Venture Capital Unlocked: What Every Investor Needs to Know | Conviction Capital | Episode 2

Two leading money managers, two different strategies, with thanks to InvestmentMarkets, this is Conviction Capital.

Welcome to Conviction Capital, I'm Juliette Saly.

We are going to take a deep dive today into venture capital and what investors need to know.

So venture capital is a maturing high growth market in Australia driven by technology, biotech and fintechs.

AI and software startups are a big focus and the overall market is worth an estimated five billion US dollars.

Joining us to discuss investing in VC is Adrian Bunter from Sydney Angels and Mark Esterhausen from Aura Ventures, which has just launched a new fund.

Great to have you with us, both.

So I guess let's just start and drill it down to start with.

We are seeing more everyday investors look at venture capital.

What are you seeing, Adrian?

That's very open ended question.

Seeing investors pretty much look for new, exciting opportunities to make great returns.

Sydney Angels, where I do most of my investing for early stage venture capital is really targeted as very earliest stage investments.

So we're looking for companies that have got a great idea, great founders that are ultimately going to generate a high growth return.

for investors.

But there's a lot of choice out there.

So one of the things investors are struggling with is like, what do I look for?

What do I need to, how do I get involved in the asset class?

What kind of, you know, what kind of things should I be seeking out?

Yeah.

And I guess to that point, Mark, what do you think investors need to know before they dive in to this asset class?

I think venture previously have been sort of ring fence to a wholesale investor and to your point earlier on access is that a lot more retail investors or wholesale investors that don't realize that the wholesale investors are trying to get access to asset class.

So I think the ecosystem and the funds themselves and you create more optionality in terms of how they can on ramp.

new investors into the asset class and a new investor looking at venture.

I think the key to it is that it has a convex relationship to markets.

So what that means is as we're seeing what we're seeing in the oil shock in the markets, because it's long duration, you actually have a longer hold period and there's less reaction to a market setting.

So the thesis at which you're making an investment holds true over time, rather than sort of auto-correction your portfolio and your market reaction where you see share prices dump up.

five to 10 or 20 percent as we're seeing in local markets.

So we mentioned that the opportunity is quite big.

How quickly do you think Australia's VC market is growing?

I think it's growing really quickly.

There's a lot of excitement that happens as a result of, in particular, certain companies.

So there are a couple of really big marquee unicorn type companies.

So when those do big things like your Canvas, your Atlassians, your Airwallexes, all those kind of companies, they

drive people into the market, which means more and more people are aware of it.

It's still amazing how few people are actually aware of the venture capital market.

They're very much aware of listed companies.

They don't understand that all those listed companies exist as private companies before they go onto listed markets.

So that just brings more people into it.

And how fast is it growing?

I don't know, but it's growing quickly.

Well, if I could just jump in, I think it's expected to more than double over the next decade.

So in your view, what would be driving that growth story?

So I think if we cast our mind, when I say we or we cast our mind back to when we first launched and this was post-GFC, so we were one of the longest standing brands in markets.

The market has certainly evolved and matured.

There's arguably a little bit more depth and breadth in markets.

And I think what's driving that is that your first time success rates of founders are coming back into the markets and you're seeing sort of the wave of teams that we're sitting at Canvas and the Glassesons and the like are coming back.

applying that muscle memory learnt within those organisations and sort of setting up their secondary businesses or their first time finding.

And as you have these re-rates coming through and capital being returned to the markets, as recently seen by Eucalyptus and others, is that the confidence of an investor or an LP in those funds are increasing over time.

So more dollars are attracting to an ecosystem or to a market is generally enabling a groundswell of benefit for the venture capital space.

And speaking of that ecosystem, Australia is considered one of the most capital efficient.

In your view, Adrian, why do you think we're punching above our weight?

Australian startups notoriously, what's the word, they're rigorous.

They're rigorous, but they're scrappy as well, right?

So the Australian market is a decent sized market, but it's not necessarily big enough to, by itself for most areas, like generate extraordinary returns.

