Is the government’s innovation statement just a $1.1 billion cash-splash for votes? An in-depth look at ESVCLPs

This is the fifth article in a series where CapitalPitch co-founder Jeremy Liddle explores different aspects of the government’s innovation statement and the potential impact they will have. You can read his take on the tax incentives, the support for accelerators and incubators, global landing pads and crowdsourced equity funding.

The innovation, startup and investment community rejoiced in December 2015 when our new Prime Minister chose to make the statement about innovation and science the first priority policy decision of his tenure.

Fast forward to May 2016, with an impending election; we must ask the question of our government: “Are you investing public money based on sound decisions for the future prosperity of Australia or are you buying media opportunities and votes?”

Thankfully, legislation for the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 was passed on May 4, 2016, announced by the minister for industry, innovation and science.

The changes to the Venture Capital Limited Partnerships will come into effect from July 1, 2016. Of particular interest for startups are the Early Stage Venture Capital Limited Partnerships (ESVCLPs) and the Significant Investment Visa (SIV).

But what is an ESVCLP?

An ESVCLP is a venture capital fund structured as a limited partnership and registered with Innovation Australia. It provides investors – limited partners (LPs) – a way of investing in startups without being taxed.

Income distributions and capital gains earned as a result of investment in an ESVCLP will be exempt from tax in Australia in the hands of both domestic and foreign partners. The tax-free treatment is a significant legislative incentive which has the potential to both considerably increase a fund’s internal rate of return and assist in attracting a wider pool of investors.

This tax free investment vehicle is one of the best things government has done for the startup and innovation ecosystem. This is the vehicle of choice for venture capital fund managers such as AirTree, ReInventure and the flood of new VCs seeking to attract the Significant Investment Visa.

What is the Significant Investment Visa (SIV)?

Under the new rule changes in 2015 every migrant seeking to enter Australia on a Significant Investment Visa, requiring an investment of A$5 million, must now deploy $500k into a VCLP or ESVCLP.

Whilst this change has slowed down the rate of visa applications, the expectation is that now that migration agents and advisors have had some time to educate foreign investors and select VC fund managers to partner with, the flow will return and add more than $100 million per year to Australian venture capital.

At CapitalPitch we are establishing an SIV compliant ESVCLP and intend to work with both Australian and foreign investors to grow the VC industry. Due to the potential flow of capital, it will be possible for us to set up multiple funds that can target specific stages of the startup growth cycle.

We will therefore be able to plug some big gaps in the seed and Series A stage investment rounds for the startup ecosystem in Australia.

The Innovation Agenda, coupled with the SIV changes, will provide a big shot in the arm for our ecosystem.

There are also some important changes to ESVCLP’s announced in the Innovation Agenda. What is changing?

Innovation.gov.au states that under the new arrangements:

• Partners in a new Early Stage Venture Capital Limited Partnership (ESVCLP) will receive a 10 per cent non-refundable tax offset on capital invested during the year
• The maximum fund size for new ESVCLPs will be increased from $100 million to $200 million
• ESVCLPs will no longer need to divest a company when its value exceeds $250 million
• It removes the restrictions for foreign Venture Capital “Fund of Funds” that had previously prevented them from holding more than 30 per cent of capital, provided the fund is widely held and the ultimate investors are eligible foreign investors

These changes to both the VCLP and ESVCLP will enable new fund managers to raise much larger funds and also entice more conservative investors into a less risky proposition than direct investment into startups using the tax offset.

We’ve already seen a huge increase in the registration and announcements of VC funds and we do not expect this to slow down in the next 12 months.

2016 has been a bumper year for the raising of venture capital to support the Australian startup and innovation ecosystem. The problem now for investors is how to source and select the highest quality deal flow in order to generate a return for investors.

Therefore fund managers and investors should be looking for platforms and systems that can attract great deal flow whilst efficiently applying a rigorous and systematic approach to screening, selecting and preparing startups for investment.

The new fund from CapitalPitch Ventures will be a minimum $10 million ESVCLP and we are now accepting expressions of interest from both Australian and foreign investors.

We will co-lead each investment round on our platform with 15% of the raise target and thereby catalyse follow-on investment from the rest of the ecosystem.

We’re very excited.

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