Super changes not so super for startups

This means that if, as a startup founder, you take capital from a venture capital fund that has an Australian superannuation fund as an investor, their investment and their valuation of that investment in your company will be open for the world to see.

You might think this is a storm in a tea cup. Who will really look at these disclosure websites anyway? Lots of people. In the private equity industry they already do it with the data from the US public pension funds (which only have to disclose to the fund level – a far more realistic requirement).

As soon as these websites pop up, people will start screen shotting them to build a store of data on companies, especially unlisted private companies and startups. I predict that this data source will become a standard way of judging the health of a startup for prospective investors, acquirers, customers and employees.

This can have some very real side effects for your business. Remember that you have no control over how your venture investor or super fund values your company on their own books. They have valuation policies that are set and enforced by other regulations and codes of conduct and are subject to the opinions of their auditors. In some cases the revaluation may be solely due to currency movements as super funds often hold venture investments denominated in other currencies which flow back into Australia.

Imagine any of the following:

• You are trying to raise a new funding round at a reasonable valuation, but your venture capital investors or indirect superannuation fund investors have for some external reason decided to write down the value of their investment in your company. It’s going to be hard to raise that next round if this data is a starting point for every investor (US and Australia) to judge your company.
• Ditto when you are trying to sell the company.
• Your company is really starting to grow and you have a chance to raise a big funding round from an amazing Silicon Valley-based VC firm, but they decide not to do it because one of your existing Aussie indirect investors needs to disclose the progress of your company.
• Imagine you’re a struggling enterprise software business, working hard to close that sale with a large corporate, but it’s taking a bit longer, and money is tight (anyone been in this situation?). That may well trigger a write down by your investors. Normally this wouldn’t matter – who cares how they value your company right now if you just can close that sale. But in this case, your potential customer is looking at the superannuation disclosure data, and seeing that you’ve just been subject to a write down in value. Think you’ll close that sale?
• Ditto when you’re trying to build a team, attract that stellar a board member, or generally build the profile of your business.
• It also works against you on the upside. When everything works out spectacularly for you, do you want everyone being able to calculate what the company sold for? Does the buyer want this disclosed? Could it be a reason someone doesn’t end up buying you, or isn’t willing to pay such a high price?

At these and many other times in a startup’s life, your investors’ valuation is not the best indicator of success and should not be public. But under these new laws it will probably be one of the first things people look up about your company. At other times, it puts you at a disadvantage if your investors’ valuations are made public.

So as a founder of the next big global tech company, do you want to take money from an Aussie venture capital fund that has Australian superannuation investors? More importantly if you had a choice between an offshore venture capital fund (without these obligations) and an Aussie one, which would you pick? If you are lucky enough to be a hot tech company and you’re pulling together a stellar investor syndicate for one of your rounds, do you want to let that Aussie venture fund in for a slice? My guess is probably not.

So the logical conclusion of this is that Aussie venture capital funds that are funded by Aussie super funds will be shut out of many of the best Australian investments. This in turn means that we’re stuck where we are now … with almost no superannuation funding getting into Aussie startups. And US pension funds reaping the rewards of Australian innovation, as they have done for years.

Another logical conclusion of the disclosure requirement is that the Aussie superannuation industry is effectively shut out from the best investments in the global venture capital (and part of the private equity) asset classes. I know from my friends in the industry that this is already happening.¹

A simple solution

Firstly, let me emphasise that I think the concept of super funds being more transparent is a good idea. Surely we can come up with something that works without seriously inhibiting the growth of our venture and startup ecosystem.

Here’s a simple exception based solution in two parts:²

1. Create an exception based on materiality: Most of these investments will be a tiny portion of any superannuation fund’s assets. Take an average small super fund of $5 billion, say it makes an average investment of $20m in a $200m venture fund and the venture fund makes a $2m investment in a company. The indirect holding in a typical venture backed company for the super fund is 0.04% of the super fund. In many other cases it may be as little as 0.01%. This is immaterial for super fund members.

2. Create an exemption based on confidentiality for venture capital investments: It seems crazy that we would create a regulation that kills the ability of Australian super to invest in a certain asset class. If there is a real need for confidentiality then the disclosure regulations should not apply.

While I think that either condition should remove the need to disclose, an exception requiring both materiality and confidentiality would also be workable. Due to the asset allocation of all superannuation funds, these exceptions wouldn’t have a material effect on the benefits of disclosure. Some would argue that by limiting a long tail list of tiny investments, we are in fact making the disclosure information more valuable to super fund members.

In any case the startup and venture community needs to jump on this and make sure the current government knows the unintended side effects it will have on our nascent, but rapidly growing sector.

Notes:

(1) I used to be responsible for venture investing at one of Australia’s largest superannuation fund managers.

(2) I can’t take much credit for this – it has already been suggested by many within the private equity and venture capital industry. I think it works and hopefully can help by articulating it in a clear fashion.

Rick Barker is a managing director at Blackbird Ventures. This post originally appeared on the Blackbird Ventures blog.

This article first appeared on StartupSmart.