So it actually forces an Australian founder to look necessarily outside the Australian market.

So everyone gravitates in a lot of cases to the US market because it's the largest market.

But there are other markets, especially into Asia.

Australia is really well placed to go into Asian markets from an expansion opportunity.

But even UK markets and other Commonwealth countries.

So I think ultimately Australian founders are more frugal.

And as a result of that, they don't need to raise as much capital to actually be successful.

Let's talk about industry trends.

Where do you think the smart money is going, Mark?

I think when we as investors look at the space that we've been covering AR, the AR wave or the AR boom for the last three years, pause is probably your strongest friend in the market like this.

Where there was the feeding frenzy around your application layer a few years back, the easy ones, as you roll for the clock and you see the rise of Anthropic and Claude and how they're sort of eating.

majority of the lunch and most businesses, I think, a highly regulatory environments where you can truly create defensibility.

There's this question around AI and what defensibility looks like, but where you're applying, where founders are finding teams of applying a deep insights of problem that is in essence, very difficult to solve by taking what sits inside one's head and applying it in a very technical AI way.

An example of that, if you think of a control tower in a manufacturing site, critical to the way that manufacturing site operates.

There's multiple decisions that are happening on a day-to-day basis, but it inherently sits within maybe one or two people's heads and how that day-to-day facility runs.

If you take the insights of that individual's head, it applies it to a more scalable AR.

lens and enablements and workflow management, then the process in itself can operate with that much better.

So we're looking at very regulatory orientated and a thesis that is formed by a founder that has high conviction and very deep insights.

Because at the end of the day, we pay taking a punt on an individual rather than the business case.

If I can just follow up, because you touched there quite a bit on AI, so software dominates a lot, but we are seeing a surge in climate, clean energy as well.

Do you see that as a structural shift or a trend?

I think it gets us closer to solving the structural issues that have presented themselves previously.

I think in your large infrastructure products, again, there needs to be a deep, deep understanding in how you can use this type of technology and new technologies that are really coming down the pipe to solve those types of problems.

I think as you look at computes and you look at the layers of the AR stack, energy is a front and center when addressing this.

There's endless use case for AR, but at the end of the day, you need energy and compute to solve sort of the AR application and sort of intelligence layer.

So I think with any founder building a business, they need to have sort of energy and sort of the sovereign nature and sovereign policy of local markets before they think about entering a market or building in a market.

Adrian, we're also seeing more super funds, institutional money into the space.

How is that changing things?

It's interesting, it's actually got two components.

In some respects, it's really positive.

In some respects, I see it as not a negative, but could actually be better.

So the benefit Australia, one of the benefits Australia has is there's huge amounts of super fund money.

But as a result of being a really, really large fund, when you're actually deploying capital, you need to put really, really large checks for investment.

That means a small fund actually almost can never get a large super fund to be an investor in them.

So the really big funds are getting huge amounts of money from super funds.

The super funds are also deploying capital into overseas venture capital.

So they're actually generating great returns, actually getting access to some of the best managers.

So underlying Australians via their super are getting access to the venture capital space.

And I think that's a fantastic thing.

What I think you're not getting as a result of that is there's a gap forming in the smaller stage of the market.

So I think the angel sector, the really early stage is very vibrant.

There's lots of growth happening there.

The really big money is actually growing, is actually really strong.

There's lots of US investors also coming into the market and global investors.

But that middle T becomes harder again.

So there's this natural inherency for funds to get larger because you do the same amount of work as you're doing a $20 million investment as you're doing a $4 or $5 million investment and therefore funds over time skew to be larger.

We've just had a third interest rate hike as well from the RBA.

So how are higher interest rates changing venture capital both in investors and for startups?

Well, when interest rates are going up, the risk-free return that someone can get increases, which means the hurdle rate for investment is actually harder.

We saw the reverse of that in the zero interest rate days where the zero interest rates were really low.

You couldn't get a return there.

So people returned to more high growth, more speculative type investments to try to generate returns.

I think it does make it harder.

It actually shows the sign of the economy is difficult.

