Venture Capital 2024 Comparisons

In 2023, there were fifteen reported financings, with funds raised of more than AUD50 million, and six of these financings involving funds raised of over AUD100 million (Something Ventured Pty Ltd. (2024) The State of Australian Startup Funding 2023). The largest reported financing during this period was Employment Hero’s Series F financing, in which the company raised AUD263 million.

Market Conditions

As seen for venture capital (VC) markets globally, the past 12 months have been challenging for raising venture capital in Australia, with a general decline in deal volume, deal sizes and valuations. There were 413 reported deals (versus 712 in 2022) and only 15 involving more than AUD50 million raised (versus 28 in 2022). Overall, the amount of capital raised in 2023 was AUD3.5 billion, a 54% decline from 2022 (Something Ventured Pty Ltd. (2024) The State of Australian Startup Funding 2023). A key factor in the weaker deal flow was the significant amount of capital raised by companies at high valuations during the pandemic – as valuations came down, companies sought to conserve cash rather than suffer a “down-round”.

Deal Structures

Many companies employed alternative deal structures to avoid a down-round, with a significant increase in the use of convertible instruments such as SAFEs (Simple Agreements for Future Equity) and convertible notes. For companies that raised priced equity rounds, there was an increased focus on due diligence by investors, with deals taking longer to close, and generally more investor friendly deal terms. Specifically, for preference shares, multiple and participating liquidation preferences and full-ratchet anti-dilution mechanisms were observed on several deals – all features that were virtually non-existent in Australia for several years prior to 2023.

Flight to Quality

Difficult market conditions led to a division in the market, with those companies that were able to demonstrate proven business models, fiscal responsibility and sustainable growth more likely to be able to raise a priced equity round. Many companies who did not fit these criteria were forced to raise smaller rounds, employ alternative deal structures or delay raising capital.

Secondaries

Australia historically has not had much of a secondary market, but the long path to exit has gradually led to increased secondary activity, whether directly (sales of shares by earlier investors in a company to later investors, creating opportunities to clean up company cap tables and preference share stacks) or indirectly (with increasing activity in the establishment of continuation funds, giving earlier investors in a fund opportunities to exit all or some of a portfolio).

In Australia, much of the VC activity until recently was focused on software as a service (SaaS) businesses. While companies in enterprise software, fintech and cleantech continued to feature heavily in venture capital financings, there was a marked increase in financings by companies in industries such as hardware and robotics, space/aerospace and defence.

Exit opportunities remained elusive across the board, with significantly depressed IPO markets. The local bourse, the ASX, saw 45 listings in 2023, less than half of its five-year average of 120 listings.

However, investors in more capital-intensive, deep tech industries would generally expect to see a longer path to exit than software businesses, so we do expect a distinction to emerge in coming years.

Types of Vehicles

There are three main structures available in the Australian market:

• Venture capital limited partnership (VCLP) – this is typically established as an incorporated limited partnership (a hybrid vehicle which has the characteristics of a body corporate and a partnership) which is a flow-through vehicle (ie, the VCLP itself is not taxed) which provides certain tax advantages, mainly to qualifying foreign investors (such that they would not be subject to tax in Australia on gains made from sales of eligible investments) and fund managers (who receive guaranteed capital account treatment on their carry), in exchange for which the fund must make certain kinds of investments (for example, investees must generally have an Australian nexus, not be engaged in prohibited industries such as finance and property development and must be valued at less than AUD250 million immediately before the investment is made).
• Early-stage venture capital limited partnership (ESVCLP) – this is also typically established as an incorporated limited partnership and provides certain tax advantages to all investors (generally, gains made on the sales of eligible investments will be tax free in Australia, subject to certain limitations) and fund managers (who receive guaranteed capital account treatment on their carry), in exchange for which the fund must make certain kinds of investments. The investment restrictions are similar to those applying to VCLPs, except that the maximum permitted entity value is AUD50 million immediately before the investment is made and the fund must operate in accordance with its investment plan (which must be approved by the local regulator and which must demonstrate the early-stage nature of the proposed investments).
• Unit trust – this is generally a flow-through vehicle (however, in certain circumstances, it can be taxed like a company). Most fund managers will try to ensure that any unit trust included in their structure meets the criteria to be a “managed investment trust” (MIT), which offers certain tax advantages to investors (guaranteed capital account treatment on gains made from sales of investments). The main restriction on a MIT’s investments is that it cannot control a trading business. Fund manager carry out of a MIT is deemed to be ordinary income. A fund manager may also have the trust opt into the “attribution managed investment trust” (AMIT) regime, which has certain administrative advantages.

