Investors in Australia

Jan 2013

(Based on a talk at a WI Investor Conference.)

“I could make anyone a good investor. I would give them a ticket with only 20 slots in it so that you had 20 punches–representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.”

-Charles Munger, Berkshire Hathaway

“The best way to do something “lean” is to gather a tight group of people, give them very little money and very little time.”

-Bob Klein, F-14 Fighter Plane Project

What is a good investor? An interesting way of exploring this question is probably what does an investor actually do, and what does a good investor do that is atypical in such a way that makes them good.

Most investors lose money the same way most startups fail. It’s their default state since both fields follow a power law distribution where most of the returns are concentrated in a small number of highly performing companies. But a failed startup is synonymous with a bad startup, similarly an investor who loses money consistently is a bad investor.

So when a good startup meets a good investor, something magical happens. Which is interesting since it is two power law distributions meeting one another. The odds of that occurring are so unlikely, yet remarkably common. Why? I think the math is missing the human element. If someone is the best at something and you want to do that same thing, of course you would want to learn from the best. So the yet to be successes gravitate towards the successful which begets more successes.

But what happens to everybody else? This is a power law distribution we are talking about and the great law of the universe is that 20% will always be in the top fifth, which means the majority are not and probably fall into one of a handful of combinations.

A good investor backing a bad startup. Or a bad investor backing a good one. God help the bad investor backing a bad startup. Which is better? A good startup with bad investors will probably still do better than a bad startup with good investors. So the market will always favour the entrepreneur side of things.

I think there’s an argument that a good investor can force a bad startup to become good but I’m not entirely sure about that. They brute force it into being successful the same way when picking a lock most of the time just raking back and forth will work.

So it’s very difficult to just become good, which is why investors take a portfolio approach to efficiently spread the risk but what that really means is they don’t know if it’s good or not. The entrepreneur equivalent of this is to be a career entrepreneur moving from one company to the next. Soon you’ll start to figure out if you’re a good entrepreneur or not since the success of the company is your metric.

I think people undervalue the role a good investor plays. Behind every great entrepreneur is probably a great investor nobody hears about. The same way behind every great artist is a great producer.

I was having an argument recently with an investor who was complaining about how he has to say no to so many entrepreneurs. I asked him why he says no to so many and he said smugly that he is very selective about his investments. I asked how many investments he’d made in the last year and the answer was none.

If you are turning down most entrepreneurs who approach you and do not invest regularly, I think that is a sign of poor dealflow. It’s not that there aren’t good companies being formed it’s that they’re just not approaching him. The good entrepreneurs are going elsewhere which is as good as saying he’s not very good. I think that made him really angry but I feel like it’s a point worth exploring.

I think the two heuristics of being a good investor are probably high quality dealflow and successful past investments. Implicit in this is that they add value. But how do you get successful past investments if you don’t already have them? I think the answer is to just be a good person and be generous. If you’re generous with your time and advice sooner or later someone will ask you to invest. Implicit in being an investor is that you’re wealthy, if you’re not then you probably shouldn’t be investing.

When people complain of a lack of innovation, I think it’s probably the fault of investors — there isn’t enough people funding it. At any given point there are plenty of innovators but few who have the financial freedom needed to innovate. In Ancient Rome, it was a government sanctioned duty to provide for the thinkers and artisans of their time. It was seen as beneficial to the health and moral fabric of society that they be allowed to hone their craft and as a result the society flourished.

Which is what I don’t understand because if someone is working on something that would benefit humanity, why wouldn’t you want to fund it? If it succeeds lots of people benefit which means everyone involved gets rich. Definitely more than 5% annual stock growth ever could, and you feel good because you’ve helped the world.

How do you fix that? I think it is partially government and partially private industry. The government has done a lot in Australia, probably more than people realise and definitely more than other countries. There is Commercialisation Australia and R&D Tax Incentives and the ASSOB as well as Tax Breaks to Venture Capital firms and the NBN. Perhaps the most significant is Government Funded Tertiary Education in the form of HECS so a quality education is accessible and within reach of everyone. The government is amazing and those criticising it are obfuscating the root cause of the error.