People think twice about where they're going to make an investment.

I do think there is also some positives around it from a company starting perspective is almost all companies are looking to do things better.

So when they're actually growing and developing their products, they're actually delivering a better solution and outcome for their consumers, whether it be a consumer or a business.

Normally saving money.

In tough economic times, people like to save money.

So it's actually a great time to be building a business and I actually think it's a great time to be investing in startups as well, although it feels like it's not.

Well, and you touched earlier, Mark, on what we're seeing with the geopolitical conflict as well, and this war in the Middle East continues to rage on.

So what impact do you see that coupled with what we just talked about with the high interest rate environment having on capital flows and risk appetite?

Yeah.

I think our venture arm is a part of a broader group called Aura Group and we have multiple strategies being private equity, multi-asset venture.

And we can definitely see the nuance of how investors are thinking about their portfolio construction.

We're seeing the ripple effect of high inflation come through across all things, whether it's your woody shop or what you're feeling at the petrol pump.

I think when, as investors, we look at existing businesses or new businesses, we're looking at sort of that sensitivity to these global shock events.

It's all now, it's going to be something in the future.

So investors, when they do an annual review of their portfolio, when they're thinking to add some type of alpha to their portfolio defensibility.

I'm of the belief that venture does have a role to play in that because of this long duration, it sort of can soften the highs and the lows of the markets.

And if you think of how the sort of

previous lines of funding that have entered businesses before, I think your private credit market's going to tighten.

So your equity funding is actually going to probably rise in the short to near term.

But there's certainly no shortage of dollars out there for investments that go, for investments to be made into the earlier stage positions.

But do you think investors are being cautious or selective?

Selective, I think as capital consideration tightens actually presents opportunity in venture because naturally your cream rises to the top and your selection criteria too can be quite selective in the way you deploy your capital if you do have some open funds within your structure.

But certainly we're seeing a typing of investors in where they put their dollars, but equally being very deliberate in how they shape their portfolio, private versus public.

So Adrienne I'll follow up a little bit on that because there has been, I guess, a late stage capital lack of issue, I guess.

What does that mean for those that are trying to scale?

If you're scaling and you think there's a lack of capital, I think it forces you to be more frugal.

You can't necessarily rely on capital being available, so you have to be profitable.

So I think it actually tightens up some of those companies to actually make them focus on profitability rather than growth at all costs.

It also goes down to the earlier stages from an investment perspective, because you were investing in earlier stages.

If you're reliant on that company being able to raise capital in the future, you want to make sure that that company is going to be in a position to raise capital.

If there are no funds available, then you need to run a different strategy for that startup and actually help them actually get through the profitability earlier.

And is there regulatory complexity that you think may be holding Australia back or not?

That's an interesting question.

I think in, I think in different areas there are, there's, there's reaction and response.

I think we'd sort of touched earlier on AI and data centers.

You know, huge amounts of energy and water in particular being used.

We've got a housing problem from a developments and approvals perspective.

So I think people focusing on areas around that regulation is actually quite significant and how you actually go and improve that.

Like if we're going to continue to do what we think.

is going to happen with AI in terms of the amount of data centers we're going to need is we're going to need to solve those energy problems that we're going to need to solve those water problems.

You'll start to see a lot more startups focus on those particular areas.

Can you actually drive efficiency?

I mean, one of the recent Sydney Angels portfolio companies is actually specifically focusing on the energy consumption and water usage on data centers to actually turn them from water consumers to water producers and actually drive the efficiency of that, of that data center.

all these things create significant opportunities as well.

I think also what we're seeing is that you can be quite focused on your sovereign policy, but as companies are expected to migrate to international markets, we've got a strong portfolio growth expansion rates north of 80%.

And how early do you go into a new market and which market to enter next?

And

When you entering a new market, you actually look at the policymaking and whether it's going to be enable in fact, or a blocker for you.

More recently, we've done, we've partnered up with the Chamber of Commerce on both Australian and the American side, enabling startups, your hardware companies to land and expand in the US and what that means, whether it's as simple as opening up a bank account, which state to land in first, some of the policymaking to think of.