A fourth vehicle, the “corporate collective investment vehicle” (CCIV), has been legislated but has yet to find a real use case.

In practice, a venture capital fund will most commonly be structured as an ESVCLP stapled to a unit trust qualifying as an MIT. This enables the fund to make both ESVCLP-eligible investments and ESVCLP-ineligible investments. (The VCLP is not commonly used for VC funds because most VC funds in Australia do not have investors that would benefit from investing through a VCLP.)

Governing Documents

Each of a VCLP and ESVCLP is governed by a limited partnership deed. The general partner has the exclusive power to make decisions in relation to the fund (delegated to the manager, usually a related entity), and investors are limited partners.

A unit trust is governed by a trust deed. The trustee has the exclusive power to make decisions in relation the fund (delegated to the manager, usually a related entity), and investors are unitholders in the trust.

Fund managers will typically be remunerated via a management fee and carried interest. The fund manager may also be required to commit to the fund.

Management Fees

The management fee is usually a percentage of committed capital during the fund’s investment period, and a percentage of invested capital plus capital reserved for follow-on investments after the investment period. (This is different to private equity funds, where the post-investment period management fee is usually linked to invested capital only.)

Carried Interest

In terms of carried interest, typically the proceeds of a venture capital fund will be distributed according to a waterfall by which the investors will receive their drawn capital back first and may receive an additional preferred return, the fund manager may receive a catch-up, and the remaining proceeds will be split between the investors and the fund manager.

Legal Structure

In terms of legal structure, for ESVCLPs and VCLPs, the manager’s carry is distributed to the general partner (which is itself usually a limited partnership) and by the general partner to its limited partners (often an aggregator vehicle for the ultimate carry recipients). As noted above, this carry will generally have guaranteed capital account treatment (which creates an opportunity for certain end recipients to qualify for a capital gains tax discount).

For unit trusts, the manager’s carry is typically distributed via a special class of units, called sponsor units, which are usually held by an aggregator vehicle for the ultimate carry recipients. As noted above, this carry will be treated as ordinary income in the hands of the beneficiaries and will be taxed at ordinary marginal rates.

Performance Fees

For unit trusts that cannot qualify as an MIT, carry may be paid by way of a performance fee to the manager (rather than a distribution on sponsor units).

Manager Commit

Investors will often require that the management team makes a meaningful investment into the fund, usually somewhere from 1-3% of committed capital.

Market Amounts

It is still generally the case that the management fee will be 2% and the carry will be 20%, but institutional investors will frequently average down these fees by negotiating fee and carry free (or reduced fee and carry) co-investment arrangements.

Financial Services Licensing

Fund managers are required to hold an Australian financial services licence with appropriate authorisations (or be an authorised representative under a third-party licence).

Regulation of ESVCLPs and VCLPs

In addition, ESVCLPs and VCLPs must be registered by the Innovation Investment Committee of Industry Innovation and Science Australia, a federal government agency which, among other things, manages the Commonwealth’s venture capital programmes.

ASIC Regulation

Most VC funds do not target retail investors and so are not regulated from a disclosure perspective (other than that the fund manager cannot engage in behaviour that would be misleading or deceptive). Any fund that did target retail investors would be regulated under the Corporations Act 2001 (Cth) and would be required to comply with more onerous, prospectus-level disclosure requirements applicable to retail investors.

Difficult Fundraising Environment

While fundraising was quite robust during the peak of the pandemic, it has become increasingly difficult over the past 12 months with fund managers taking much longer to reach a first closing and generally raising less than initially targeted. There are a few reasons for this, including the opportunity to get quicker returns in other investment opportunities and the lack of demonstrated exits.

