It was a company that had some signicant VC successes,including LookSmart, Gecko Mining Systems, and seek.com, as well as a couple of others. It paid backthe entire investment of the Australian Government in the rst round of IIF funds, helping to establish thefact that you could make money in venture capital.

Most of the companies that were handed licences in the rst round of the IIF scheme have gone on tobecome institutional grade venture capitalists that now form the backbone of the Australian VC industry.

Figure 10: IIF licence companies

In 1999, the industry began formally collecting data on its activities, with the Australian Bureau ofStatistics and Thomson Venture Economics both beginning regular surveys and reporting on the VC

industry. The Thomson/AVCAL yearbook reported that a record $A800 million owed into the industryduring FY1999. A number of new funds were also established that year, with capital coming from bothAustralian and offshore institutions. According to Thomson, at the end of 1999 AVCAL’s 35 investormembers had $3.5b in funds under management.


ROUND 1

Allen & Buckeridge

AMWIN/CHAMP

CM Capital

GBS/Rothschild

Momentum Funds Management

ROUND 2

Foundation IIF / Stone Ridge Ventures

Nanyang Ventures / Four Hats Capital

Neo Technology Ventures

Start-up Australia

ROUND 3

Andover Venture Partners

Brandon Capital Management

Cleantech Ventures

IB Australian Bioscience

Yuuwa Capital


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The 2000sThe venture end of the spectrum was hit hard by the dotcom bust. GBS Ventures (then Rothschild &Sons) closed a $64.5 million fund just after the dotcom crash of March 2000. After this event fundraisingfor cash-hungry high tech businesses was difcult for a number of years. High tech industries werefurther hit when the global telecoms industry crashed just a year later.

From 2002, later stage PE experienced a fund-raising boom, attracting signicant offshore investmentand increasing its domestic capital base. VC however was growing at a much slower pace. It has beena frustrating time for those who have dedicated their careers to Australian technology innovation.

“The ow of investment dollars has not come from the institutions,” says GBS’s Brookes. “It is extremelyfrustrating that many Australian super funds are willing to invest in US venture capital, even thoughlocal venture produce returns that are absolutely comparable with those in Silicon Valley.”

The numbers back up this assertion: Australia’s best VC managers achieve returns comparable withthose seen in the US – a recent AVCAL survey showed that positive cash exits in the Australian VC sectoraverage 39.3% IRR with a 4. 1 multiple.8 Yet Australian super funds allocate less than 1% of their capitalto VC and PE investment in total (see Figure 11).

Figure 11: Superannuation funds committed to VC and PE in value and as a % of total assets of superannuation fundsSource: Australian Bureau of Statistics

One observer points to the relative stagnation in average fund size over the decade – the rst fundscreated by the IIF over ten years ago were in the order of $40 million. Aggregate fund raising levelshaven’t changed greatly since 1999. It is, say many commentators, a “chicken and egg” problem: investorswant more quality local investment managers, but without investment dollars the industry cannot grow.“We have proven over the last ten years that Australian VC can create technologies, build companies,create jobs and wealth,” says one industry veteran. Yet the industry has failed to attract the volume ofcapital it needs to attain truly critical mass.

Commitment toVC and PE byinvestors fromsuper funds

Percentage

0.2

0.4

0.6

0.8

1.0

1.2

1,000

2,000

00

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

S u p e r c o m m

i t t e d

t o P E a s a

% o

f t o t a l

s u p e r a n n u a t

i o n a s s e

t s

%

S u p e r a n n u a t

i o n

f u n

d s c o m m

i t t e d

t o V C & P E ( $ m

)

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08

8 Dr. Mike Hirshorn and Tim Peters, “Positive cash-on-cash Exit s”, Australian Venture Capital Journa l, Oct 2008, pp. 23 – 25.



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What’s more, the relative lack of investment capital is frustrating for participants, because there havealways been more investment opportunities in Australia than there is funding. Australian innovationis one of the most underfunded in the world: overall VC investment in Australia is just 0.05% of GDP,less than half the OECD average.

Figure 12: VC and PE new and follow-on investments ($m)Source: Australian Bureau of Statistics

OutlookThe credit crunch will have a signicant impact on the ability of an Australian venture to attract newcapital. Nevertheless, there is still some – if now much more highly contested – capacity, in the marketfor funding promising technologies.

