Creating opportunity

Removing the obstacles that block business creativity and the commercialisation of innovation could help start-up entrepreneurs flourish into much bigger businesses, writes Tony Featherstone.

Start-up entrepreneurship and governance at times seem like polar opposites. The former is about creativity, speed, risk-taking and managing during extreme uncertainty. The latter is mostly about strategy, compliance and risk management in established organisations.

But the coming entrepreneurship boom has huge ramifications for company directors and the governance community. After decades of neglect, Australia’s entrepreneurship ecosystem is starting to flourish, in turn creating opportunities and risks for boards.

“From a tech perspective, Australia is on the cusp of an entrepreneurship boom,” says Future Capital Development Fund co-founder and chairman, Domenic
Carosa MAICD. “There is much more money around to fund promising ventures than there was a decade ago, and the cost of starting a venture has fallen dramatically.”

Carosa is a non-executive director of the emerging listed companies Shoply and Qanda Technology, and is listing the promising Crowd Mobile on the Australian Securities Exchange (ASX) via a backdoor listing. His pooled development fund, Future Capital, provides funding and strategic board direction for emerging companies.

Carosa says better access to finance is creating a stronger ecosystem for entrepreneurs. “There’s been a lot of progress in the last 10 years, but much more still needs to be done, especially around having a stronger business judgment rule to protect directors of start-ups, and on the taxation treatment of employee share ownership plans, to allow tax to be deferred.”

The latest Global Entrepreneurship Report (GEM), which compares entrepreneurial activity across countries, found Australia’s entrepreneurship rate was second only to the United States, with almost one in 10 adults starting or running a new business in 2011.

The report identified 1.48 million people involved in early-stage entrepreneurial activity. By capturing small business, GEM data arguably inflates entrepreneurial activity in Australia. But it shows the potential to turn more small business owners into entrepreneurs who form advisory or formal boards as their venture grows.

The latest EY G20 Entrepreneurship Barometer ranked Australia in the top quartile of countries for fostering entrepreneurship, alongside the United States, United Kingdom, Canada and South Korea. Australia also ranked second on education and training, fifth overall on entrepreneurship culture and access to funding, seventh on tax and regulation, and only 15th on co-ordinated support.

Equally telling is the entrepreneurship activity bubbling beneath the surface. “A decade ago there were a handful of venture capital firms funding early-stage ventures,” Carosa says. “Now there are dozens.” Rapid growth in the incubator model, which speeds up the funding and development for start-ups, and likely regulatory change to allow equity-sourced crowdfunding, and formalise the “friends, family and fans” component of start-up finance, are other positive developments.

Realising potential

In the next few years, these developments could lead to a wave of start-up companies raising capital through an initial public offering (IPO) and listing on the ASX or an offshore bourse. ASX has said publicly that it wants more technology companies to list on its exchange and it wants to become a regional Asia-Pacific hub for the booming technology sector. As more start-ups list, more boards will be formed to ensure these organisations comply with ASX Listing Rules, creating greater demand for company directors.

Other developments also have potential. More universities and schools are teaching entrepreneurship than ever before. There is greater coverage of entrepreneurs in the media and much-needed recognition that entrepreneurship is no longer a dirty word associated with failed business owners from the 1980s.

The stakes are high. “Australia urgently needs to develop a stronger culture of enterprise,” says Dom Talimanidis, the Ian Mence Fellow of Entrepreneurship at the Institute of Public Affairs (IPA). “We have an economy in a period of sustained transition as the mining investment boom plateaus. The next tranche of new jobs needs to come from small and medium-size enterprises that have capacity to grow.”

The bad news is there are still too many obstacles for entrepreneurs. Australia’s knack for starting fast-growth ventures is not matched by its ability to grow them into multi-billion-dollar global enterprises. For all the promise, Australia is yet to develop an equivalent of Facebook Inc., Twitter, Google, Apple or the Chinese e-commerce outfit, Alibaba Group Holding, which broke records with its IPO and US $231 billion valuation this year.

