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Jessica covers Australia's technology start-up scene, writing on breaking news and trends in entrepreneurialism, media and marketing. She was previously named Australia's best New IT Journalist for 2011.

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Why Australian technology start-ups don’t need to go to Silicon Valley

Published 23 August 2012 04:35, Updated 24 August 2012 00:01

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Why Australian technology start-ups don’t need to go to Silicon Valley

Poster girl ... 21-year-old Sydney entrepreneur Nikki Durkin spent six months in Silicon Valley wooing prospective investors in her 99dresses online fashion market place, but she’s moved back to Australia to enjoy a lower cost of doing business. Photo: Hugh Hamilton

Nikki Durkin was the poster girl for the “brain drain”. In May, the ambitious 21 year old was the face of a front page article in the Sydney Morning Herald, that blamed risk-averse Australia financiers for driving technology entrepreneurs overseas. Durkin was moving to Silicon Valley in the United States and taking her online fashion marketplace, 99dresses, with her.

But now she’s back. Durkin says she found Silicon Valley an expensive place for a start-up that is still tweaking its business model. “I’ve decided I want to stick around in Australia and keep our costs really low, to get it to the point before we can really scale it,” she says.

All up, Durkin spent six months in the Valley, including three months at start-up king maker, the accelerator Y Combinator, where she wooed US financiers. She is in the final stages of negotiating an angel funding round but has moved home to work on 99dresses from the Sydney co-working space Fishburners.

On the other hand, Melburnian Anthony Goldbloom is a Silicon Valley convert. The 29 year old behind the big data modelling website Kaggle – dubbed “99designs for geniuses” – calls San Francisco the “cradle of innovation”, comparing it with Florence in the Renaissance or London in the Industrial Revolution. A little over a year after writing code for the basic first version of Kaggle in his Bondi flat, Goldbloom raised $11 million from investors, including top-tier US venture capital firm Khosla Ventures in November 2011. He now has 20 employees in Kaggle’s San Francisco office and counts PayPal co-founder Max Levchin as his chairman.

Goldbloom and Durkin’s opposing positions typify the technology start-up entrepreneur’s dilemma: should I stay or should I go? Can aspiring entrepreneurs recruit talent, acquire customers, raise money and generally nurture a technology start-up in Australia, or do I have to go to Silicon Valley to prosper?

And behind the individual entrepreneur’s dilemma is a bigger policy question: can Australia be a start-up nation? In the internet age and the era of the lean start-up, is building significant and serious technology ventures from Down Under possible?

The founders of companies such as Shoes of Prey, Bubble Gum Interactive, rome2rio and BugHerd certainly think so. All four have raised angel and venture rounds recently, from Australian and US investors. They are “ones to watch” but aren’t seduced by the Silicon Valley narrative.

“We plan to keep our head office here [in Sydney],” Shoes of Prey co-founder Michael Fox says. “I can’t see that changing any time soon, if at all.”

For start-ups that want to stay locally-based, their idol is Atlassian. Just 10 years after it was established by Scott Farquhar and Mike Cannon-Brookes with just $10,000 in credit card debt, Atlassian is regarded internationally as a powerhouse in enterprise software. In July 2010, the duo turned heads globally after taking $60 million from Silicon Valley venture capital fund Accel Partners in return for a minority stake. It was the fund’s biggest software bet ever.

For his part, Cannon-Brookes urges entrepreneurs to be sceptical about Silicon Valley evangelism. “Don’t listen to them,” he says. “I think people do blindly pack up their family and houses and move.”

Atlassian’s path shows it is possible to build a successful global operation from scratch in Australia but Cannon-Brookes says the company has also benefited from a blended approach. He has spent about two years in total, out of the past six, at Atlassian’s San Francisco digs (the company also has an office in The Netherlands and developers in Poland).

“I would definitely tell them [start-up founders] to spend time in the US,” he says. “It doesn’t need to be a pitchforks at 20 paces kind of a thing. We definitely gain as entrepreneurs, as a business, a tonne from having spent a lot of time there . . . I’ve learned a lot but that doesn’t mean that I don’t bring those learnings back and apply them down here and vice versa.”

His point is that in the early stages, entrepreneurs shouldn’t regard the decision as a prerequisite step on the start-up path.

“I think there’s a lot to be learned [from Silicon Valley] and a lot of connections to be made but I don’t think that means founders need to move the whole company and the whole business over there.”

For Cannon-Brookes there are huge advantages to keeping your base in Australia – not least to the point Durkin discovered about Silicon Valley: this corner of the world is a lot cheaper from which to operate.

“There’s great engineering talent,” he says. “And relatively easy access to that talent.”

Developers are cheaper, more loyal and no less skilled, the company founders chorus. Anecdotally a top graduate can command six figures in San Francisco, while a Sydney chief technology officer says “awesome junior developers” earn $60,000 to $80,000 a year.