This has in turn put pressure on fund structures, especially for smaller funds, as the success of the stapled structure described above depends on there being sufficient capital in the structure to satisfy the following:

• ESVCLP investment requirements (a minimum of $10m must be available to the ESVCLP); and
• investor concentration and spread requirements in the ESVCLP and MIT.

End of Statutory Life Issues for VCLPs and ESVCLPs

Both the VCLP and ESVCLP have a mandatory 15-year life from the date of formation – there is no opportunity to extend. A number of VCLPs and ESVCLPs established soon after these vehicles were legislated are now reaching the end of their statutory lives. In retrospect, it has become clear that 15 years is insufficient for venture capital funds, particularly in the biomedical or deep tech sector, as many still have substantial investments in their portfolios. As such, the creation of continuation funds has become common to manage these statutory end-of-life issues. This has led to substantial negotiations around issues such as investor exit rights, dealing with accrued carry, fees and carry going forward, and term.

Government-Backed VC Funds

The Australian government has been a significant backer of venture capital funds in Australia. These include matching capital programmes, such as:

• the Innovation Investment Fund programme;
• the Renewable Energy Venture Capital Fund programme (targeting renewables); and
• the Biomedical Translation Fund programme (targeting biomedical investments).

State governments have also become involved, with numerous states launching programmes to invest directly into, or co-invest with, venture capital funds in exchange for those funds making investments into companies headquartered in those states.

The level of due diligence is generally substantially lower than that undertaken for a change-of-control transaction. The scope and extent of due diligence will depend on the stage of the company, the size of the financing and the type of investor. For example, strategic and corporate venture capital investors are often more inclined to undertake a greater degree of due diligence than a traditional VC fund. Foreign VC investors in the Australian market will often also undertake a greater level of due diligence than local funds.

For early-stage companies (ie, seed and series A), areas of focus will be those that are central to the company’s value proposition and its ability to execute on its growth strategy. These will typically include the following.

• Corporate: confirming the shareholders and the number and class of shares on issue, reviewing the terms of any convertible securities / instruments, confirming the directors and structure of the corporate group, and ensuring the cap table correctly reflects all options that have been issued or promised.
• Constituent documents: reviewing the existing constitution and shareholders’ agreement (if any).
• Intellectual property: confirming that the company’s core intellectual property is validly owned or licensed by the company, including confirming that all employees and contractors have validly assigned any relevant IP they have developed to the company.
• Employment: reviewing the employment agreements for the founders and other key employees.

For more mature companies (eg, Series B or later) further areas of focus may be included in due diligence to reflect the more sophisticated operations of the company, including the following.

• Material contracts: reviewing the terms of the company’s most important contracts for legal risks.
• Privacy/data security: reviewing the company’s privacy policy and other policies/agreements concerning the collection, storage, use and dissemination of data.
• Finance and debt: reviewing the details of any financing or debt arrangements the company has on foot.
• Litigation/claims: confirming whether the company is subject to any claims, litigation, investigations, etc.

Depending on the sector(s) in which the company operates, due diligence may also extend to other matters, such as reviewing relevant licences/consents, or other regulatory due diligence.

There are a significant number of variables which will have an impact on the timeline of a new financing round. Key factors include:

• the number of existing shareholders in the relevant company and their level of sophistication;
• the number of investors in the financing round and the extent to which they individually seek to negotiate the terms of the financing round; and
• the extent to which existing shareholders seek to negotiate proposed changes to any existing constituent documents (ie, the constitution of the company and shareholders’ agreement).

While smaller rounds may take as little as two weeks to close, during the past 12 months deal timelines have been significantly pushed out, with some deals taking several months to close. If foreign investment approval is required by a lead investor, this approval may take up to six months to obtain, greatly extending the deal timeline.

Generally speaking, the lead investor and their legal counsel will negotiate the terms of the financing with the company and their legal counsel, including any amendments to the existing constituent documents (ie, the constitution and shareholders’ agreement). These amendments will then be shared with other investors and existing shareholders. It is not uncommon for other investors to seek to comment on the constituent documents, although this is often resisted by the company and their counsel, as this approach can cause significant delays to the deal timeline.