Red tape is still a big problem. Job Capital founder and managing director, Jo Burston, was frustrated when launching her second venture, Rare Birds, a for-profit social venture that provides education, mentoring and networking for female entrepreneurs. Burston has been recognised as one of Australia’s top 30 female entrepreneurs by the website SmartCompany.

“It is too difficult for entrepreneurs to get information from government on programs, grants and funding,” Burston says. “Entrepreneurs come to me and ask, ‘where can I access guidelines to see if my enterprise is eligible for a grant?’ I tell them I don’t know. Governments have a habit of closing one program and leaving everybody in the dark before a new one starts. I tried talking to government about Rare Birds but I struggled to find someone who could tell me anything.”

Market barriers

Lack of co-ordinated information for entrepreneurs at a federal and state level is compounded by myriad other problems that inhibit start-ups. They range from an industrial relations system that reduces labour-market flexibility, a payroll tax regime that should have been abolished years ago, and inadequate protection of small suppliers in duopoly-like industries.

Australia ranked 54th for labour-market rigidity and 128th on the burden of government regulation, out of 144 nations, in the 2014-15 World Economic Forum Global Competitive Index. Australia also slipped out of the top 20 globally competitive nations for the first time, falling to 22nd and was overtaken by New Zealand.

The previous federal government introduced 21,000 regulations between 2007 and 2013. A small enterprise with fewer than 50 employees, on average spends $28,000 and 500 hours each year complying with their tax obligations, according to IPA.

Removing these impediments would help entrepreneurial ventures capitalise on this country’s improving performance in innovation and commercialise their ideas. Australia achieved its high ranking of 17th in the latest Global Innovation Index Report, which measures the pace of innovation in 140 countries, but it only ranked 22nd on innovation outputs, up from 32nd place a year earlier.

The federal government is heading in the right direction when it comes to entrepreneurship. “There is certainly a willingness in government to help small business and entrepreneurs,” says Start-Up Australia co-founder, Brian Sher. “The government is saying all the right things about reducing red tape and regulations, and getting out of the way. And in my discussions with the federal Small Business Minister, Bruce Billson, it is clear the government is very open to ideas.”

Sher is a successful serial entrepreneur who has founded nine companies. Start-up Australia, a not-for-profit enterprise, was established in 2012 to support entrepreneurship.

The government announced the $484.2-million Entrepreneurs Infrastructure Program in the 2014-15 budget, to streamline access to grants. But in doing so it axed several bodies that helped start-up enterprises, details on the infrastructure program are thin, and the entrepreneur community seems confused about this initiative.

The government is also expected to respond this year to the Corporations and Markets Advisory Committee (CAMAC) proposal on regulatory changes for equity-sourced crowdfunding, a rapidly developing global market that allows entrepreneurs to raise small amounts of capital from investors via the internet.

More favourable tax treatment of employee share schemes for start-up companies, as part of the delayed findings from the National Industry Investment and Competitiveness Agenda, chaired by Prime Minister Tony Abbott, is also expected. (As Company Director went to print, media reports suggested the governent was about to finalise new rules on employee share plans, making them more attractive for small companies). Entrepreneurs have long complained that taxing employees on share options they receive from employers immediately, rather than when they vest, damages the local entrepreneurship ecosystem and creates a disincentive for employees to take shares in their venture, in lieu of higher salary.

Company directors should be aware of these trends. The first prerequisite of an entrepreneurship boom is in place: more people starting ventures, receiving specialist support and advice, better access to funding, and stronger innovation networks. But the second part, removing obstacles so more start-up ventures can grow into multi-million-dollar ventures, is a work in progress.

Nobody knows how Australia’s entrepreneurship ecosystem will evolve. When it does, established companies will have more start-ups biting at their heels and disrupting established markets, and greater opportunities to acquire promising start-up ventures.

Company directors will also have more opportunity to join the boards of fast-growth ventures – provided there is sufficient protection – and add directorships of promising small private or public companies to their portfolios.