Loyalty is linked to a lack of competition. As Cannon-Brookes explains, local ventures are not competing against Facebook or Google, but instead banks, retailers and resource companies so it’s easier to be a cool, preferred employer.

Lifestyle is an important consideration for many founders. There’s no Bondi or MCG in San Francisco. When Ian Gardiner was starting online video streaming provider Viocorp in Sydney in 2002, the Scottish emigrant and his wife had an 18-month-old and a baby on the way and he needed a job. If he’d started the business as a “gung-ho” 25 year old, Gardiner says he probably would have gone to the US. “I’ve been prepared to accept the slightly worse than optimal technology start-up landscape for the pay-off of a better life balance,” he says.

Old and solid personal networks can also be of benefit. “When you’re quitting a job and starting a business, it’s great to have support of friends and family and other people you know in the industry,” Fox says. Shoes of Prey has benefited from its founders’ previous occupations – Fox and Mike Knapp are ex-Googlers and Jodie Fox worked in advertising for The Campaign Palace.

“[The Campaign Palace] gave us desks for three to four months at no costs,” Michael Fox says. “We ended up staying there for 12 months on sub-leased desks.”

The government also offers some serious support for start-ups.

The research and development tax incentive was widely praised. Fox calls it “fantastic”.

“A lot of our software development is [considered] research and development so we get 45¢ in the dollar [spent on that activity] back in cash at the end of the year,” he says.

Companies such as Sydney video game developer Bubble Gum Interactive, which is building an online universe for children, Little Space Heroes, has received more than $500,000 from three state and federal grants, its chief marketing officer and director of community, Paul Gray, says.

While company valuations and capital on offer from local venture firms and angel investors are both lower than in the US, money available from government can counter that. “If you raise $500,000, then you can use the R&D credit and a Commercialisation Australia grant to convert that maybe to $800,000 or $900,000,” the co-founder of Melbourne travel start-up rome2rioMichael Cameron says. “That government assistance levels the playing field a bit.”

Another reason is that the internet has shortened distances. Transactional businesses can be run from anywhere. “We operate out of Sydney but there are kids playing the game in over 100 countries,” Gray says. “We can deliver that service from here ... We can’t be everywhere physically.”

Many founders and financiers are advocating a blended model: where development stays in Australia but sales and marketing (and often capital raising) happens in Silicon Valley. This taps into the strengths of both locations. That’s the route being taken by two companies from the local accelerator Startmate’s 2012 batch, Happy Inspector and ScriptRock.

“[The US] is where our customers are,” Happy Inspector co-founder Jindou Lee says. “We’ll also have access to the talent of the mentors and advisors. That whole eco-system is really crucial to us.” However, the property inspection app’s developers will stay in Adelaide.

But companies that intend to have links to major social platform businesses such as Facebook or LinkedIn may benefit from being close to their head offices – just look at social media marketing business Wildfire Interactive, which was started by Kiwi Victoria Ransom and bought by Facebook for $250 million in July.

Which brings us to the reasons why you still might want to base your start-up in Silicon Valley. The fact is there’s energy in the region that comes from a potent mix of dreams, money and success. “The volume of crazily inspiring, interesting, thought-provoking conversations you have [here] is off the charts,” Goldbloom says.

When you walk down University Avenue, Palo Alto, Americans in jeans and sneakers talk loudly into their phones, their one-sided conversations peppered with phrases like “what I’ve got is definitely patentable”. Inside cafes, nerds tap away at their netbooks, pausing only for sips of oversized frappucinos. (For Aussies seeking the only decent caffeine in Mountain View, try Red Rock Coffee). Once at the till, point of sale material promotes a loyalty or feedback smartphone app that the business is trialling. The start-up bug is everywhere.

Ryan Junee arrived in the Valley from Sydney in 2003 to study at Stanford University. In late 2007, with two others, he began building video search tool Omnisio. Less than a year later it was sold to YouTube for about $15 million. He’s now onto his second start-up, Inporia, and has no plans to come home permanently. “Everyone you see is doing a start-up,” he says. “Everyone is on their laptops. Changing the world is a normal thing to do.”

The outcome of this is a wildly different attitude to doing business than is found at home. Cannon-Brookes says Australia has “absolutely excellent management talent”, which means successful businesses have “real revenue, real customers. It’s not a, ‘I’ve got 5 million people and I’m trying to work out how to make a dollar out of it’ type style [of business].”

But American entrepreneurs have an “innate understanding” of the start-up game, he says. “The DNA is just kind of ingrained in them.”

Without that understanding, Australian start-ups can lack “speed of execution”, he says. This can extend to employees who don’t understand things that are basic start-up IQ in the US, such as employee share options. “In the States, I never have to explain our option papers to anybody, here I almost have to sell them at times,” he says. “We’ve had people come to us and say I’m thinking of leaving for this other company and I’m like ‘why would you do that, you’re losing tonnes of money, like what do you mean?’