In Australia, financings will often practically require the approval/agreement of all existing shareholders, although contractual mechanisms to allow for financings to proceed with the consent of less than all shareholders are becoming more commonplace.

It is rare in Australia for VC fund investors to receive ordinary shares (equivalent to common stock) for investments in early-stage companies, although some pre-seed and seed companies may conduct a financing with angels/friends and family through ordinary shares. Typically, investors will receive shares in a new a class of preference shares with customary rights, including a liquidation preference and anti-dilution rights.

Liquidation Preferences

In Australia, preference shares will typically have a 1x non-participating liquidation preference, meaning that the holder will receive, on a liquidity event, the greater of the subscription price for the share or the amount they would receive if the preference share was converted into an ordinary share at the prevailing ratio.

Generally, each new class of preference share will be ranked ahead of all other shares on issue (including other preference shares) in respect of the liquidation preference.

Anti-dilution

Preference shares will typically have a broad-based weighted average anti-dilution mechanism, meaning that if the company issues shares at a price that is lower than the subscription price of the preference share, the number of ordinary shares that the preference share will convert into is adjusted to reflect the dilutive effect of the new issuance. There are customary carve-outs to the anti-dilution mechanism, such as issuances of securities under an employee share option plan.

In Australia, the more common position is for anti-dilution rights to be triggered on an issuance of shares, meaning that the anti-dilution provisions will not be triggered by an issuance of securities which are convertible into shares (until the securities are actually converted). However, some investors prefer to apply anti-dilution provisions to any issuance of securities.

Other Investment Instruments

Simple Agreements for Future Equity (SAFEs) are often used in Australia for investments in early-stage companies, particularly pre-seed/seed stage companies, although they are sometimes used for bridge rounds for later-stage companies.

Convertible notes have become an increasingly common investment instrument in venture capital in recent years. Convertible notes issued by early-stage companies will often have the same basic features of a SAFE, but with an interest rate and a fixed maturity date. Interest is typically accrued and either repaid on redemption or capitalised and converted into shares on conversion of the notes. Generally, convertible notes will automatically convert into shares on an eligible financing (ie, a priced equity financing) at the lower of a discounted price to the subscription price paid for shares in the eligible financing or a priced determined by a pre-agreed valuation cap. Investors will also usually have the right to redeem or convert their notes in an exit scenario. However, the treatment of the notes (ie whether they are converted or redeemed) on maturity is often subject to negotiation.

For a priced equity round (ie, a financing round involving the issue of shares), the key transaction documents are as follows:

• subscription agreement;
• shareholders agreement; and
• constitution.

Generally, the company and the lead investor(s) will negotiate a term sheet setting out the key terms of the financing, including the valuation of the company, the size of the round (the amount of capital being raised) and key terms of/changes to the shareholders’ agreement and constitution. Side letters are less common than in other jurisdictions, and there is no standard “management rights letter”. However, if certain investors are to receive rights that are not granted to all investors (and in circumstances where other investors’ cooperation is not needed), these may be documented in a side letter.

Subscription Agreement

A subscription agreement is typically entered into between the company and the investors concerning the subscription for and issue of shares in the company. The company will typically give a customary set of warranties concerning the company and its business (see 3.7Contractual Protection). If the financing has multiple closings with different investors, a separate subscription agreement may be entered into for each closing.

Shareholders’ Agreement

The shareholders’ agreement is a contract entered into between the founders, the company and its shareholders and will typically contain some or all the following provisions:

• director/board observer appointment rights;

• pre-emptive rights on new issuances and transfers of shares;
• information rights for shareholders;
• drag-along and tag-along/co-sale rights;
• founder provisions; and
• non-competition restraints.

Board appointment rights and pre-emptive rights

Typical board appointment rights and pre-emptive rights are discussed further in 3.6. Corporate Governance.