It’s one of those give an inch, take a mile situations. It doesn’t matter how many hospitals you build, there will always be people complaining there aren’t enough hospitals. There will always be more that can be done but it is usually more useful to focus on the point of highest yield.

When you look around at successful Australian technology entrepreneurs, the ones typically criticising the government or venture industry and asked them how many investments they made in the last 12 months, I’d bet the answer would be few, if none. Therein as the bard would say, lies the rub.

That is why it is difficult to create a self-perpetuating ecosystem. Silicon Valley didn’t emerge because the government helped it. It became self-perpetuating because the previous generation invested in the next generation ad infinitum. It is not uncommon for a Silicon Valley angel investor to make dozens of investments per year.

By 1993, less than a decade after founding the company that provided his wealth; Cypress Semiconductor, TJ Rogers had made nearly a hundred angel investments. This was in the days when angel investments were typically measured in millions. Fast forward 5 years and there were the likes of Ron Conway who began investing in 1998. Today he makes a new investment nearly every week and sometimes does so 50 at a time. Just these two individuals have backed nearly two dozen billion dollar companies.

By comparison, neither were spectacularly wealthy when they started angel investing. Modern equivalents are perhaps Dave Mclure, one of the most famous investors today, well known for his fund 500 Startups which invests in, well, 500 Startups. But he famously began investing with a net worth of less than a million dollars and had never even started a company. Or Paul Graham who began investing with a net worth in the low millions but wrote dozens and dozens of cheques which led to the creation of a school YCombinator. They now invest in startups 100 at a time in each of their class sizes and have since backed over 800 startups with a combined market capitalization of YC companies being over $30B.

That kind of success comes from a funnel they have very directly widened through their own actions. But there definitely seems to be a stopper here in Australia. The investment amount doesn’t really matter anyway. If the Modigliani- Miller theorem suggests anything it’s that the financing of a company is largely irrelevant to its success, past a certain point. That is unintuitive though and is why the common excuse of not having deep pockets is a fallacy.

Almost a litmus test for a great disruptive company is whether it can succeed without a lot of money. Until they’d reached huge amounts of traction even large iconic companies hadn’t raised much money. Google raised only $100k. Facebook raised only $500k. Microsoft only $1 million total. Ebay only $500k. They raised a lot more money afterwards but by the time they did they were already going to be successful so were a safe bet.

So the next question is why don’t wealthy Australians make more startup investments? And that is the multi-billion dollar industry fixing question. I suspect largely, it’s because they’re not very good and they don’t care. Ron Conway, TJ Rogers, Dave Mclure etc all cared. Enough to all lose millions of dollars, when they weren’t rich enough to afford it, investing in startups under the belief that the wins would make up for the losses. That’s what made them the best investors in the world. They cared.

In Australia, the investors are risk-averse. They want everything to be a win. But the whole point of a portfolio approach is the portfolio can take on the increased risk of failure and is able to absorb the losses and arbitrage that against the wins so in net end up much further ahead. The reason is actually counter intuitive.

It’s because in Australia you can get a very lucrative, near guaranteed return from the property market. So rich entrepreneurs don’t go investing in new companies, they go and invest in properties and buildings. Their money is already being put to use providing a great return without them needing to do anything. That is why they don’t invest in startups. To generate an exceptional return in startups you have to both be very good and be ambitious. To generate an exceptional return in real estate you just need to have money and can be lazy.

It’s also because they’re not good teachers. Being a good entrepreneur doesn’t make you a good investor. And what separates a lot of the best investors is that they are excellent teachers and mentors. They quite literally teach a young inexperienced entrepreneur how to build a successful company around them. Investors in Australia expect to invest money into a company and then do nothing. They are investing in startups in the same way they are generating a return in real estate.

There is however another way to look at the problem of why Australian investors don’t make lots of investments. That it is indicative of a lack of talent or interesting startups. That is the same thing as saying there is a lack of good entrepreneurs. A good entrepreneur could probably make any company succeed. The degree to which varies but I suspect they would probably be able to bring any company to its natural maximum.

What is a good entrepreneur? I’m not sure. Entrepreneurship takes many shapes. I think the best way of describing it is there aren’t enough people who know they are going to succeed even though statistically they aren’t going to. One of my favourite quotes is “The world doesn’t want you to succeed, you have to force of will it into existence.” There aren’t enough people like that. When you imagine a person and that quote fits them then they are probably a good entrepreneur.