“Since becoming established in 2001 we’ve raised close to $400 million of capital,” says John Dyson, nowa principal at Starsh Ventures. “The current market demise may slow us down a bit, but in the broaderpicture we are just where we want to be. To a large degree the credit crisis doesn’t really affect us, becauseour companies have next to no debt. What does affect us is sentiment; the ability for us to raise fundsand investors to take risk.”

The next few years are likely to see something of a “battening down the hatches”. That means makingdecisions that will preserve remaining cash in the expectation that quick exits will not be easily comeby, and new funds will be more difcult to raise than they may have been in the past. Nonetheless, the

industry has been through lean times before and has good experience in waiting these out until thegrowth cycle kicks in again. It is an industry made up of experienced professionals with a great depthof experience. What’s needed now is for the industry to be bolstered by a new wave of fresh capital –both nancial and human.


$m

0

2,500

1,200

500

1,000

1,500

2,000

FY07 FY08FY06

256157 492

185

227140

1248

1672106

289

1419

350

Investments in new deals – VC ($m) Follow-on investment – VC ($m)

Investments in new deals – PE ($m)

Follow-on investment – PE ($m)


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THE CUTLER REVIEW

The Rudd Government commissioned a formal review of Australia’sinnovation system early in its rst term. Delivered in September 2008, the report found that the systems Australia uses to support its capacity to innovate have been suffering from neglect for over a decade.

The proportion of Government spending on innovation fell markedly over the past 10 years, educationspending fell below the OECD average, and productivity growth has attened in recent years.

The report recommended a complete overhaul of the country’s innovationsystem, from the establishment of new bodies to specically promote Australian innovation andhuman capital, to a revision of the tax benets that accrue to research and development. The reportrecommended that the IIF program be maintained and extended, with a fourth round after 2012.It also recommended a raft of other initiatives to support Australian VC and to attract offshoreventure funds to Australia.


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Private Equity

Birth, boom and beyond In the late 1980s, the PE industry was embryonic but it supported a core group of professionals. Theearly practitioners are today seen as the pioneers of the industry. Notable players in the industry atthe time included John Grant from Hambro-Grantham (then later Colonial First State Private Equity),Bill Ferris and Joseph Skrzynski from Australian Mezzanine Investment Trust (now CHAMP PrivateEquity), Andrew Rothery, Doug Bartlett and Ross Grant at Byvest, Alex Varley, Ian Lansdowne, Geoff

Berry, and Gordon Windeyer at Catalyst, and a number of captive operations within the investmentbanking community, including Peter Chapman and Bill Robinson at Citicorp Capital Investors, andSandy Lockhart at Macquarie Bank’s Bond Street Investments.

The rst institutionally subscribed PE funds in the country had been raised in 1987. They were the $30million fund raised by AMIT and a $95.5 million fund raised by Byvest. According to CHAMP partnerBill Ferris, one aspect of the industry hasn’t changed for twenty years: “The size of our rst fund was just$30 million, and everyone said to us in those days ‘How on earth are you going to nd ways to deploythose funds?’ and it’s true to say that every fund since then including the last one, which was a $1 billion,has attracted the same response.”

Figure 13: Average PE fund size FY99 – FY08Source: Thomson Reuters/AVCAL Yearbook 2008

In the interim, there have been many signicant developments in the industry. According to Peter Wiggsof Archer Capital: “Going back pre-2000, the whole idea of buyouts dominating the space would’ve beenvery foreign to 90% of the participants.

“In terms of people employed, funds under management and deals done, the vast majority were venturecapital or growth capital in nature with very few controlled acquisition deals. We were not big users ofdebt because these were all companies that were net importers of cash rather than producing cash sothey couldn’t support debt. So the standard deal was a $5 or $10 million equity cheque into a promisingif somewhat embryonic company.”

FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08

$m

0

200

400

600

800

1,000

1,200

1,400


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The eco-system develops – PE comes of age in late 90sThe introduction of compulsory superannuation in the early 1990s radically increased the amount ofinvestment capital available from the domestic market. With increasing sums of investment capital tomanage, conservative Australian investment managers were looking for ways to diversify their holdingsaway from traditional xed income and equity investments. Allocations to “alternative assets” such asVC and PE increased accordingly.