Information rights

Information rights are often an area of substantive negotiation. However, it is common for all shareholders to have some basic information rights enshrined in the shareholders’ agreement. Certain shareholders may also receive more extensive information rights. For example, larger shareholders or shareholders who are funds may have the right to receive more regular reports, rights to receive copies of the company’s annual business plan or rights to discuss the business with management. Funds organised as VCLPs or ESVCLPs will generally also have the ability to compel the provision of information that they require in order to satisfy certain regulatory requirements.

Drag-along and tag-along/co-sale rights

In Australia, the shareholders’ agreement will typically contain drag-along rights. Drag-along rights give a group of shareholders who hold a specified proportion of the shares to force the remaining shareholders to join in a sale of the company or the business. The threshold for triggering drag-along rights varies significantly and may be a single or a double majority – for example, the threshold may be shareholders who collectively hold somewhere between 50% and 80% of the shares on issue, or it may also require approval of shareholders who hold a specified proportion of the preference shares on issue. Traditionally, drag-along rights only applied to a sale of the company’s shares although, increasingly, drag-along rights are being expanded to cover all customary exits (eg, share sale, asset/business sale, IPO, etc). Drag-along rights may be subject to customary limitations – for example, shareholders who are “dragged” may only be required to give customary title and capacity warranties, and their liability is generally several and not joint and limited to the proceeds that they receive for their shares. In the context of an IPO, the drag-along rights will generally also contain restrictions on the escrow/lock-up on shares that shareholders may be required to agree to. For further detail see the Trends & Developments section in the France chapter of this guide.

Tag-along rights are also a standard feature of VC financings in Australia. If shareholders with a specified proportion of shares agree to sell some or all of their shares to a buyer, tag-along rights give the remaining shareholders the right to sell the same proportion of their shares to the same buyer on the same terms. The relevant threshold for triggering the tag-along right varies, but is typically between 25% and 50% (based on the number of shares on issue). Founder co-sale rights are less common in Australia, although certainly not unheard of. Founder co-sale rights give shareholders (other than the founders) the right to sell the same proportion of their shares to the same buyer if the founders agree to sell some of their shares.

Founder provisions

In Australia, it is common for founders to have their shares vest over a specified period, typically between two and four years (usually with a one-year cliff). If the founder ceases to be employed or engaged by the company before the end of the vesting period, their unvested shares may be compulsorily acquired for nominal value. Vesting will generally be accelerated if the company achieves an exit. Accelerated vesting may also apply if the founder ceases to be employed or engaged due to death, sickness, disability, etc. Vesting may be extended, or “reset”, as part of the negotiations for earlier financing rounds (eg, Series A-B), but it is less common to do for later financings.

Founders may be subject to restrictions on disposal of their shares. Disposal restrictions may be partial or total, or a mix of both – for example, a founder may be restricted from disposing of any shares for an initial period of two years, after which they are limited from selling more than a specified percentage. Typically, the restrictions on disposal may be waived by a board resolution (generally requiring approval of one or more nominee directors of investors). Restrictions on disposal are often negotiated in conjunction with founder co-sale rights – for example, some funds prefer to impose ongoing disposal restrictions on founders, while other funds are comfortable relying on founder co-sale rights to appropriately protect them from founders selling their shares.

Finally, founders may be subject to “bad leaver” provisions. Under these provisions, if the founder becomes a bad leaver, their shares may be compulsorily acquired at less than their market value. Typically, the price paid to acquire a bad leaver’s shares is determined by reference to the fair market value of those shares at the time. The discount that may be applied in a bad-leaver scenario is generally the subject of negotiation but, anecdotally, the typical discount is 50% of fair market value. The definition of what constitutes a bad leaver will typically include, at a minimum, the following:

• the founder ceasing to be employed in circumstances of serious misconduct, or where the company is entitled to terminate their employment without notice; or
• founder breaching any applicable restrictive covenants (eg, non-competition restraints).

“Good leaver” provisions, which allow the company to compulsorily acquire a founder’s shares for their fair market value in circumstances where they cease to be employed/engaged by the company and are not a bad leaver, are less common in Australia.

Constitution

The constitution is the basic constituent document of a company in Australia. It sets out the basic rules which govern the company’s relationship with its directors and shareholders and typically contains provisions dealing with, for example, how board and shareholder meetings are called and held, how the assets are distributed if the company is wound up and the terms of issue of any classes of shares (including the terms of issue of any preference shares on issue).