Another way of saying that is if you would describe someone as an effective person. A lot of people when they come up against hardship break down. Almost the definition of being effective is to thrive in adversity. When I first wrote this, I googled the definition of effective and it means, “Successful in producing a desired or intended result.” Someone who does that repeatedly is a good entrepreneur.

So how do you fix that? Economically it means there is a shortage of supply and excess demand. Too few good startups trying to raise money with an abundance of capital. So to fix it we need to shift the supply curve up and create a new equilibrium. That is synonymous with saying if more startups were getting started, then more good startups would also emerge and it would force the demand curve up. Meaning it would brute force more money to go into startups.

If there are lots of good startups happening then capital from other places will be reallocated into startups. All the institutional capital will collectively be like, ok something interesting is happening economically in this area and start to pay attention to it. That’s when big hedge funds or superannuation funds will start seeing VC as an acceptable asset class.

Something that’s interesting to observe when you look at Aus is that none of the standout successes are institutionally venture backed. They’re all backed by angels or bootstrapped. That’s something really important.

The canonical example of this are the category defining 99Designs vis a vis DesignCrowd. Both are basically the same business. Both founded in Australia but 99Designs is number 1 in the world whereas DesignCrowd is 3 or 4. 99Designs was bootstrapped whereas DesignCrowd was venture funded by Australian funds. Therein begs the question, why didn’t venture funds back the business that is number 1 instead of the business that is number 4?

Venture economics suggests the number 1 in any market is usually an order of magnitude larger than its competitors due to network effects and such. That is the same as saying 99Designs is roughly X larger than DesignCrowd. If you were an investor you’d want to back the former wouldn’t you?

Isolating this is in practice is when you return the error. The venture capital industry in Australia has generated net negative returns in the last few decades. That is to say as a sector it has consecutively lost money. VC’s don’t seem to be getting the winners. Angels do. That is indicative of an endemic structural failure there.

I think it has something to do with the fee structure.

The fee structure of a venture capital firm is usually 2 and 20. Venture capitalists get 2% for looking after the money and making sure it doesn’t get lost. And 20% of what ever money the money makes. That means 20% of the returns from the success of the companies they invest in and is called the carry.

In really good venture firms that 20% is much much higher than the 2% of the capital managed. But you’ll notice pretty quickly that these are percentages. So 2% of capital managed means that if the fund has more money in it then the firm gets paid more in fees.

Sometimes these fees can be very high. And if you are a firm that does not back huge successful companies, then sometimes the management fees can be higher than the carry. If you’re not investing in really good companies then the carry will probably not be much.

What I think happens is you get a lot of people go into venture capital or private equity for the management fees. That’s not really where the wealth is created though. The wealth is created by the carry which is the same as saying the wealth is created by investing in startups and helping them become large successful companies.

If the VC industry in Australia has had net negative returns, doesn’t that mean a company accepting venture capital is in a way, predicated to not be successful? It seems to be way too highly correlated to not have some form of causation present.

So there is this cache 22 situation. Historically and statistically it is better to go at it alone than to raise money in Aus which is counterintuitive since conventional wisdom suggests you need to raise money to be successful.

This is why everybody talks about startups being hard in Australia. It’s two parameters, but one is a lagging indicator of the other. Once more good startups occur, more good investors will come to fund them which will in turn cause more good startups to occur. But for that first batch it would have been very difficult. Why is it so difficult?

I think it’s probably because venture capital in Australia is run by investment bankers and private equity people. But VC is actually a subset of private equity which is to say they are completely different but fall from the same tree.

When all the venture capital is run by private equity people it’s a little bit like someone who knows all the models and theory but ignores the human aspect. Another way of putting it is probably the difference between writing a business plan and starting a company.

It isn’t explicitly bad. Private equity firms know everything about companies whereas venture capital firms are like a hyper specialised form of private equity that know only about startups, more specifically how to turn startups into large companies.

All a venture capitalist really has to know is how to pick good companies and know lots of people who can help that company succeed. Optimizing further all a venture capital firm has to be good at is how to pick good entrepreneurs because after they’ve picked enough of them they will probably start helping each other.