“All this activity meant that PE companies, which had been the poor cousins to the investment banks andothers in the nancial services industry, could now raise large enough funds to hire well qualied peopleto manage their money,” says Ironbridge’s Julian Knights. “By 2001 there were a number of $200 – $300million funds that could compensate four or ve people with reasonably competitive salaries. It’s true tosay that after 1998 the number and quality of people in the industry grew in leaps and bounds.”

At the beginning of 1998, there were few lawyers, accountants or other transaction support serviceswith dedicated PE expertise. Local institutional investors were both sceptical and conservative, andinvestment from offshore was unknown. What private investment activity there was generally focussedon early-stage investment, with public to private and other later stage buyouts unfamiliar to the market.In fact, a number of observers note that, at the time, PE was considered a buyer of last resort. Vendorswere reluctant to talk with the industry because they felt PE wouldn’t be able to raise the capital to pay an appropriate price, and many in the legal fraternity felt that a management buyout created a conictof interest for management.

The late 1990s saw a series of events that laid the foundation for the success of the industry for thefollowing decade. One was the establishment of several signicant PE nds, including AMP DevelopmentCapital, the Development Capital of Australia Fund, GS Private Equity (the successor to Byvest), andthe formation of CHAMP Private Equity.

A further important development was the success of local funds in attracting capital from foreign investorsfor the rst time. In 1998 a team of professionals from Bain & Co. set up Pacic Equity Partners, now one of the country’s largest PE funds, raising its rst fund with 90% of its capital sourced from overseas investors.

Although this fund may have been the rst signicant foreign invested fund in the country, its successhad been built on the back of a decade’s work pioneers had put into increasing Australia’s prole amongstthe international investment community. “Getting US investors’ interest has been a long haul,” saysAndrew Rothery (then of Byvest). Senior partners of international fund managers such as Harbourvest(the world’s largest fund manager) and other foreign investors visited Australia and met the Treasurerand local companies right through the 1990s, before initial investments in Australia were made.

At the same time, the banking market was developing its leveraged nance resources. Domestically,BT boosted its acquisition nance team, and offshore competitors such as the Royal Bank of Scotland,HBOS, Société Générale and Crédit Agricole sent fresh teams to provide the burgeoning industry withthe leverage it would need to grow over the next decade. Meanwhile, the global professional servicesrms were setting up dedicated PE teams in Australia to service the growing number of active funds.

The new funds looking for larger deals concentrated on opportunities created by the strategic restructuringof conglomerates, while others in the market completed signicant smaller deals that used the new PE

infrastructure to provide know-how and capital to Australia’s small and medium enterprises.



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In March 1998, CVC Capital Partners acquired Amatek, an Australian building products group fromUK conglomerate BTR for $1.625 billion. For many the arrival on the scene of a signicant global player,purchasing a major local business for a signicant sum of money, marked the beginning of a new phasefor Australia’s PE industry. But there was something of a hiatus after this deal, during which funds wereraised, but big deals were not getting done.

The dam was broken with the $730 million purchase in 2001 of the Pacic Brands division of PacicDunlop by CVC Asia Pacic and Catalyst. This was the rst of the country’s dozen or so public-to-private deals that have happened to date. It was a classic PE play that took an unloved division of a large

conglomerate, turned the business around, and reaped the reward. The business was boosted throughinitiatives such as an increased advertising spend, a 163% increase in staff training expenditure and astrong focus on working capital. The company was oated in April 2004, achieving an IRR of 141%.

According to the Thomson/AVCAL yearbook, in scal 2000, 42 new funds were formed, nearly doublingthe number of funds formed the previous year – a historic high.

Figure 14: Amount of funds raised by scal year (in A$ millions)Source: Thomson/AVCAL Yearbook 2008

Meanwhile, at the smaller end of the market, PE was completing a number of high prole deals – someof the country’s best known brands, such as Repco, Just Jeans and JB Hi-Fi were transformed by PEover this period, and drew the attention not only of the local press and business community but alsoof international capital and competitors in the PE market.

“I think we were all true believers,” says Archer’s Peter Wiggs. “There was no reason, given Australia is amature industrialised economy with a deep debt capital markets, that you wouldn’t expect a strong andvibrant leverage buyout industry to be present. And I think we’d been surprised that a buy-out industryin Australia hadn’t been a part of the local PE and M&A scene. I think for a few of us, this was what wehad intended to happen and it was just nally happening. We weren’t feeling like this was amazing, wewere feeling like this was preordained.”