The constitution is generally a fairly standardised document and, other than the terms of issue of the preference shares, is generally not substantively negotiated.

Open Source Documents

The Australian Investment Council, in collaboration with a number of Australia’s leading law firms and venture capital funds, published a set of open source transaction documents for seed financings. These documents are available here.

While many law firms will often use their own house precedents in preference to the AIC’s open source documents, these documents do provide a good point of reference for early-stage venture capital financings in Australia. In particular, the terms of issue of preference shares contained in these open-source documents are widely used in priced equity rounds by Australian early-stage companies.

The key protections for investors in a “downside scenario”, such as a down-round or a winding up of the company, are the liquidation preference and anti-dilution provisions contained in the terms of issue of the preference shares which investors typically acquire as part of a priced equity round (see 3.3 Investment Structure). As mentioned earlier, in Australia, preference shares typically have a 1x non-participating liquidation preference and a broad-based weighted average anti-dilution mechanism.

Investors in Australia typically also have pre-emptive rights on any new issuances of shares and other securities, which offers them a level of protection if the company undertakes an overly dilutive issuance of shares. Pre-emptive rights are generally on a pro-rata basis, ie, the shareholder has the right to participate in the new issuance in proportion to the number of shares they hold, although investors may negotiate with the company to have the ability to take up a greater proportion of the new securities in the event other shareholders do not take up their full pro-rata allocation. Pre-emptive rights may be afforded to all shareholders or may be limited to certain shareholders (eg, shareholders who hold a certain minimum percentage of the shares on issue).

Generally speaking, the influence that investors may wield over the management and affairs of the company can be categorised as follows:

• rights to appoint a director and/or observer; and
• veto rights at a board and/or shareholder level (commonly referred to as board or shareholder reserved matters).

Board Rights and Board-Reserved Matters

Lead investors will often negotiate to have a right to appoint a director to the board as part of a financing. The right may be contingent on the lead investor continuing to hold a certain proportion of the shares, or it may be accorded to the holders of a class of shares (eg, Series A Preference Shares) rather than an individual investor.

Investors who are given board rights will typically also negotiate a list of matters which require approval of more than a simple majority of directors. The exact threshold for approval is usually a negotiated matter, taking into account the composition of the board – for example, the list of matters may require approval of at least one investor nominee director or a specified percentage of directors (eg, 75%). The matters which are typically be included in this list of board reserved matters will typically cover material board-level matters, such as material changes to the business plan, appointing/removing key employees, material capital expenditure, incurring material indebtedness, etc.

Investors will commonly also negotiate a list of matters which give the shareholders veto rights over certain subjects. The exact threshold is a negotiated point and may require a single or double majority – for example, it may require the approval of shareholders holding a certain proportion of shares on issue and/or the approval of holders of a certain proportion of the preference shares on issue. The list of shareholder reserved matters generally includes matters such as the creation of higher-ranking classes of shares, the payment of dividends and the voluntarily winding up the company.

For a financing round, the subscription agreement will typically contain a set of warranties in relation to the company and its business. The warranty package is generally negotiated and the warranty coverage will vary based on the stage of the company, the size of the round and the type of investor (eg VC fund versus corporate VC/strategic investor), but will, at a minimum, typically cover matters such as:

• the due incorporation of the company and warranties concerning its solvency;
• the ability of the company to issue the relevant shares;
• the company’s capitalisation table before and after closing the fundraising round;
• ownership and use of key intellectual property;
• compliance with key laws (employment, tax, privacy); and
• the accuracy and quality of information provided to investors as part of due diligence.

Typically, the warranties will be subject to qualifications and limitations, including time limitations and a cap on claims for breach of warranty.

In contrast to certain other jurisdictions, in Australia, the warranties given by the company are customarily qualified by the information that is fairly disclosed in the data room, rather than being limited to the matters disclosed in a disclosure letter.

Both the federal and certain state governments have created matching capital programmes whereby the government will invest directly into a venture capital fund, often providing an equity “kicker” to private limited partners (by reducing the share of the profit that the government would receive).

