Behind almost every big tech company was an early investor willing to take a huge risk. Here’s how venture capital works, what funding rounds mean, and how Australia’s start-ups get their money.
Venture capital is a type of investment in young companies, usually start-ups, that have the potential to grow very quickly.
Venture capital firms raise money from investors, such as super funds, universities and wealthy individuals, and invest it in start-ups in exchange for a share of ownership.
Funding rounds
Start-ups usually raise money in stages, known as rounds.
Early on, founders may raise money from friends, family or “angel” investors, wealthy individuals who back promising ideas.
The first institutional money is often called seed funding, used to build a product and find customers.
Later rounds are labelled Series A, B, C and so on. Each round typically raises more money, at a higher valuation, as the company grows. The money is used to hire staff, expand into new markets and build out the product.
With each round, existing owners’ stakes are diluted, as new shares are issued to new investors.
Valuations
A start-up’s valuation is set by negotiation in each funding round. If an investor pays $10 million for 10% of a company, that implies a valuation of $100 million.
Start-up valuations can be very high compared with revenue, because investors are betting on future growth. Companies valued at more than US$1 billion are known as “unicorns”.
The economics
Most start-ups fail. Venture capitalists know many of their investments will lose money, so they rely on a few huge successes to deliver their returns.
They usually make money when a company they’ve backed is sold or lists on the share market, allowing them to sell their shares.
Like private equity, venture capital firms typically charge a management fee and take a share of profits.
Australia’s start-up scene
Australia’s start-up industry has grown significantly in the past 15 years. Its best-known successes include design platform Canva, software company Atlassian, and Afterpay, which was sold to U.S. company Block for about A$39 billion in 2022.
Australian venture capital firms include Blackbird, Square Peg and AirTree, alongside overseas investors.
Australian start-ups often say it’s harder to raise large sums at home than in the U.S., and some move their headquarters overseas as they grow.
Booms and busts
Venture capital funding tends to boom when interest rates are low and investors are hunting for growth, and to slump when rates rise. Funding fell sharply in 2022 and 2023, before a surge of investment in artificial intelligence start-ups, which now attract a large share of venture capital worldwide.