YEAR VENTURE CAPITAL PRIVATE EQUITY TOTAL

1999 411.60 1,182.00 1,593.50

2000 338.60 1,153.40 1,492.002001 385.50 969.90 1,355.40

2002 115.50 821.60 937.20

2003 203.20 467.90 671.10

2004 152.60 1,079.20 1,231.80

2005 82.80 3,572.90 3,655.00

2006 184.70 3,210.90 3,395.60

2007 398.10 10,359.30 10,757.50

2008 174.30 6,134.30 6,308.50


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In the 2002 AVCAL Yearbook, then chief executive Andrew Green wrote that Australia was top of mindwith global investors for ve reasons: a sophisticated PE infrastructure; integrity; transparency; a criticalmass of funds under management; and world class entrepreneurship skills. The deals done around thistime boosted Australia into the top ranks of global PE markets, delivering some of the strongest returnsin the world. Over the next few years, the world’s largest PE houses set up shop in Australia. These wereoften part of their Asian businesses, looking to invest a portion of the signicant amounts of capitalthat had been drawn to PE in Asia during this period.

“This was the age of the frustrated Pan-Asian fund,” says Tim Sims of Pacic Equity Partners. “Large

amounts of money were owing into Asia, but the Asian deal markets were proving to be more granularand less developed than the perhaps optimistic international investors had hoped. There was a largevolume of investment funds in Hong Kong, there was some activity in Korea, there were early growthcapital businesses in China and other places, but the really hard-core LBO activity that the internationalplayers were looking for didn’t really present itself in Asia. The result was you saw increasingly largeefforts being made by offshore PE in Australia.”

With interest from offshore investors, high prole PE houses setting up shop, and local and internationalbanks offering signicant leverage, the foundations of Australia’s PE boom were in place.

The boom and beyond

In 2006 a number of signicant deals were consummated, indicating that Australian PE was followingthe rest of the world. Global capital ocked to take advantage of the country’s transparent and well-regulated markets, a perception of undervalued equity markets, and opportunities for signicantstrategic transformation and value realisation.

Not only did the number and size of deals accelerate, PE was becoming the owner of some of thecountry’s highest prole companies and brands. In February 2006, TPG bought Myer, one of thecountry’s two major department store chains for $1.4 billion. In June, KKR bought Cleanaway andBrambles Industrial Services from Brambles for $1.83 billion. When the country’s media ownershiplaws changed in October 2006, PE quickly partnered with Australia’s largest media owners. KKRbought a 50% stake of the Seven Network from the Stokes family, and CVC Asia Pacic purchasedhalf of PBL Media, which included the Nine Network and other media assets. Each deal totalled over$2 billion.

In addition to the high prole brand names, PE funds were also involved in a number of importanthealth and pharmaceutical deals. CVC Asia Pacic and Ironbridge bought Afnity Health from Maynefor $813 million. Public to private deal DCA Group by CVC Asia Pacic for $2.7 billion, and Archerand Ironbridge purchase of iNova for $450m. Proving that the business expertise of PE ownership canapply to a breadth of specialised industries.

The excitement these deals created generated a powerful buzz around the investment community,and provided a real stimulant to asset prices – both public and private companies were trading atsignicantly increased earnings multiples than they had been just 12 months earlier. With large poolsof PE capital backed up by affordable and accessible leverage nance, PE could afford to pay goodprices. But as 2006 turned into 2007 there were signs that these prices were nding their limits.



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Figure 15: PE Investee companiesNumber of companies and value of investment ($m) at nancial year-end, FY00 – FY08Source: Australian Bureau of Statistics

Early 2007 saw a number of high prole public-to-private deals in which PE made offers that werespurned by boards of directors and shareholders. These deals included Flight Centre, Orica, Coles,APN News & Media and Qantas. “Even before the credit crunch slowed international leveraged buyoutactivity, mega-deals in Australia found themselves struggling against the strength of the Australianequities market,” wrote the Economist Intelligence Unit in a report published in March 2008. 9

In August 2007 the global sub-prime led credit crunch hit, and with it a notable deceleration in the

number and size of PE offers hitting the boardrooms of Australia’s companies (see Figure 16).