The government has also instituted a “significant investor visa” programme by which permanent residency visas will be granted in exchange for qualifying investments. The qualifying investments include a mandatory AUD1 million to be invested into venture capital funds.

ESICs

Investors which invest in companies which qualify as an “early-stage innovation company” (ESIC) will be entitled to certain tax incentives. In order to qualify as an ESIC, a company must not be a foreign company and must meet both an early-stage test and an innovation test.

Investors who buy new shares in an ESIC may be eligible for a non-refundable tax-offset equal to 20% of the amount paid for their shares (up to a cap of AUD200,000), as well as modified capital gains tax treatment. Generally speaking, capital gains on qualifying shares that are continuously held for at least 12 months and less than 10 years may be disregarded and capital losses on shares held less than 10 years must be disregarded. There are various other conditions concerning the ESIC tax incentives and legal advice should be sought before seeking to rely on these incentives.

ESVCLPs

The ESVCLP structure was created to increase investment in early-stage Australian companies. As noted in 2.1 Fund Structure, for funds that are established as ESVCLPs, gains made on sales of eligible investments may be tax free in Australia for both Australian and foreign resident investors (subject to certain limitations). 

In addition to the ESIC and ESVCLP tax concessions referred to in 4.2 Tax Treatment, Australia’s tax laws also provide a research and development (R&D) tax incentive to companies which undertake qualifying R&D. For entities with “aggregated turnover” of less than AUD20 million, a refundable R&D tax offset is available equal to the corporate tax rate plus 18.5%. For entities whose aggregated turnover is AUD20 million or more, a non-refundable R&D tax offset is available equal to the corporate tax rate plus a premium which depends on the level of R&D intensity (essentially determined based on R&D expenditure as a proportion of total expenditure).

Founders

Generally speaking, the primary long-term incentive for founders is their shareholding in the company. Founders will typically hold ordinary shares (equivalent to common stock). Founder’s shares are often subject to vesting, effectively requiring the founder to remain employed or engaged by the company for a number of years in order to vest their entire shareholding (see 3.4 Documentation). The vesting applied to founder’s shares in Australia is often “reverse vesting”, meaning that the founders hold all of their shares, but may be forced to dispose of their unvested shares if they cease to be employed by the company before the end of the vesting period.

Founders may also be afforded further equity-based incentives through an employee incentive plan, although this will typically only occur in later stage companies or where the founders do not hold a significant portion of the company’s equity.

Employees

Typically, early-stage companies in Australia will establish one or more equity incentive plans, such as an employee share option plan (ESOP). It is common for most, if not all, employees to be invited to participate in a company’s ESOP and most employees will typically be subject to time-based vesting. Vesting schedules vary, but a customary vesting schedule is four years, with a one-year cliff. Key employees may receive a larger grant of options and may be subject to a mix of time and performance-based vesting conditions. Vesting imposed on options and shares is typically “reverse vesting”, meaning that the relevant employee is granted the entire holding of options/shares upfront, with unvested options/shares being cancelled/compulsorily acquired if the employee ceases to be employed before the relevant vesting conditions are satisfied.

Generally speaking, participants in an ESOP may be taxed upfront on the difference between the amount they pay for the securities issued under an ESOP and the market value of those securities. However, there is a special tax concession available for ESOP participants in an early-stage company, known as the “start-up concession". There are a number of conditions which must be satisfied in order to qualify for the start-up concession, including the following (which is not an exhaustive list):

• the company (and any affiliates such as subsidiaries or holding companies) must have been incorporated for less than ten years and must be unlisted;
• the company must have an “aggregated turnover” of no more than AUD50 million in the most recent income year before the employee acquired the shares or options;
• the employee must hold their securities until the earlier of three years from the date they acquire the securities, or until they cease to be employed; and
• for shares, the amount paid to acquire the share must be at no more than a 15% discount to the market value of the share at the time it is acquired; and
• for options, the amount paid to exercise any option must be greater than or equal to the market value of an ordinary share in the company when the option is granted.

