Less is more for Australian startups

Australia's startup ecosystem has come a long way over the past two decades, but there remains a big difference between the local market and the homeland of the ecosystem that it is working to emulate: Silicon Valley.

The domestic startup sector is seeing more and more entrants vying to pony up money to help early stage businesses get off the ground, but when it comes to more substantial later-stage funding, the dollars tend to dry up.

However, the economic foundations underlying California's technology sector -- and the United States' tech industry in general -- run far and deep, with numerous wells from which to draw rich seams of funding. Some of the larger venture capital firms in the country manage funds worth billions of dollars.

In March this year, US venture capital firm Accel Partners raised two new funds with a combined value of $1.48 billion. The organisation alone manages funds that claim a cumulative value of more than $8 billion.

Its investment portfolio reads like a roll call of the world's most recognisable internet companies, including Facebook, Spotify, Dropbox, 99 Designs, Etsy, and Australia's own Atlassian.

By comparison, the Australian Private Equity and Venture Capital Association Limited (AVCAL) estimates that Australia's total venture capital fund tally comes in at just under AU$2.19 billion.

According to AVCAL, Australia's total private equity and venture capital investment for the financial year ending 2014 came to AU$2.5 billion -- a 13 percent fall from the previous year's investment tally.

Venture capital firms invested a combined AU$516 million in Australian businesses during the year, according to the organisation's 2014 Yearbook, with almost half (AU$266 million) coming from US-based VC firms.

Additionally, venture capital fundraising in Australia fell by 21 percent compared to the previous financial year to AU$120 million across four funds, according to AVCAL's annual report.

This drop in local VC fundraising has coincided with the Australian government's decision to cut hundreds of millions of dollars of public funding from programs aimed at providing startups with capital and assisting them commercialise their products and innovations.

This perceived lack of support for the local startup sector may at first glance appear bleak, but there could be a silver lining.

The absence of seriously cashed-up venture funds and other backing may in fact be encouraging local tech entrepreneurs to develop a compelling market offering early on in their businesses' life cycles, giving them no other option but to establish a profitable model from the outset.

Australian startup star Atlassian was turning a profit and gaining industry clout for years before receiving its first substantial external capital raising round.

Atlassian founders Mike Cannon-Brookes (L) and Scott Farquhar.

 (Image: Atlassian)

Founded in 2002 by Scott Farquhar and Mike Cannon-Brookes, Atlassian bootstrapped off the back of credit card debt in its early years, but by 2004 it claimed more than 2,000 paying client companies.

A year later, it opened its San Francisco office. It wasn't until 2010 that the company saw its first major capital round, in the landmark $60 million investment it received from Accel Partners for a reported 20 percent of the company. By that time, however, the company already had enough dough to shell out on its 2007 acquisition of developer suite maker Cenqua.

Farquhar and Cannon-Brookes showed early on that it was possible to build a tech company from Australia without masses of later-stage, or even mid-level, VC investment.

Rush to revenue

The ability to build a successful international business out of a startup operating in a market with minimal mid- to late-stage investment dollars, as Atlassian did, is an achievement made possible by an early focus on product and immediate revenue, according to Scribd and Parse founder Tikhon Bernstam.

While both of Bernstam's brands have gone on to lofty commercial heights with the help of funding from US-based VC firms every step of the way, startups operating in markets with a funding shortfall are often built for profitability from their inception.

"If I was starting a company from scratch, and it was my first one, I would really focus on something that immediately was generating revenue." Scribd founder Tikhon Bernstam

"You get more resilient, because you're not going to get funding as easily, so you're going to have to grind things out harder, you're going to have to be more persistent, and get by on less resources," Bernstam told TechRepublic.

In contrast, the development of Scribd, which occurred primarily in California's San Francisco, was not initially driven by a focus on profit, but rather on building a large user base with which to establish monetisation further down the track.

"For Scribd, we didn't monetise that for years," he said. "We could never have done that anywhere else."

However, in almost any other market on the planet, Bernstam believes that building a profitable, resilient business from its earliest days is the only way to go.

"I think you have to show incredible traction or revenue and growth much sooner than you would if you were a Silicon Valley company," he said. "If I was starting a company from scratch, and it was my first one, I would really focus on something that immediately was generating revenue."

This is precisely the trajectory that Sydney-based online design startup Canva has taken, with co-founders Melanie Perkins and Cliff Obrecht setting up the platform to turn a profit from day one.

Guy Kawasaki, Melanie Perkins, Cliff Obrecht.