Figure 16: PE new and follow-on investments ($m vs number of deals)Source: Australian Bureau of Statistics

Number of deals

Investment ($m)

FY07 FY08FY00 FY01 FY02 FY03 FY04 FY05 FY06

N u m

b e r o f

d e a

l s

600

I n v e s t m e n

t ( $ m

) i n P E

1,000

2,000

3,000

4,000

5,000

6,000

500

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300

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100

00

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$m

N u m

b e r o f

d e a

l s

20

40

00

60

80

100

120

140

FY06 FY07 FY08

Investments in new deals – PE ($m)

Follow-on investment – PE ($m)

Investments in new deals – PE (no.)

Follow-on investment – PE (no.)

9 “Private equity moves in: the impact on business in Australia” Economist Intelligence Unit, 2008.


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MINING CAPITAL PE is a global industry, as is mining. Australia is a centre of mining excellence,and as such it is in the early stages of developing its own PE eco-system for investment in the globalmining industry. It is small, but Australia’s growing mining equity industry leads the world.

Traditionally, early stage mining rms are listed on the stock exchange, raising modest capital sums of $3 – $5 million to fund claim development and drilling. There are some 400 junior mining rms on the ASX, many of which will fail in the process of proving their claims.

Specialist PE companies are an alternative form of funding for companies atthis stage of their development. Companies such as Pacic Road Capital Management, based in Sydney,Resource Capital Funds in Perth, and the Sentient Group provide development capital to miningventures across the globe. These three groups specialise in early stage exploration and development,seeking exits once projects become cash ow positive.

“Traditional PE is very comfortable in the mining services area,” says LouisRozman, a director of Pacic Road Capital. “But the difculty for people not familiar with the earlystage development character of this business is how to manage the risks. We’ve been in mining allour working lives and understand how the models work. The industry needs people who can runbusinesses in a different way, and PE provides a different form of capital to the public markets thatbrings its own benets.”


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OutlookPE, like all industries, suffers during a downturn in the economic cycle. But the industry has afundamentally strong and sustainable business model. Australian PE has historically been amongstthe best performing in the world. There is no reason why that is likely to change in the future.

In the current economic environment Australian PE, in common with its competitors around the world,faces signicant challenges. The global nancial crisis has severely restricted credit for most economicactivity. Economic commentators expect the amount of leverage available across the globe to contractat least tenfold from 2007 levels. Still, it is likely that loans will be available for those deals where valuecapital will add signicantly to the prospects of a business through its strategic business focus andinnovative management capability.

Over the last few years, the Australian superannuation industry has been investing signicantly inalternative assets including PE. But the market dislocation has reduced the absolute value of investmentpools, as well as the risk appetite of a generally conservative investor base. Raising fresh funds will bechallenging for the foreseeable future. Australian PE rms raised $11 billion in scal 2007. By scal 2008that number had fallen to $6 billion (see Figure 14).

Investment funds are likely to restrict allocation to PE, but the industry will continue to attract capitalfrom other sources including sovereign wealth funds and high net worth individuals.

PE funds currently have around $6.5 billion of unused commitments available for investment inAustralian businesses over the next two to three years (see Figure 7). This is likely to be an attractive sourceof capital for liquidity-constrained corporates as they look for investment partners in coming years.

With the consumer and industrial markets suffering in the downturn, PE is likely to consider newopportunities for investment. Areas such as property – delisted property trusts, for instance – as well asdistressed assets that require competent management attention. But at the same time, PE will scrutiniseits investment opportunities closely.

Indeed the current market conditions provide an opportunity for Australian PE rms to invest in andconsolidate their existing portfolios, to ensure that when conditions improve their companies willmaximise exit values.

Australian PE practitioners remain optimistic. In relative terms Australia remains a healthy market forprivate investing. It is stable and well regulated. Its capital markets are sophisticated and, even amidstsignicant turmoil, relatively deep. It presents a pool of well-developed businesses, many looking forsuccession strategies. Its proximity to the relative strength of the developing markets of Asia puts thecountry in a prime position to prosper from one of the world’s most dynamic set of economies.Short-term complications aside, many in the industry are excited about the future and look forwardto the progress the next decade will undoubtedly bring.


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WHAT ARE VENTURE CAPITALAND PRIVATE EQUITY?

APPENDIX:


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What are Venture Capital and Private Equity? VC and PE are two of many different ways for investment capital to nd protable ways to be employed.Like other forms of investment management, it has advantages and disadvantages, and is appropriate forsome companies, investors and investment managers, but not for others.