Perhaps the biggest opportunity is linking start-up entrepreneurs with established company directors who provide advice, mentoring, access to networks and possibly capital. And who help starts-up embed strong governance systems, tailored for emerging ventures, at the start.

With almost two million businesses in Australia, and many others on the way, there is potential for hundreds of thousands of new company directors in coming years. Only a fraction will build successful ventures and form advisory or formal boards, but it will take only a small uplift in entrepreneurial activity to make a big difference for the governance community.

Far from being polar opposites, start-up entrepreneurs and company directors might have more in common than many realise, if the government can reduce critical obstacles that prevent business creativity and innovation being commercialised into much bigger business.

Company Director asked several entrepreneurship experts for their ideas on how Australia can build a more vibrant enterprise culture, and distilled the views into 10 core areas:

1. The role of government

The federal Minister for Small Business, Bruce Billson, told Company Director in February 2014: “We have significant work ahead to create a stronger entrepreneurship ecosystem. The Prime Minister has provided his encouragement to me to identify and eliminate policy barriers for innovators and entrepreneurs. We must also consider cultural obstacles for entrepreneurs in Australia, and celebrate self-employment, business formation and success. Although we know a great deal about entrepreneurs from small enterprise and family business, we know less about the type of cutting-edge entrepreneurship that can transform economies.”

Therein lies the problem. Governments past and present have mostly focused on small business, and some have confused it with entrepreneurship. But the entrepreneurship community is hopeful this government can address shortcomings on entrepreneurship policy.

Dr Tim Mazzarol, a Winthrop Professor with UWA Business School and a prominent business academic, says there is a risk that governments try to replicate overseas entrepreneurship ecosystems, such as Silicon Valley in the United States, or try to pick industry winners. “Government should work on addressing market failures such as stimulating entrepreneurship in regional Australia. Ultimately, it has to encourage the private sector on entrepreneurship and get out of the way.”

Mazzarol adds: “Government should not try to pick industry winners and provide handouts. How many state governments have wasted taxpayer dollars over the years trying to build big life science industries, for example? Industries that are growing strongly, or have potential to grow, usually have capable entrepreneurs who do not need handouts. The challenge for governments is to remove obstacles in the way of a stronger entrepreneurship ecosystem, but not over-engineer it. They must accept the ecosystem will grow in unexpected ways.”

2. Energise small business

Purists point out that start-up entrepreneurship and small business are different things. One is focused on high-growth ventures, the so-called “gazelles” that can grow revenue by 20 per cent or more annually for five years. The other focus is on businesses that often have lower growth/risk aspirations or might be regarded as a “lifestyle” enterprise for the founder.

But about 1.96 million of two million registered businesses in Australia are small and medium-size enterprises, and within that 60 per cent are micro-businesses, Mazzarol says. “We often see governments trying to stimulate high-growth ventures and overlooking what they already have in their backyard: millions of small businesses with potential to grow faster. Helping even a fraction of those businesses become more entrepreneurial would have great benefits for the Australian economy.”

Like others interviewed for this feature, Mazzarol says payroll tax and industrial relations law are key impediments to small businesses hiring more people and growing. In this month’s Company Director profile, coffee entrepreneur Phillip Di Bella said he would hire another 10 employees if payroll tax was abolished. Helping family businesses become more entrepreneurial as their founders retire would also energise Australia’s small business sector.

Mazzarol says government can also help small enterprises access supply chains that larger companies control. “We have seen this work very well in countries such as South Korea, where the government helps small companies get to a standard where they can meet procurement requirements in giant projects. It can take two or three years to get small companies to a level where they can compete for work in the supply chain, but the benefit is more Australian companies with capacity to bid for work on large overseas projects.”

Reducing red tape is critical, says IPA’s Dom Talimanidis. “Small business owners and entrepreneurs need to spend time running their business, creating new markets, creating jobs, and being successful – not filling out forms.  If we want to create a stronger enterprise culture, government needs to get out the way of small business and free them up to get on with the job.”