So I think it's probably less around immediate policy within the Australian setting, but more around sort of your enablement partnership, channel partnership, go to market strategies that are really going to dictate the success of Australian companies targeting large markets like the US or alternate markets.

Well, speaking of dictating success, you've just launched, as you mentioned, the venture crowd investment trust.

What was the thinking behind setting up the fund now?

Yeah, so I think the VentureCard trust or initiative is a collab between Aura Ventures and VentureCard.

Aura Ventures has been a longstanding venture capital investor.

We've been around since 2009.

This is our fourth Australian fund and across the group we've also got some funds out of Asia.

I think venture cards thesis around making venture capital more accessible to investors is what sort of excited us.

We already have a feeder fund structure where we combine private credit and venture capital as a feeder or an alternative entry point to our venture capital fund.

But I think what venture card have, how they position this product is to allow a more retail like investor or wholesale like investor at a lower check size, where previously your minimum check sizes were sort of 250 plus.

In order for the overall benefit to be seen by the markets and for the market, we need more available dollars targeting venture capitals and early stage businesses.

And that's predominantly where we base that first institutional check seed all the way through to series A.

to your point, Andrea, was that we need the successes that we see on the ASEXA listed exchange across the globe.

They started somewhere, a garage on the spare bedroom.

They needed capital.

And we have a responsibility to enable that next wave of businesses.

And it's a great time to be building and investing in businesses.

But as you mentioned, it's a crowded space.

Investors are being selective.

What do you think makes you stand out?

I think at the end of the day, I call it the monopoly money syndrome.

There is a slur where many funds that were originated call it from 2014 and beyond.

You can only stand by your numbers and your performance.

If you haven't been able to return any investments or return any capital to investors that allows you to buy a bread loaf with that DPR, then the performance is questionable.

What we've been able to do is return capital on a consistent basis across all our vintages.

We've had multiple tracks for our companies.

Example of that is Catapult, it's a billion dollar business that's listed on the ASX.

We were an early stage backer and rode that wave all the way through.

So we have a lot of muscle memory in identifying businesses in the deep dark pockets of the markets, following those businesses all the way through and having multiple exits routes by way of your traditional RPO market, trade sales, M&A, and the list goes on.

So I think there's just a lot of muscle memory by being in the game for a long time.

understanding the seasonal changes and not wavering on our strategy as the markets matured and there's more depth comes to the markets.

We've seen more later stage strategies evolve.

We still have the belief that there's still not quite enough depth in the Australian market to underwrite a growth, a purely growth strategy.

Hence why we're focusing on high convection early stage bets.

And Adrian, what are you focusing in on at Sydney Angels?

Insignia Angels is generally sector agnostic.

So we'll take applications from anyone except for things like, you know, mining and property, but we'll do technologies in those spaces.

Like most people, we're seeing a lot of stuff in the AI space at the moment.

If you're not a pure AI business, you've got some application of AI within your business, but we see a lot of technology, a lot of software.

We also see a reasonable amount of biotech and medical devices.

There's not a lot of people who focus at the very early stages in those areas.

So, Sydney Angels actually have a pretty decent track record.

One of the standout ones was Clarity Pharmaceuticals, which has gone from the original seed round of three, four million dollars to multi-billion dollars listed on the ASX and a number of other great outcomes.

So you're very much tech, what we're ultimately looking for is a business that can generate really, really high, strong returns that generally means they have to be highly scalable, which lends itself more towards technology businesses.

So what do you actually look for when you're looking to invest?

What are some of the key aspects you're looking at?

So first and foremost, the team is the most critical component at a super early stage business.

Everything relies on the team, their backgrounds, why they're doing it.

Then you start thinking about what's the problem they're actually trying to solve and is that problem a really, really big market size and opportunity?

So the combination of a quality team and a fantastic market size and opportunity gives you a greater chance of success.

If they've built a product, then you're looking for, are there revenues?