In its broadest sense, PE is equity investment in a business not quoted on a public exchange. All privatecompanies have equity investors, including family companies and other small businesses. The term PEmore often refers to the practice of investing in an unlisted company with the aim of improving thebusiness over a period of years, and selling it for an optimal price.

The difference between VC and PEPE rms come in all shapes and sizes, and invest in businesses at all stages of their development – frompre-seed capital technologies seeking research and development funds to the outright purchase ofpublicly-listed companies.

Firms that invest in early stage companies are known as venture capitalists, while expansion and laterstage buyout companies are termed private equity.

Stages of VC and PE

The VC and PE lifecycleVC and PE capital ow and activity follow a cycle. Each stage of the cycle is described in moredetail below:

VENTURE CAPITAL

PRIVATE EQUITY

WHAT ARE VC & PE?

Seed Early Stage Expansion Buyouts

VENTURE CAPITAL PRIVATE EQUITY

Fund raiseIdentify and

developnew technology

Commercialiseand build sales Realise capital

Remit return toinvestors

Fund raise Invest Improve theinvestee Realise capitalRemit return to

investors

STAGE 1 STAGE 2 STAGE 3 STAGE 4 STAGE 5

STAGE 1 STAGE 2 STAGE 3 STAGE 4 STAGE 5


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Fund raiseThe standard VC or PE rm is structured as an investment fund. The managers of the fund are knownas General Partners (GPs) – they are responsible for the fund’s legal debts and obligations. Investors inthe fund are known as Limited Partners (LPs), because their liability is limited to the amount of theirinvestment. LPs are usually sophisticated investors – superannuation funds, for instance, will often havea manager dedicated to investing in PE. Other investors include insurance companies, banks, universityendowments and high net worth individuals who understand the commitments they are taking on.More recently, sovereign wealth funds have also invested capital in PE.

Figure 17: Source of funds FY08Source: Australian Bureau of Statistics

VC and PE funds are generally limited in their lifespan. A particular fund, for instance, will state thatits objective is to have all its capital invested investments exited, with all its funds returned to investorswithin 10 to 12 years from the date of fundraising.

Identify and develop new technology In VC, the amounts invested are predominantly at the seed and early expansion stages. In the seed stage,the business concept exists with R&D being carried out but commercial operations are not yet fullyestablished.

A major aspect of the venture investment life cycle is identifying the beginning of an industry, or uniquetechnology, that probably has few competitors, high IP protectability, that cannot be replicated easily andhas the potential to be commercialised on a sufciently lucrative scale. Investment at this stage addressesthe gap between promising R&D and commercialisation. VC funding therefore provides the fundingneeded to support the edgling business during this vital gestation period.

Non-residents

Pension funds

Authorised deposit-taking institutions

Trading enterprises

Governments in Australia

Life insurance ofces

Trusts

Other residents

1 ,8 9 1

5 7 7

1 , 2

4 9

8 5 0

3 6 0

7 0 6

2, 0 8 1

1

5 %

7 %

4 %

9, 4 2 0

5 5 %

WHAT ARE VC & PE?


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WHAT ARE VC & PE?

Investment opportunities actively sought by VCs predominantly relate to new intellectual property inareas such as IT, life sciences and cleantech that can be commercialised to meet a global need.

As these are higher risk investments, VCs manage their risk by only investing in businesses after havingcompleted extensive due diligence. Given the highly technical nature of the market for new innovations,VC professionals also tend to hold specialist qualications and experience in the high-technologysectors they invest in.

Commercialise and build salesAt this stage, the business is product-ready and may have registered some initial sales. This is a capital-intensive period for businesses where revenues may exist but with minimal prots, with capital injectedto help the business grow. Much of this capital is usually directed towards product development andinitial marketing, manufacturing and sales.

It is also at this stage that the business’ management team particularly benets from the VC’s managementexpertise, networks and mentoring, which helps to build up the entrepreneurial skills of researchers andbuild links with the nance and business community.

InvestmentsIn PE, the managers of the fund will identify companies that they believe to be promising, determine

what they believe a company is worth in its current form, and how they believe they may be able to addvalue if they were successful in buying it. They will do detailed due diligence to determine the strengthsand weaknesses of the business.