3. Education

School and university education has a vital role in exposing young people to the possibility of starting a high-growth venture and equipping them with the skills to do so. Those who argue entrepreneurs are born rather than bred – an antiquated argument – overlook the number of successful start-ups being developed through US and European university sectors.

Talimanidis says Australia is “miles behind other countries” in teaching entrepreneurship. “To be fair, US universities have been teaching entrepreneurship a lot longer than our universities. Australia needs to make up ground so young people at university realise that starting a high-growth venture is a valid career path, and develop stronger entrepreneurship networks around universities.”

Talimanidis says entrepreneurship education should extend to schools. “I doubt school teachers are the best people to do this. We need specialist entrepreneurship teachers and programs at schools, and parents supporting such initiative.” He says directors should encourage school boards to develop much stronger enterprise teaching programs.

Other countries are reviewing how their education systems prepare young people to create, rather than only apply for, their job. The Enterprise for All Report, released this year in the UK, made a range of suggestions to embed entrepreneurship education in schools and universities.

4. Mentoring

An interesting recommendation from the Enterprise for All Report was creating an electronic “digital passport” for students, so their enterprise activity or work with start-up ventures can be recorded. The aim was to create value and recognition for this type of on-the-job learning.

Rare Birds founder, Jo Burston, believes there is a significant knowledge transfer gap between successful and emerging entrepreneurs. Unlike the US, the Australian university system does not have a strong history of successful entrepreneurs becoming adjunct professors or part-time teachers, to pass on their knowledge to the next generation of business owners.

Burston wants to develop a quantifiable mentoring program for female entrepreneurs through Rare Birds. “There needs to be better platforms that connect established and emerging entrepreneurs, and recognise knowledge sharing as an accredited form of education,” she says.

“A company director would take comfort knowing the entrepreneur has been pre-qualified or validated through structured mentoring programs, as would financiers. We need to recognise that traditional forms of education do not suit all entrepreneurs and that mentoring is a valuable form of education for many start-ups owners who want to hear from those who have done it before, and get practical rather than theoretical information.”

5. recognise that high-growth ventures are not small versions of large companies

A one-size-fits-all approach in regulatory and listing requirements is a recurring problem for start-up ventures in Australia. Rules designed for large companies and applied to small companies, are even more constrictive for high-growth ventures that are still searching for their best target market, business model and strategy.

CAMAC’s recommendation for a specially created exempt public company status for ventures that use crowd-sourced equity funding has intriguing possibilities for entrepreneurs and directors that govern such organisations.

CAMAC executive director, John Kluver, last month told Company Director: “The exempt public company structure proposed by CAMAC would effectively relieve corporate controllers from a considerable burden of public company reporting requirements, for a limited period. After a maximum of five years, the exempt public company would revert to a full public company and the organisation would have to prepare audited accounts for the earlier period, thereby ensuring full financial accountability.”

Although this recommendation relates to crowdfunding, an exempt public company structure, if regulated by government, has potential implications for boards that govern such organisations. It is not clear how the responsibilities of directors of such organisations would change, or if there is scope to provide tax concessions and better protection for directors of exempt public companies that use equity crowdfunding in the venture’s early stages.

The Future Capital Fund’s Domenic Carosa believes Australia needs a stronger business judgment rule, to protect directors who make decisions to the best of their ability, using information provided by management. “It is crazy that Australia is so far behind the US, Israel and other countries that provide much better protection for directors of start-up ventures. We need to recognise that start-up ventures, by their nature, have more risk, and that directors and investors need better protection.”

Start-up Australia’s Brian Sher says better legal protection for directors of start-ups “is a very valid idea”. He adds: “Australia has very strict liabilities for directors and there is no grey zone if a high-growth venture gets into trouble and faces insolvency. The minute that happens, it is game over. We need to review insolvency laws and consider if a US-style Chapter 11 Bankruptcy system for high-growth start-ups, which may go in and out of insolvency briefly, makes more sense.”

6. Better incentives

Nobody doubts the potential to link experienced company directors with emerging private or public start-up ventures. These ventures typically need strong advice and mentoring in their formative years, and access to capable experienced executives. But for many directors, there is too much legal, financial and reputation risk in joining a start-up venture.

