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INVESTMENT CLINIC: The capital crunch

INVESTMENT CLINIC: The capital crunch

As reported widely over the past year, April 2000's stark market correction in the technology sector has resulted in investors pulling back from new investment activities. In addition, investors are cleaning up their portfolios in an attempt to recover some cash from bad investments. The impact of this reduction in private equity is indicated by investors treating any new investment with great caution. It is a "buyer's market", where many good business opportunities are not being funded.

The flight to more secure investment propositions means there is almost no seed capital available. Although the industry has the support of the incubators, which are traditionally a source of seed funding, their offering usually consists of very small amounts of cash and large amounts of service - not quite the right mix of ingredients required to achieve business traction and solid commercial contracts. Incubators and/or angels who are providing seed funding are doing so where the companies typically have great management teams, sound business models, and not just great technology or products.

We are now observing massive reductions in valuations and an increase in mergers and acquisition activities as companies endeavour to survive. The noticeable reduction in seed funding is consistent and attributable to the decline in the number of startups surfacing since the correction. However, investment hasn't stopped completely and later-stage investments with established distribution, cashflows and profits are attracting attention. Some businesses are moving forward, with the resurgence of "back-to-basic" models, an emphasis on quality and are obtaining funds for development and expansion.

An important factor in the seed funding process is the requirement of strategic and practical business advice in addition to quality management. The time and resources required to suitably prepare companies at this stage is considerable, and therefore of even less attraction to investors. Additionally the difficulty in arriving at accurate valuations for these companies in question is also challenging, and leads to more complex investment structures with claw-back provisions.

Fundamentally, further government assistance is required to strengthen the available seed funding. The other obvious impediment for growing high-tech companies in Australia is the high cost of bandwidth. Supporting clients across multiple countries around the globe requires an internationally competitive cost structure. While the skills of our people and their relative low cost is an advantage, this is often more than not offset by the bandwidth cost disadvantage.

Richard Llewellyn is the CEO of strategic capital and Investment group Nextec. Contact him at richard.llewellyn@nextec.com.au


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