PE will nance its purchase of companies with a combination of equity – money provided to the fundby the limited partners – and debt – loans from banks and other nancial organisations. The proportionof debt to equity will be determined by the price and availability of debt. In a normal market, a typicalbuyout of a mature company would use perhaps 50% equity and 50% debt (in 2009 we would expectto see much higher proportions of equity due to a lack of readily available credit), but this will bedetermined very much by the nature of the company in question – its maturity, cash ow strength, theamount of investment it will need, and its general ability to service loans. As early stage rms are oftennot yet revenue positive, they do not have sufcient cash ow to service debt.

Later stage PE uses debt for two reasons. First, by using debt rather than capital from the fund, they can make more investments from the fund as a whole. Secondly, using debt can increase the returnsto the equity used in each transaction, and investors can make a greater return on their funds. Wheninterest rates are low, and debt is a relatively cheap form of nancing, PE is able to nance more purchasesor pay relatively higher prices for the companies that they buy. Lower interest rates mean that companiesare more easily able to service their debts.

Fund managers receive a management fee based on the size of the fund and also receive a share in thecapital gains delivered to the fund’s investors. The management fee is usually calculated as a percentageof the funds originally invested in the fund. The percentage is negotiated between the investors and themanager at the time the funds are raised. An indicative gure is 2 to 2.5% p.a. for smaller VC funds and1 to 2% for larger PE funds. This gure covers the overheads of the business including salaries and the

costs of conducting due diligence on investments.


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Improving the investeeThere are many ways to add value to a company – PE may be able to provide investment capital, know-how, contacts, management competence and strategic insight. PE’s greatest successes are achieved withcompanies that are not getting enough management attention, strategic direction or investment capital.If a PE rm is successful in buying a company, it will usually put one or more directors on the boardand become actively involved in the management of the company and its strategic progress.

According to a 2008 study of 13 Australian PE exits, the greatest gains in enterprise value were achievedby proactively growing the core business, with the smallest gains coming from nancial engineering

and investing in growth sectors or opportunities.

Figure 18: Primary investment rationale in AustraliaSource: Ernst & Young study 2008 “How do private equity investors create value?”

Realising value – the exit processThere are four main paths that PE investors can choose to realise value from an investment: sale toa strategic buyer (such as a publicly listed company or another rm with presence in the company’smarket), sale to another PE investor (known as a secondary buyout), initial public offering (otationon the public markets) or a share buyback (under which an existing shareholder will buyout the PE

rms stake in the company). Part or all of the PE fund’s investment may be realised.

As shown in Figure 19, in recent years the vast majority of exits have been realised through sales tostrategic buyers or through public oats.

Buy and build

Accelerate growth from the core business

Invest in growth sector/opportunity

% o

f t o t a l d e a l s

b y

i n v e s t m e n

t r a

t i o n a l e

Proportion of Deals

0

20

40

60

80

100%

8.4%

92.2%

Growth RateCompound Annual

EV

8.4%

92.2%

42%

33%

25% 76.4%

WHAT ARE VC & PE?


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Figure 19: Exits and other decreases during the year ($m)Source: Australian Bureau of Statistics

Capital returns to investors

Figure 20: PE and VC returns – periods to end June 2008Source: Thomson Financial, Standard & Poors

FeesThe manager’s share of capital gains is around 20% in most funds globally and is calculated after allfees and expenses paid by the fund have been returned to the investors. The VC and PE manager onlyreceives a share in capital gains if the fund has delivered a minimum return known as the ‘preferredreturn’. If the capital gains do not exceed the preferred return then the manager receives no share incapital gains. The preferred return is usually similar to the long-term bond rate.

The bottom line is that if VC and PE funds do not perform by adding value to the companies they buy,they will not earn performance fees. The interests of the managers of the fund are aligned with thoseof the management of the investee companies. It is the unique structure of the industry that provides itwith its powerful value creation incentives and makes it such a valuable part of the Australian economy.

WHAT ARE VC & PE?

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08

$m

0

200

400

600

800

1,000

1,200

Other (includes secondary buyouts)

Write-offs

Buybacks

Initial public offers

Trade sales

STAGE 1 YEAR 3 YEAR 5 YEAR (IRR P.A) (IRR P.A) (IRR P.A)

Australia Private Equity 0.8 8.1 14.2

Australia Private Equity and Venture Capital 0.6 7.3 12.4

S&P/ASX 300 (price index) -17.1 7.1 11.4

S&P/ASX 300 (accumulation index) -13.7 11.4 16.2


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Alignment of interest The foundation of PE’s ability to add value is the alignment of interest between owners and management.Each has a genuine stake in the business and is rmly focused on increasing its value. Often in a buyout,senior management will participate in the equity structure of the company, giving it a huge incentiveto act in the interests of all shareholders. “We were encouraged to act as if we owned the company,” saysBrian Hodges, CEO of Bradken, talking about the value PE rm CHAMP brought to the company.