“It’s like ‘see these options over here, these are going to be worth a lot of money’,” he laughs “And they’re like ‘oh really’. It’s a piece of paper in their head. It’s that experience or knowledge [that’s lacking].”

The real lure of America though is the money. Like Wall Street is to the stock exchange, Sand Hill Road in Palo Alto is the home of venture capital. The offices of funds such as Andreessen Horowitz, Sequoia Capital and Greylock Partners line both sides of the road.

As well as the traditional venture capital funds, the previous generation of start-up founders, from PayPal, Google and even Facebook, have cash and wisdom to burn. If they’re not moving onto their own new idea, they are eager to get a slice of somebody else’s.

The concentration of both money and start-up IQ leads to more generous capital and terms. Startmate founder Niki Scevak says that even though the ability for start-ups to raise angel money in Australia has improved, they are doing so on a pre-money valuation of $1 million to $1.5 million, versus $3 million to $5 million for the same stage in the US.

The funding landscape in Australia has “gone from really bad to not that bad but it’s still, I don’t think, very good and I don’t think it will ever be on the scale of Silicon Valley,” he says.

Many US investors won’t invest unless you’re nearby. When investing small sums, they can’t afford to have portfolio companies spread far and wide. The Shoes of Prey team met this roadblock in talks with overseas investors, whose feedback was, “‘We love the e-commerce mass customisation space you’re in, we love what you’ve achieved . . . but we will only invest if you’re based down the road’,” Fox says.

In the end, the trio raised a healthy $3 million. Although some US venture capitalists did finally invest, such as Bill Tai and Michael Arrington’s CrunchFund, Fox says the process took an arduous 18 months. “We had to cobble together six to seven different investors,” he says. “If we were in the US, it definitely would have been able to go quicker and maybe from only one to two investors.”

The reluctance of US investors to invest from afar does seem to be changing. Shoes of Prey was one of three Australian investments made by Bill Tai in June. He also took part in Posse’s $1.2 million round and Bubble Gum Interactive’s $2.5 million raising. And ScriptRock was the beneficiary of a $1.2 million angel round led by Facebook board member and PayPal co-founder Peter Thiel – his first in Australia after setting up southern hemisphere focused venture capital fund Valar Ventures.

But Junee calls these companies “the lucky few”. Through persistence they have been successful in raising money in what is considered “the gap” of the local venture funding landscape. For companies in Australia that want to raise in the awkward $1 million to $10 million range, capital is scarce.

Below $1 million, raising angel funding has improved, spurred on by tech-focused angel networks such as Innovation Bay and Aurelius Digital, as well as founders picking up the slack, such as RetailMeNot founders Guy King and Bevan Clark, who invested in rome2rio.

And above $10 million, mature companies are luring “growth” venture funds from the US. BigCommerce’s $15 million round from Boston firm General Catalyst and Accel Partners’ Australian investments typify this space.

Accel’s Rich Wong, who sits on the Atlassian board, says the firm is seeking more Australian investments. “We see three to five other Atlassian, OzForex, 99designs-like opportunities . . . across the eastern part of Australia.”

A new venture fund, Blackbird Ventures, made up of technology company founders such as the Atlassian duo and Scevak and run by former MLC private equity expert Rick Baker, is looking to fill the gap. This is promising but one founder-led fund won’t drastically change the landscape. The sums on offer will be tiny compared with the sums flowing through Silicon Valley. All the players agree on this.

So Australia will never become Silicon Valley. But maybe that’s the point. From a smaller population and constrained capital environment, Australian companies are revered overseas. Wong says the Australian companies he sees are “far less me-too than perhaps the average sample of 50 companies we might meet on a normal week here [in the US]”. He adds that the smaller pool of capital on offer means the start-ups that succeed are “really special, because they figured it out, almost on their own”.

And to make more of those companies, start-ups need links to the capital, attitudes and zeitgeist of Silicon Valley. “Australia will never have a tech-industry that dominates the world but if we structure our alliances carefully, we can integrate . . . which will give us a fighting chance of being a leading industry globally,” says US-based Australian entrepreneur Elias Bizannes.

Southern Cross Venture Partners managing director Larry Marshall says the founders he meets in the Valley who then return home excite him most. “Because they go back changed,” he says. “Their perspective has been widened and what happens is they’ve made these contacts here and then they go back and chip away at it.”

He could be talking directly to Nikki Durkin’s experience. Her Silicon Valley connections and conversations will influence 99dresses.

Forget the brain drain, Bizannes says.

“Rather than [taking] the attitude that we’re losing talent, it should be that we’re fostering the links,” he says.

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