Investing in Australian Startups
Mar 22, 2016
I've previously covered some of the cultural and competitive advantages
would-be founders have in starting a company in Australia.
Not to mention the incredible access to capital,
despite the lack of a Venture Capital industry the size of Northern California.
But what if the days of starting a company are long behind you? What if you'd rather
invest in the next generation of companies?
We've got you covered there too! None of the following is tax advice. The examples are
for illustrative purposes. Before investing speak to your financial advisor. Yadda yadda. You
know the drill.
Got a large tax bill?
Sarah is a person of means. She's amassed a considerable property portfolio over the past 20
years, like many Australians. Her high-paying job combined with the positive rental yield on
her investment properties (she's had some of them for 20 years remember!) means that along
with large amounts of equity she also has a really large tax bill every year. She admits
these are good problems to have.
She's thinking of taking $1M of equity out of her property portfolio and investing it in
a handful of innovative startup companies.
She puts $200K into 5 companies, and in return each company grants her an equity stake.
That's not all though. The recent amendments to the tax law
means she'll also get a $200K tax offset. Which means she can earn almost $9K per week
before she has to pay any tax.
You read that right! Sarah can invest $1M, and then the next $468K she earns is tax free.
Need to diversify that portfolio?
Diversification of assets across multiple investment vehicles and asset classes is
basically the first thing they teach would-be financial planners. Weighting risk
and return with risk appetite. It's important to take the net return into consideration (that's financial planning 201 :wink:). After
operating costs, after tax. But what about if there's no tax?
You heard right! Tax free gains! Come and get them!
Sarah has a friend, Megan, who has also done well with her previous investments. The main
difference though is she's in the twilight of her career. Megan doesn't have a high 6-figure job.
Her investments aren't returning enough to retire on, yet. So she sells off a couple of investment
properties and spreads the profit across a number of funds and... you guessed it, some innovative
She's going to hold the startup investments for at least 12 months. Which means she qualifies for
the Capital Gains Tax exemption for those investments. Obviously they're all going to become unicorns
in the next 5 years. And so when there's a liquidity event and she gets the opportunity to see that
$200K turned into $5M, it's all tax-free. All of it!
No more buying lotto tickets and trying to pick the winner of the Melbourne Cup. There's a new
way to make millions tax-free.
Got lots of friends with money?
Cathy is fortunate to be close with many of her old school friends, most of whom have been
incredibly successful. Captains of industry. Minor celebrities. She grabs coffee with a
few of them and floats the idea of pooling their resources to launch an investment fund.
All she needs is $10M and a plan and she qualifies as an Early Stage Venture Capital Limited Partnership,
(though she can raise as much as $200M!).
The ESVCLP works great for all of Cathy's friends. They lead complicated financial lives. And the
ESVCLP works a bit like a trust. It doesn't pay any tax directly. Any profits it makes pass straight
through to the investors. No "double taxation". And they fit into whatever existing (or new) structures
each individual investor wants.
The investors in Cathy's ESVCLP also get that tax-offset that Sarah got, but at half the rate (10% of
the amount invested vs 20%). So each of Cathy's 10 investors who invested $1M each will get a $100K
tax offset to apply to their tax return.
Live outside Australia?
Hey hey hey! Have we got the perfect way for you to maximise you investment returns and have
a legitimate excuse to deduct a trip or two to this country as a business expense.
Remember how I said Cathy's ESVCLP works a bit like a trust? I know they're not a common investment vehicle
in other countries so it's worth pointing out the benefit again: they pay no tax. Money passes
through them, untouched by government agencies and tax departments. The expectation is the tax is paid
by whatever person or entity ultimately receives the money.
That includes foreign entities. The Australian Government has decided that if you're willing to
invest your dollars to help kick start our companies, we're not going to punish you when you reap
the reward. That money leaves Australia tax-free, and you only need to pay whatever local taxes
you must on the gain. No double-taxation. No worrying about tax treaties.
That all sounds great and... innovative.
I keep using that word. Does it mean what we think it means? Thankfully we've a handy 100-point innovation test.
Schedule 1, Part 1, 360-45. It's okay, there's only 8 points. And you need to qualify for 2, maybe 3, of them to
pass the innovation test and qualify as an "innovative startup".
If a company passes the test, all of the benefits aforementioned are bestowed upon its new investors! :tada:
Tying a bow in it
There's a lot to love with this setup. It's been influenced very heavily by the SEIS scheme in the UK which
has been quite successful by most accounts. The primary difference is you get a tax offset instead of a deduction.
The latter heavily skews the net benefit towards those on the highest marginal tax rates and can cause complications
with other benefits and programs that are assessed on net taxable income. And offset provides a fairer
net benefit to all recipients irrespective of their marginal rate.
A cynic might suggest the reason we've used an offset is because a large population of potential investors are massively
leveraged and are using our negative gearing concessions to reduce their total taxable income to close to $80K, and
thus wouldn't receive much or any benefit from further deductions. Hold your tongue! Tax reform that is attractive
property investors too?! How could you suggest such a thing?! :astonished:
I suspect that's part of the plan. As a nation we're hugely over-exposed and in debt in our domestic property market.
With the downturn in mining we need to both find alternative sectors to drive our economy and limit our exposure to
the inevitable rises in interest rates. Here's a scheme that provides an incentive for those who are sitting on
a gain in a potentially over-valued asset class to cash in some of those gains. Invest them in another vehicle.
Receive an immediate tax benefit for doing so. And avoid paying tax on a future gain on that investment. It's
Founders now have even more access to capital. Friends & family rounds of a reasonable size are completely feasible.
ESVCLPs are springing up all over the place, and have funds they need to commit somewhere. [I don't believe lack
of access to capital](/thoughts/abcs-of-startup-financing) has ever been a truly limiting factor for Australian startups,
but if it was it's less so now.
Foreign investors have less to uncertainty to deal with, and legitimate reasons to be excited. Find a ESVCLP that
aligns with your own investment ideals. Trust their local market knowledge to find the right companies. Know that
generous tax concessions, government grants, and significantly lower wages than the
Bay Area mean that money will go further. Know that there's a history of using investment to scale cash-flow positive businesses into
global players, rather trying turn around the fortune of companies with huge negative gross margins.
More foreign investment. Greater access to seed capital. Transitioning out of our dependence on property to build wealth. Thousands
of new profitable companies.