The difference is usually in the life cycle. Venture capital has evolved to mean investing in a company before it goes mainstream, at any stage before that. Sometimes that means right at the founding. Whereas private equity sometimes buys big public companies.

The mistake made is that company education is centred around already existing companies and usually only large ones. So when you apply a formula used to crunch a large data set on a small data set you typically return a false-positive which is why private equity firms accidentally kill startups.

Most valuation tools don’t really apply to early stage companies when trying to figure out how much stock to take. If you measured the EBITDA of a pre-revenue startup the numbers are pretty demoralising. It’s more art than science at that stage and owning a lot of stock so early is a lot like crippling the company before it has even begun.

It defeats the purpose of investing in startups if by doing so you take too much stock and remove the founders motivation for starting it in the first place.

It’s not uncommon to meet startups in Australia that have given large amounts of stock, sometimes even as much as 50% before even reaching a Series A round of financing.

I met a guy once who said proudly he’d raised an $800k investment. But I asked how much of the company he’d sold to do so and it was nearly 80%. He, the founder only owned 20% of a company he started. Even if the company does really well, there isn’t much left over let alone for employees.

That’s not just detrimental to the company but to the whole ecosystem. It sets up a Tragedy of the Commons situation where everyone is acting in their own self interest to the detriment of the whole and sets precedence which others follow. The kind of predatory investors who would do a deal like that are probably not the kind you would want in a startup anyway.

It’s like as a breed, they are trying to maximise their stock return rather than maximise the success of the companies they invest in. Which feels so unnatural since returns in venture economics come from building large companies, irrelevant of how much stock of that company is owned. It’s like the difference between picking winners and making the most of losers which suggests implicitly, they weren’t optimistic enough to believe they were investing in a winner.

The way to own more stock isn’t to negotiate harder it’s to invest earlier. The earlier an investor invests, the less traction the startup has since they haven’t had as much time to work on it, so they take on more risk and the reward is proportional. The startup doesn’t usually change but the mind of the investor does.

At one point we were offered $300k for roughly a third of the company. But the investors could genuinely not fathom why that was a bad offer. Buying a third of the company for less than the cost of our assets was absurd. But had that offer come in 3 months earlier we probably would have taken it.

It may also be confirmation bias but the typical Australian institutional investor seems really mean. They don’t seem nice. Like they got to where they are by being bullies. I can imagine some of them when they were little having fun squashing butterflies. But if that is my image of an investor from my limited experience then something is very wrong.

I remember the first time a venture capitalist spoke to me seriously. I asked my university lecturer for advice and he said I should be careful, calling them “vulture” capitalists. The default reaction was to be wary, not excited. My lecturer not knowing any details about the company expected us to be taken advantage of. That says a lot.

It’s like the mentality of the typical Australian investor is almost to try and take advantage of rather than to help the company become successful. An investment is supposed to be a partnership between the entrepreneur and the investor and should be a win-win situation.

Venture capital is actually a beautiful ideal. It is a business model crafted to withstand stress and absorb the risk necessary for huge companies to succeed, but the way it’s practiced leaves much to be desired. It’s a bit like The Force in Star Wars, it isn’t inherently good or bad but depends on how it’s used. It’s just a tool and if used the right way creates huge value but when used the wrong way accidentally destroys it.

That’s not to say bad or mean investors can’t make money. I just don’t think they can consistently which is the real measure. In cricket it’s not the person who scores a century but the person who scores the most number of centuries that go down as the greats. If you score lots of runs then you can also get a few ducks and nobody will care.

But if the default reaction of the prototypical investor is to attempt to take advantage of an entrepreneur, something is very wrong. How do you fix that? I don’t know. If a file is corrupted on a server, sometimes it’s just easier to reboot the server.

An investor who is a mean person is probably not very good at their job. Because all an investor does is provide money and know a bunch of people who can help their companies succeed, but if they are not a nice person then other people won’t want to help their companies succeed which is to say, they are bad at their job.

That’s the heuristic I’d use. You’ll see Australia start to produce big technology companies when all the investors and venture capitalists seem like really nice people.

