Australia’s startup ecosystem will face a tipping point in the years ahead as the sector continues to mature, Dan Gavel says.

Sure, early-stage tech investment is happening; there’s now a healthy list of local venture capital funds, mainly providing seed and Series A funding rounds.

And as a director at Black Sheep Capital, Gavel knows what it takes to get companies off the ground.

The Brisbane-based VC fund invests in pre-seed, seed and Series A rounds for Australian startups, and counts Sendle and Airtasker among its investment success stories.

But as VC funds move closer to the end of their seven-to-ten year investment time frame, questions will start to be asked. Specifically, where are the exits?

In an interview with Stockhead, Gavel says those questions may grow increasingly louder over the next couple of years. At the same time, he expects there’ll be some positive answers.

“Is anyone actually close to what you would call a big outcome? Yeah, there probably are — everyone’s got someone in their portfolio where they’ve probably almost banked the money and said ‘this one’s ready to go'” he says.

But at this stage it’s more of an all-or-nothing approach — funds hold their stake to the end, and trade sales or IPOs are generally viewed as the only viable exit strategies.

Gavel says that will need to change if the local market is to continue its development.

When second(ary) is better than first

“My biggest thesis is we need a secondary market — a really developed secondary market where players can get in and out on a regular basis,” Gavel says.

“Because there’s going to come a point where VC funds have to answer to their limited partners (LPs). Whereas if there’s a more developed market, you’d constantly be getting returns you could give back to LPs which would feed into more funds.”

Summing up the local startup ecosystem more broadly, Gavel said there’s plenty of activity in early stage investing up to Series A rounds which are typically around the $2-$5 million range.

It’s the next stage up — companies that are looking for $10-$20m in Series B rounds — where there’s a big void. In turn, the creation and development of a liquid secondary market would help fill it.

As with many aspects of the local tech scene, Gavel looked to the more mature US market as an example of how private sales help spur activity in the sector.

“Not all exits come from a trade sale or an IPO. I’ve been to San Francisco a lot, and you talk to VCs who say I got into such-and-such company at Series C, Series E. It’s like a rite of passage,” he says.

“From that comes a lot of stuff — some of the best performing funds in the US are operating in this secondary market. What it does is it democratises the purchase and sale away from VCs a little bit.

“Our market just moves flat, everyone’s in a similar space. Some funds might have a niche — say, they only invest in B2B SaaS platforms. But the reality is there’s not enough depth for people to stick to that. And then you’re even more limited because you can’t buy other people’s shares.”

All or nothing

At the same time, all that doesn’t mean Australian VC investors have closed themselves off from finding a potential diamond in the rough.

“Any company that should’ve been funded in Australia has been funded. No one’s missed out,” Gavel says.

However, “there’s a lot of deal flow, but it’s still a tight market for high-growth deal flow”.

In other words, the current market environment means investors are pretty cagey and protective when it comes to companies that look to have a winning strategy.

“We’re almost the opposite to the US in the sense that they invest in wolf-packs. It’s like ‘yeah, we love these guys, we’ll invest together and we’ll all put in $1m each’. In Australia, it’s ‘I want all of that interest’.”

“And that again creates some issues around the market maturity because there’s not enough to go around.”

Aussie VCs be all like…

Gavel says that on one hand, that’s a good thing for Australian investors because current valuation multiples in the local market are more attractive than the US.

But at the same time, some nuance and overlays need to be applied to that line of thinking. For one thing, US investors have a tendency to think in much more specific niches — e.g. they’re less afraid to throw some money at a junior startup with a couple of founders who are just out of college.

In addition, “you can’t just be a VC fund and say I’ve got $50m”, Gavel says.

“People would go are you cyber? Are you AI? what’s your thesis? If you don’t have that clear differentiation, you won’t get anything.”

Where to?

So, what does Australia have to do to advance its secondary market, and provide more liquidity for larger funding rounds?

Like many industry players, Gavel said the increasingly propensity of large super funds to dip their toes in the VC waters will play a role.

The HostPlus industry fund run by Sam Sicilia — generally regarded as a leader in the field — has around $1 billion of its $36bn in funds under management devoted to VC investments.

Gavel said he’d met with some of the country’s largest super funds, and found riskier VC investments are still a tough sell for managers who are accustomed to running conservative portfolios.

But a bit more risk-on appetite would be good, he says. After all, devoting $500m of a multi-billion dollar portfolio towards is unlikely to move the needle too much — particularly over a medium-term timeframe.

But for Australia’s tech scene, “things would happen with that amount of money dumped in, because you’d start to get differentiation”, Gavel says.

Particularly for the all-important Series B rounds — after all, capital flows from super funds are unlikely to be directed at $500,000 seed raises.

“For us to get anywhere, we need more activity in that $10-$20m range,” Gavel says. “Right now, a lot of companies in that range go offshore, to Asia-Pacific markets like Singapore.”

“I think it’s coming though. I think the biggest issue for super funds isn’t releasing their own cash, it’s getting over their own internal thesis of whether they see a market and how they should go into it.

“There’ll come a FOMO (fear of missing out) point because if three or four big ones go in, then everyone will drop because you can’t not be in it.”

He also forecast that more interest will come from elsewhere in the financial sector. If not the big banks, then smaller institutions such as mutual funds or credit unions.

“I think money will start coming from places you don’t necessarily expect. There will have to be a tipping point.

“The thing is — and as harsh as this sounds — someone’s going to have to lose for everyone else to win.”