Greater risk of insolvency, and thus potentially breaching director duties, is a concern. Start-ups, too, can struggle with paying high director fees when they have cashflow constraints and need to reinvest surplus cash to scale the venture.

Sher says directors also need greater potential rewards to compensate for higher risk of governing an unpredictable start-up venture. He believes directors of such companies should not pay capital gains tax on shares that are paid in lieu of director fees. “Start-ups should also have a zero tax base for the first three years of their life, and any dividends taken from the business in that period should be tax free. We need to help start-ups preserve as much of their capital as possible at the start, or reinvest surplus cash in other ventures, rather than tax the life out of them when they are just getting going,” Sher says.

7. Industrial relations reform

Sher believes an overly rigid labour market inhibits the ability of start-up ventures to grow rapidly. He believes start-up companies should be allowed to pay people below the minimum wage, with the federal government topping up the rest of the payment.

“Obviously there would need to be rules around how this worked, and monitoring of this system,” he says.

“But such a reform would make Australian start-ups far more competitive with companies overseas, lower their costs, provide more incentive to hire young workers, and give those people valuable training through internships. It would be like an apprenticeship program for start-up ventures that want to hire young people, and for young people that want the experience such employment would provide.”

High rates of teenage unemployment and rising unemployment for university graduates suggest new employment models in small business are needed. Sher says finding ways to link start-up companies with those looking for work and experience, through subsidised internship programs, has much to offer.

8. Commercialisation

Murray Gillin, Emeritus Professor of Entrepreneurship and Innovation at the University of Adelaide, says there is too much focus on innovation and not enough on value-adding commercialisation. “Ideas and innovations are great, but they mean nothing if they cannot be commercialised. True innovation adds to the bottom line. Governments are too fearful of investing in end-points, because politicians are usually not around to see the results of long-term planning. They would rather invest in grants or research, which is all worthwhile, but not as beneficial in helping companies commercialise their ideas.”

Gillin adds: “I would like to see a system where tax concessions are tied to the venture’s actual sales.

“There are arrangements in the US where high-growth ventures get a rebate of four to six per cent back of the total value they sell to government. Israel is also showing the way in tying government support around commercialisation and sales, not just around ideas and innovations.”

9. Access to capital

One of the great entrepreneurship obstacles – access to finance – is being reduced as more funding mechanisms are developed. The big hope is a new regulatory regime for equity crowdfunding, which would allow entrepreneurs to raise small amounts of money, in exchange for equity, from a large number of investors via the internet. However, the CAMAC September 2013 review of the regulatory implications of crowd-sourced equity funding was criticised in some quarters as heavy-handed. “The current proposed framework for equity crowdfunding is too restrictive,” Carosa says. The CAMAC review puts the onus on the company, and by default its boards, to disclose information to investors, and believes intermediaries that link companies and investors should be more than a “match-making service”. CAMAC also suggests non-binding limits on how much retail investors could invest: $2,500 per company per year and no more than $10,000 a year. New Zealand has proposed no limits so far. Although it has long-term potential, equity-sourced crowdfunding is likely to fill only a small part of the financing landscape for start-up ventures. There might be bigger gains in finding ways to make it more attractive for superannuation funds, including self-managed funds, to invest in start-ups, or by making it easier for start-ups to raise capital and list on stock exchanges. As Company Director went to press, media reports suggested that the federal government had given in-principle support to CAMAC’s crowdfunding recommendations, but would reserve a final decision until further consultations.

10. Attitude towards failure

Start-up Australia’s Sher believes reducing the stigma around entrepreneurial failure would go a long way to encourage people to pursue it. “If you want more people to start high-growth ventures, you have to take greater risks and accept higher failures,” he says. “When you take the road as an entrepreneur you are inevitably going to fail somewhere along the way. Failure is seen as such a negative thing, even though countries such as the US see the ability to recovery from a failure as a huge positive. We should do the same.”