So if you are a mean investor, you are probably also a bad one. Something worth mentioning is that bad investors, like bad entrepreneurs or bad anything often don’t know that they’re bad. If they did then they would fix it wouldn’t they? Admitting that you’re bad at something is probably the first step to becoming good at it.

But for the entrepreneur how do you know if you’re dealing with a good investor? Personally I use email as a heuristic. That’s the battle ground of any investor since that’s where they spend most of their time. The same way a developer might spend most of their time in front of a text editor an investor spends it in front of email.

I’ve noticed bad investors don’t respond to cold emails. I had a conversation once with a legendary investor and I asked “How do you tell if a person is a good investor?” he said, “Send them an email, if they reply, they’re a good investor…”

I think his point was a good investor will follow a lead regardless of how obscure because they’re in the business of venture economics which means searching for high risk exceptional cases which can take very different forms – plus all returns are concentrated in a small number of companies and nobody knows what they look like at the early stage, so the marginal utility of replying to a few emails outweighs the time input of potentially finding something incredible even though it’s unlikely.

Back when Tramsurance was exploding, I think I emailed every Aus and US investment firm I could think of. It was at one point the most talked about story in the entire country, front page of every newspaper, magazine, tv station, radio, big international magazines etc. It was even trending. You name it, it was covered by it.

Pretty much all the good US investors replied within a day or so, some like Sequoia replied in less than an hour… But barely any Aus investor firms responded. I think that is really interesting. Indicative of something I’m not sure of but is really important.

Symptomatic of some ingrained structural issue. The key to investing is to pick them before they become successful, not after. Good US investors saw something exploding and wanted to know more about it immediately. But Aus investors wanted to see how it all would play out before wanting to know more. I think it was their way of de-risking whatever they were seeing which is a form of complacency that occurs from a lack of competition.

I used to wonder why that was. I think I know now.

The kind of person who ends up being a bad investor is the type of person who will only talk to you if they can get something out of it. And because an investor has to be wealthy, after they’ve become a little bit successful, it goes to their head. It’s the same mentality of someone in a class conscious society who won’t associate with someone of a lower status than them.

Like how kids in high school after they’ve joined the popular in-crowd won’t talk to the unpopular kids anymore. If they really were good, they wouldn’t need to do that. Like how the really cool kids don’t need to prove how cool they are.

Two fundamental mistakes I think Australian investors make is they focus too much on the startup and not enough on the entrepreneur. Most early stage companies will look really ugly at first and go through so many iterations that often the final product looks nothing like how it first started. Like how a diamond initially is just an old rock. But the lowest common denominator that doesn’t change is the entrepreneurs behind the company.

Because there are such few capital sources available in Aus, existing venture capitalists hold a position of influence not proportional to their results. If there are limited sources of capital, every success story should be backed by one of those sources. That is to say every successful company from Australia should have been backed by an Australian venture capital firm. Because really, the entrepreneur doesn’t have anywhere else to go and the venture firms get to pick and choose who they invest in. Because that doesn’t happen is very telling. It means there is definitely a bug in the code somewhere.

In economics, a lack of competition causes existing firms to become complacent. So the way to spur innovation is to displace them. The reason funding happens on such entrepreneur friendly terms in Silicon Valley is because it is a case of hyper-competition where capital is largely undifferentiated. In Australia it isn’t, so it isn’t.

The proof for this is really simple. You can tell by looking at how many investors in Aus are also popular bloggers. In Silicon Valley most of the thought leaders are investors – the reason is because their business model is to nurture dealflow. Being insightful is a form of differentiation. When there are lots of capital sources, they have to stand out from each other. That’s why you have VC’s blogging in the first place. Blogging begets branding which begets thought leadership which begets education, which helps more companies get started.

In Australia investors make less investments and there are so few of them, they don’t need to worry about dealflow. Which is why there isn’t much education in Australia, because they don’t need to differentiate themselves by becoming more than just a source of capital. It is asymptomatic. Of the top of my head, I can’t name an Australian investor who has a widely read blog, but in Silicon Valley I can name several.

A lot of people say the way to fix this is just for institutional investors to put more money into venture capital. But that line of thinking is missing how disruption works. Disruption doesn’t happen from the top. Institutional capital is risk-averse and conservative for a reason. You don’t really want to invest peoples pensions into an asset class that consecutively loses money.