Long-term focus Because PE invests over a term of three to ve years, it is not focussed on short-term results at theexpense of long-term success. PE-backed companies are able to invest in new products, new businessesand new employees without being overly concerned about short-term protability. The public companysector, on the other hand, is under constant pressure to provide ever increasing short-term protabilitygains. 28% of ASX investors divest their shares within 12 months, and 51% between two to ve years. 10 Only a fth of investors potentially hold their stocks for a longer period than PE rms. Many rms takeninto private ownership benet from having a “time out” from the publicity circus of public ownership.Private ownership can give management a breather in which to make investments or take risks that thepublic markets might respond unfavourably.

Detailed due diligence Prior to investing in a business, a PE manager conducts thorough analysis to gain a detailed insight intothe strengths and weaknesses of the business, its growth potential and the prerequisites for achievingthis growth. This level of due diligence provides the foundation for a detailed strategy for the company’sfuture. PE will not proceed unless it has a clear idea of how it can add value to the business.

Flexibility to plan for growth The insight from due diligence allows the PE fund, as new owners of the business, to develop withmanagement a comprehensive and coherent long-term plan to increase the value of the business.

This plan will typically:

– Stress the importance of sales growth as well as cost efciency;

– Emphasise cash as much as earnings;

– Focus on a small number of essential performance metrics;

– Include a training and development program for employees; and

– Include a capital expenditure program to ensure that the business has the plant and equipmentnecessary to meet its growth targets.

Active stewardship and Performance metrics and progress against targets are monitored closely so that any remedial measuresclear performance targets can be implemented promptly. Decisions are made swiftly without the bureaucracy and complexity ofpublic company management. Plans and strategies are constantly reassessed to address changing marketconditions. Importantly, PE adds value to businesses by facilitating the introduction of lower-costcapital structure, operational change, manager incentives and exit (investment realisation) optionsnecessary to take the company forward. 11 A study commissioned by AVCAL in 2006 found that the mainreasons for seeking PE investment were the expert advice and guidance that accompanies it, and greaterexibility relating to the funding structures available and the relative simplicity of the process, comparedto raising PE.12

10 ASX Australian Share Ownership Study, 2006.11 Blundell-Wignall, The Private Equity Boom: Causes and Policy Issues, OECD Report, 2007.12 PriceWaterhouseCoopers/AVCAL, Economic Impact of Private Equity and Venture Capital in Australia, 2006.

HOW DOES PRIVATE EQUITY ADD VALUE? Because improving company value is at the core of their business, PE fundsensure that the investments they make have the following characteristics:


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ACKNOWLEDGEMENTS

AVCAL would like to acknowledge and thank the following peoplefor their time and assistance in developing this publication:

About the Australian Bureau of Statistics researchAustralian Bureau of Statistics (ABS) undertook the rst survey of Australian VC and PE rms in FY1999 and has since undertakenthis survey annually at the request of, and with the nancial supportof, the Department of Innovation, Industry, Science and Research.The ABS sourced graphs contained in this report have beencreated to demonstrate trends of the industry between the periodof FY2000 and FY2008.

As the Australian VC and PE industry has grown and evolvedover time, so too have the denitions and classications of VC andPE. In FY2006 the ABS changed its classications of the differentinvestment stages of VC and PE, to more clearly distinguishbetween different stages of investment. Prior to that the stageswere classied as seed, early, expansion, turnaround, late and LBO/MBO/MBI stages. From FY2006 the stages were classied as pre-seed, seed, start-up, early expansion, late expansion, turnaroundand LBO/MBO/MBO stages.

References to VC and PE investee companies in Figures 9 and15 refer to investee companies which were, at the time of survey

submission, in the pre-seed to early expansion stages (classiedin Figure 9 as VC), and in the late expansion to LBO/MBO/MBOstages (classied in Figure 15 as P

Documents

Value Capital 2009 Report (1)