Are people have actually bought into this is the right solution for it?

They don't have to have high reviews.

They definitely don't need to be profitable, but they've got to have that strong, brave conviction.

So if people are looking at venture capital, what is the key you would say they should be watching most closely over the next 12 months, particularly if we are going to be in a high interest rate environment?

I still think you should have come back and be selective and focused on quality of companies, the early the stage focus on the quality of the team.

I do think the other thing that's important, especially for new investors, when you're a new investor coming into the early stage angle spaces,

Everything looks fantastic.

Everything looks sexy.

It's new, it's exciting, founders are exciting.

You've got to be able to sort through that and actually understand what's positive.

You've also got to realize it's very, very high risk and the likelihood of success is very, very low.

As a result of that, you need to make sure you're highly diversified.

So you can't go into it thinking I'm going to make one or two or three investments.

You know, the data would suggest you need to make 25 or 30 investments.

So you need to be high conviction, do the work yourself or invest in a fund at those earliest stages.

Sydney Angels has got a sidecar fund that co-invest alongside the Angels, which gives people that diversification.

And then when it's more data, then the other, the funds like the Aura Fund can actually get into those companies with a higher conviction and then push those ones forward.

So same question for you, Mark, what would you look out for for the next 12 months?

I think as the legwork around managing your PA investments, 25 to 30 positions, that requires a lot of reporting, a lot of headache, and the general wholesale investor or mom and pop won't necessarily have that time available to them.

I think if you look at the fund or the manager, it's track record performance, consistency, and then most importantly, we're seeing a lot of luck with on the technical front.

some of the valuation policies and the gaps in some of the way the funds mark their investments.

So I'll do their few air pockets in the valuations and how they're carrying those funds.

So I would, when you are considering a new manager, have quite a strong look at the valuation policies and their internal rigor and call it fund maintenance outside of the underlying investments, because

I guess if you, there's one thing picking and selecting good investments, but at the end of the day, you are running a fund.

So there needs to be severe process and due course in running that fund.

All right.

Well, let's sum it up.

I'll ask you both the same questions starting with you, Adrian.

If you had to sum it up, what's the one thing investors often misunderstand about VC?

Or do you want to start, Mark?

I think the perception of risk within VC, again, there's lots of entry points, the stage of investment that you're making.

We've actually done an exercise where we looked at performance historically over the last 10 years comparing property cash, inflation, the ASX200 and ventures surprisingly outperforms majority of that.

If you look at your ETF market, there's a lot of concentration of the S&P performance by way of your MAG7 or technology orientated stocks.

And because of that, your public market concentration versus pretty high.

So when you start looking at alternative investment options, venture in my mind stands the test of the time, especially with the SVCLP overlay because of the tax initiatives behind it.

And there's a field of the story to backing the next Atlassian or Canva and having a story for your grandkids.

I think it's actually similar to that in some respects is that the misconception is that venture is super high risk.

Whereas actually if you do it well and do it right, it's actually not high risk because you have that diversification that actually comes into it.

You actually get to leverage that data.

And I think you're right.

Backing those companies that actually make a difference, actually create jobs for the future is fantastic.

That's one of the reasons why I love some of the health tech related ones, because yes, you can make money.

Yes, you can build a business and these things can actually save lives as well.

So there's a lot of positives that come out of it on top of the financial returns.

Well, a sort of similar follow up, but you've only got 30 seconds.

You're in an elevator with someone who may invest with you.

What would you be saying?

Treat venture as a succession plan, not your only plan.

Let's say, get involved in the Sidecar Fund, get exposure to all the experts that are in Sydney Angels and co-invest alongside them.

Gosh, that would have only taken you to one floor, guys.

Very good elevator pitches.

Thank you so much to Adrian Vonda from Sydney Angels and Mark Esterhausen from Aura Ventures.

And thank you for watching Convicton Capital.

I'm Juliette Saly.

We'll see you next time.

Conviction Capital was brought to you by InvestmentMarkets.

To find and compare Australian investments, visit investmentmarkets.com.au