It’s a bit like a box that has a hole in the bottom. It doesn’t matter how much you put in the box if it falls out the other side. So first you need to either fix the box or get a new box. Which means the best way to get institutional investors to put more money into startups is to fix venture capital. The best way to do that is to displace them.

The way to displace an incumbent is to create more competition but an organic increase is insufficient. It has to be like the proverbial rug being pulled from under the feet of the watchful emperor. To do this is quite literally for more capital to flow into the startup space at every point on the continuum along the curve. What that means is everyone wealthy enough to make startup investments should be. As a result the big firms will have to change or risk becoming irrelevant. That increase in competition will, like water rising in a sealed room, force those in it to learn to swim.

To in a proverbial sense put my money where my mouth is. I’m going to start making startup investments. As of now I am now an investor in startups with the investment amount matching the amount of disposable liquid assets I have. The remainder of my net worth is, thankfully, illiquid. And I’m only going to invest in ideas that are yet to formed.

There. If a broke 19 year old understands how to fix the error then the average millionaire is certainly capable of doing so.

I think a mistake entrepreneurs make in Australia is trying to convince investors to back their startups. The best way to get an investor is to just build something really great not to actively try and convince them. They will fait accompli realise how great it is by observing the natural evolution of it.

So after an investor does invest what do you do with the money? I think the two ways of using investor money are to either increase the runway ie extend the life of the company or to grow faster. But which is better? I think I’d likely side with the former as it means the company is around for longer, implicit in that is it is growing albeit at a slower rate.

The side effect of being around for longer is that more stuff happens to you. Another way of saying that is you get luckier. When companies run out of money they die. So why the founders would spend all the money seems unintuitive.

Salaries become a problem. I’ve never understood why startup founders would want to take large salaries using investment money. It seems detrimental to the company. They have stock regardless so will already be well compensated if it is successful. A salary from the perspective of the investor is basically just giving money to someone.

The same kind of works in reverse. The investor equivalent of this is probably when an investor takes a salary for taking a board seat or advising after making an investment. This is common in Australia. That is the same thing as the startup using investor money to pay a salary to the investor. Investors win when the company wins but by paying a salary to an investor does two things: It causes the company to run out of money faster and misaligns the priorities between founders and investors. This is symptomatic since there is a relatively small sample size of investors and if a lot of them are doing something then it is accepted by the industry.

Or a startup co-working space that charges its companies a lot to work out of it depleting its cash reserves early on. Something I think would be really interesting is if a co-working space took an equity stake in all of their companies instead of charging rent. That way the co-working space lives or dies of the back of the companies in it. I think it would breed a sense of camaraderie and all the companies would be pushing each other to do better because of it. The companies would have to succeed since losing your office is a really strong motivation.

When you hear people complaining about raising money in Australia is kind of a misnomer. It’s easy to raise money in Australia just not at terms the founder wants because it usually means pricing the stock lower. More people always buy something when it’s on sale. The price and interest are inversely proportional. But that means giving away more stock for less money.

Founders always assign an implicit value to their creations as its worth. It’s a bit like employment, a PHD in computer science would easily get a job at McDonalds but she probably wouldn’t take that job if she felt it was unbefitting of her level of education.

It’s the same thing with startups. Founders don’t want to give away equity even if it means they’d be able to raise money easier. For the most part, they’re right. They shouldn’t have to. And after they’ve gotten enough traction then they don’t need investment anyway. So the answer to getting good terms is to have lots of traction.

Investors are typically growth investors. Not enabling investors. The difference is an enabling investor will fund an idea to see if it will work whereas a growth investor will only fund something already operational. That is a fundamental difference and I think a common misunderstanding from startup founders.

That is the misunderstanding I think is happening in Australia. Both sides of the coin are looking at each other and wondering why it’s flipping. It’s not funds that aren’t available. It’s a certain type of funds, one that is structured to support early stage companies. If entrepreneurs realised this, they’d know immediately what to look for.

I think the reason Australia doesn’t have many enabler investors is because there is a lot more risk involved. There is a higher probability of companies dying even against a backdrop of high risk companies.