 (Image: Canva)

It helps that prior to Canva's worldwide launch in August 2013, Obrecht and Perkins had launched an online school yearbook design product called Fusion Books. This was established in 2007, while the two were still at university, and was also designed to generate revenue from the very beginning.

"We built our first company, Fusion Books, which was organically funded so that had no external investors at all," Perkins told TechRepublic. "That was really beneficial, because it enabled us to grow a profitable company, to learn all about business, to build a product, and to launch internationally.

"I feel so fortunate that we had a company for so many years without having investment, because I think we learned so many more things. I think that investment can actually be a time bomb," she said. "When you get investment, you have to be delivering, and you have to be executing, and you have to have growth curves that are going like crazy."

Canva's business model comprises a mix of free online design services combined with a paid image library, which users can purchase for a relatively nominal flat fee. This blend has ensured that the company has effectively generated revenue since its launch, while also building its user base, which in turn increases its revenue.

According to Perkins, Canva's early years prior to its global launch revolved around building a product and an offering to solve a specific problem for potential users, with the question of funding only coming into the equation later on.

In fact, Perkins confessed that in the beginning, she didn't know that venture capital opportunities existed for entrepreneurs like her and Obrecht.

"Certainly, when we started out, we didn't know what venture capital was," she said.

However, it wasn't long before the company attracted the interest of venture capitalists both locally and further afield, including Blackbird Ventures, Square Peg Capital, and Matrix Partners. In July, Canva announced that it had raised $3.6 million in its second round of funding, in addition to the $3 million seed funding it had raised in March last year.

While the company has received some serious early stage coin by Australian standards, it was never the primary goal to garner such backing, with Perkins and Obrecht first focusing on what they could offer users, rather than where they would find their next cash hit.

"It's very important to first see a problem, build a product to solve that problem, and ensure your users are happy with the product that you've built, and I think that sometimes, people think that funding is the ultimate goal," said Perkins. "Internally, as a company you need to be focused on the right things, which is delivering value to your users.

"If you're a first-time entrepreneur, I think it's a really great process to actually build a product and sell the product before you start looking at funding. For us, that was one of the most valuable experiences I could have possibly imagined. If we'd been given significant amounts of investment early on, it would be very, very challenging to execute," she said.

Connections in the Valley

Canva's backers include Facebook's director of engineering and former Google Maps co-creator Lars Rasmussen, Yahoo CFO Ken Goldman, Seek co-founder Paul Bassat, and VC extraordinaire Bill Tai, who has invested in more than 110 companies, including TweetDeck, BitFury, and Australia's Shoes of Prey.

In July this year, former Apple chief evangelist Guy Kawasaki also came on board as Canva's chief evangelist, with the aim of boosting the company's presence in the US.

While the financial backing has certainly been a boon, allowing Canva to speed up its expansion, Perkins believes that the more valuable part of all of this attention both at home and abroad has been the advice and connections provided by some of Australia's and Silicon Valley's best.

"Bill [Tai] introduced me to Lars Rasmussen, who founded Google Maps, and it was through his networks that we ended up meeting a lot of investors over in San Francisco," said Perkins. "We've been very fortunate to have a great group of investors who have had incredible experience -- and we can tap into their networks."

This has certainly been Bernstam's experience with Scribd and Parse; he argues that Silicon Valley has a much richer offering than merely the cash injected from investors' fat wallets.

I think that investment can actually be a time bomb Melanie Perkins, Canva co-founder

"It's not just about the money, it's the people that help you when you're going astray," he said. "That's incredibly valuable, because it's very easy without help to go in the wrong direction for a long time.

"We started Scribd in Boston, but in San Francisco, in Mountain View and Palo Alto, you feel this completely different energy, in the sense that there are many smart people that have done so many amazing things, and they're all happy to talk to you, and give you advice, and you're a first-time founder and you have no idea what you're doing," he said.

This was one of the key drivers behind the move to California for Australian-founded online document collaboration startup Nitro, with the company's founder and CEO Sam Chandler arguing that the move to San Francisco from Melbourne was more about connections than funding.

"When we made that decision, it wasn't just about capital; it was also about accessing talent," Chandler told TechRepublic. "The Bay Area's culture -- there's an openness to new things, an embracing of new things in the Bay Area that is unlike anything else. It's not just about money."

It would be disingenuous to suggest that Nitro hasn't heavily leveraged its headquarters' San Francisco location to connect with US-based VC funding. Just last month, the company secured a $15 million funding round from Massachusetts-headquartered Battery Ventures, which has raised more than $4 billion in its 31-year history.