Risk is something else which is different in Australia. Typically an investor would take a 10% shot at hitting 100m against a 90% shot at 10m. These are the same probability-wise but venture economics suggests the former since the risk is mitigated by having a portfolio. But the typical Australian investor would pick the latter since they don’t have deep enough pockets or make enough investments to have a broad enough portfolio to absorb the risk.

Plus there isn’t enough liquidity. People don’t see enough liquidity from startup investments so they make less of them. I think that’s an important point. It’s more important to reduce the risk of an investment rather than to maximise the return. They also don’t see enough other rich people making investments so they don’t make them.

Another is a feeling of loss. I once read that you can tell a good venture capital firm or investor by how many successful companies they missed out on. There is nothing quite as motivating as the feeling that you’re going to miss out on something huge. But in Australia there aren’t enough successes to create that feeling.

If an investor doesn’t invest in your startup and it fails, then the investor was right. It wasn’t really worth investing in. I think the feeling entrepreneurs need to give an investor is that what they are working on is going to succeed with or without them.

I think luck has a place in all of this. It may not be measurable but it’s worth mentioning. If there was a measurement of luck, whatever that heuristic would be, it would be higher in Silicon Valley. Australia doesn’t have that just yet. If you spent a day in Palo Alto you might walk past a handful of people who could potentially acquire your company.

How do you break that cycle? Probably by making more investments. That effect would domino. There is a certain critical mass that needs to be exerted to create an ecosystem that invests in itself.

Another interesting metric is the time to market. If you looked at all of the large Australian companies and plotted how long they took to become large successful companies. Something interesting happens, you’ll notice it takes between 10-15 years. That’s the time it takes for a billion dollar company to be formed in Australia. That means returns from an investment occur 15 years after it was made. That’s a long time.

But investors are all looking at Silicon Valley and seeing unrealistic growth like Instagram sell inside 2 years without taking into account their own environment. So from the get go most walk into an investment with unreal expectations of the return, expecting an exit in 3-5 years, less than a third of how long it actually takes.

The time taken for a company to reach that milestone is directly proportional to how much investable capital is present. That sounds intuitive but in practice it isn’t. A company that takes 15 years is growing much slower than a company that has investment in its early stages. When the amount of money flowing into startups increases, you will see that number decrease as a byproduct and as a result you’ll see a lot more big companies.

It’s pretty exciting though. Because there are such few capital sources it means every new investor widens the funnel significantly. So it means a new investor in Australia will have an immediate impact on the ecosystem.

Most startup investors invest to try to make money. I think that’s the wrong way to go about it. Investing in startups is a higher calling. It’s like the purest transfer from idea to wealth creation. Something new that didn’t exist now does. Making money is just the capitalist incentive necessary to do that.

Investors can make a lot of money but if they provide little or no social value it is sometimes more destructive than if they had made none at all. The same way a fire might suck all the oxygen out of a room leaving everything in it to die.

That might sound silly but economically the role an investor plays is risk allocation. They spread the risk of a venture across a portfolio so the entrepreneur has enough funds to bring their company to life. People forget that.

The relative failure or modest success of a portfolio is just the expense of being able to provide enough fuel or a large enough launchpad for that big innovation to succeed. It’s the cost of doing business. Venture economics is the only business model that can absorb so much risk and still make money.

I think entrepreneurs forget that too which is why so many are trying to raise money for what is just a tech version of a small business. Investors are there so when they go for that big project that will probably fail but if it succeeds will be beneficial to humanity, that’s when you should approach investors.

Investors in turn are supposed to be on the lookout for these companies. When they back them, that is when the wheels are in proper alignment and the machine is functioning correctly. When they don’t is when innovation and in turn the economy suffers.

But I think all of this is probably a positive. It acts as a trial by fire. The ones that were going to die will just die sooner. The companies that were always going to be successful just take longer to get there. The ones caught in the crossfire can’t be quantified so they as good as never existed.

There is a kind of bird, the yellow weaver, who nests upside down in a water cavern. At birth all of the hatchlings plummet to their deaths. If they don’t learn to fly in the instant after they’re born – they die. The ones that learn to fly carry on the species. That is kind of how the startup ecosystem is in Australia.