However, Chandler maintains that when the company moved its HQ from Australia in 2008, it was to tap into the Bay Area's rich pool of talent, and to plumb its tight-knit network of tech players for advice and connections.

"We made this decision back in 2008, and at the time, the Australian technology startup ecosystem was not very developed, was pretty immature," said Chandler. "There were a handful of startups that were having some modicum of success -- like Atlassian -- already on the scene, but there wasn't this rich ecosystem of companies of all sizes that we've got today.

"So, there just wasn't the expertise that we needed. When we looked across the organisation, whether it was technology sales people, technology marketing people, and particular types of software engineers -- there just wasn't the talent pool.

"It was actually not for the money, but more for the people. But we also knew, in the case of going to the Bay Area, that if we ever wanted to access the capital markets, that was the place to do it," he said.

After raising around AU$1 million in seed funding from friends, family, and acquaintances in 2007, Nitro moved to California as a profitable company and continued to build its business without any further funding, until it received AU$6.6 million from -- ironically -- Australia's Starfish Ventures, based in Nitro's hometown of Melbourne.

Home-grown hustle

While Nitro's trajectory saw it fly the coop early on, only to receive substantial funding from the very nest from which it had flown, local startup success story Appster -- also founded in Melbourne -- has followed the self-funded route, with no small amount of advice from Silicon Valley along the way.

Appster founders Josiah Humphrey (L) and Mark McDonald.

 (Image: Appster)

This model has turned out to be a winning formula for Appster, which was bootstrapped to profitability and now employs 150 people across three continents, with offices in Melbourne, San Francisco, and India.

"We didn't raise funding from the US," Appster co-CEO and co-founder Mark McDonald told TechRepublic. "Because we started in Australia, we didn't have the option to go and raise a couple of million dollars."

However, that didn't prevent McDonald and Appster co-founder and director Josiah Humphrey from opening an office in California, getting plenty of advice from Silicon Valley-based tech entrepreneurs in the process.

In fact, the company announced in August that it had taken on David Jacques, PayPal's former CEO and current CFO of 500 Startups, as one of its growing list of strategic advisors, along with Virgin Australia's former COO Liz Savage.

While McDonald concedes that Australia's startup landscape is somewhat bereft of VCs with deep pockets compared to the US, the local ecosystem possesses some of the other elements of the Silicon Valley mode, such as the incubators, accelerators, and community meet-up events.

Although these local opportunities haven't entirely replaced the benefits of connections further afield and advice from some of California's best, it does give local startups a fighting chance to establish a profitable business without tens of millions in late-stage funding.

"In Australia, I think that's kind of common," said McDonald. "A lot of these early stage companies, they don't have any options, so they do bootstrap them. They hustle, they go sell; they find a way to monetise early.

"They do it because the options aren't here. It's interesting that there are a lot of Australian entrepreneurs in Silicon Valley. I think what tends to happen is that they build it [the product offering] here -- the prototype here in Australia. They start making a little bit of money here, and then they go and they grow it in the US. I think that's the standard model at the moment," he said.

Appster is making moves to expand further into the enterprise end of the market, but has for years worked with local startups to develop innovative app ideas. This experience has given McDonald a unique perspective of the Australian startups scene, which he believes often possesses a greater focus on developing compelling products early on in a business' life than in other markets.

"I think it's a better way to build a startup ecosystem in Australia, with a lot of well-executed products," he said. "And that's why we're very passionate about the model we have, versus other companies in the space.

"I don't recommend that early stage startups get into debt, because a lot of the time, equity financing is the highest risk. In the later stages, when companies have the cash flow and a revenue, that's the time to take on debt.

"I don't recommend that early stage startups get into debt, because a lot of the time, equity financing is the highest risk. Appster co-founder Mark McDonald

"But the problem is finding the product market part; something that people want to use. The most risky part is then, when you're just trying to get users on board, and trying to figure out what people want to use," he said.

However, given the Scribd founder's view of Australians, taking on risk should be no problem for local tech entrepreneurs.

"I've noticed there's largely a cultural thing happening, where just in some countries, people are very risk averse," said Bernstam. "The Australians I've met are incredible risk takers, so if that generalises at all, then I don't think that's a problem.

"Even just travelling, it's often the Australians who will do the craziest cliff-jumping type of thing. So, I think the risk-taking attitude is more similar to America in that sense, based on my sample size of, like, 10 Australians," he said.