The start-up concession is only available in respect of ordinary shares or options issued over ordinary shares. There is also a restriction on participants having a 10% or more beneficial interest in shares or voting power in the company (taking into account shares which would be acquired if any options held by a participant were exercised) in order to qualify for the start-up concession, meaning that founders are often precluded from accessing the start-up concession.

Other deferral regimes may be available if the start-up concession ceases to apply.

Employees who participate in an ESOP and who are eligible for the start-up concession will not be taxed upfront in relation to the relevant securities and may be entitled to a 50% discount on any capital gains incurred on the relevant securities, provided they are held for at least 12 months.

Where the start-up concession does not apply, it may be possible for employees to defer the taxing point until such time as they dispose of any options granted under an ESOP. This could be done, for example, by attaching genuine vesting conditions to the options and also restricting any ability of participants to dispose of the options or any shares acquired by exercising the options.

Please see 5.1 General.

Please see 5.1 General.

Typically, the capitalisation table which is agreed with investors as part of a financing round will include a pool of securities reserved for issue under the company’s equity incentive plan, often referred to as an ESOP (Employee Share Option Plan) pool. However, in Australia, unlike other jurisdictions there is no concept of “authorised capital” and, subject to any restrictions in the constitution and shareholders’ agreement, the board may issue securities in the company at its discretion.

Because of this, the ESOP pool is a number of securities taken into account for the purposes of calculating the number of shares to be issued as part of a financing round (and the subscription price for those shares), but the company is not required to actually establish an ESOP or authorise/reserve securities for issue under its ESOP as part of the round. The shareholders’ agreement will generally specify a maximum number of securities which the company may issue under an ESOP without complying with the pre-emptive rights regime. This number is commonly increased as part of each financing round, and typically only existing shareholders will be diluted by any “top-up” to the ESOP pool, although this is subject to negotiation.

As discussed in 3.4 Documentation, the shareholders’ agreement for an early-stage company in Australia will generally contain the following:

• pre-emptive rights for shareholders on a transfer of shares; and
• drag-along and tag-along rights.

It is customary in Australia for all shareholders to have pre-emptive rights of a transfer of shares, meaning that if a shareholder proposes to transfer their shares (other than for customary transfers to affiliates), they must first offer those shares to existing shareholders. It is customary for these provisions to apply to all shareholders (including financial investors). However, in later-stage companies, smaller shareholders (such as employee shareholders) may be carved out from these provisions for administrative reasons.

Drag-along rights are fairly customary, and are increasingly applied to all exit scenarios, rather than being limited to a share sale – for example, a sale of the assets or business of the company, an IPO, an exit achieved through an irrevocable licence-out of the company’s key IP or a merger or other business combination.

Tag-along provisions are also customary in Australia and are an important minority investor protection. These provisions give minority shareholders the ability to “tag” onto a sale of shares by shareholders who hold a significant proportion of the shares on issue, thus ensuring minority shareholders are afforded the same opportunity to achieve liquidity for their shares.

There are numerous examples of Australian start-ups listing on the Australian Securities Exchange (ASX), particularly in the tech space. Between 2019 and 2023, approximately 79 tech companies listed on ASX through an IPO process and a substantial number of those were start-ups.

Unlike other jurisdictions, ASX has a single board, and the minimum requirements for listing are not inhibitive. This means that early-stage companies can and do choose a listing on ASX where they consider the faster access to capital it offers to be beneficial.

An ASX IPO and listing can take place approximately four months from commencement to ringing the bell on the first day of trading, although the preparation required (producing at least two years of audited financial accounts, putting in place an IPO-ready board and governance arrangements, etc.) means that, in practice, 12-18 months are more likely needed.

The most common structure for an ASX listing by a growth company is a fully underwritten front-end bookbuild. The entity and its underwriter prepare a draft prospectus and engage with institutional investors, which culminates in a bookbuild process to determine pricing and allocations of the majority of the offer size. The deal is then underwritten, the prospectus lodged with the corporate regulator (ASIC), and there is a period of marketing by retail syndicate members to retail investors (who are important in meeting ASX’s minimum spread requirements – 300 non-affiliated investors must hold a parcel of shares worth at least AUD2,000). The IPO completes approximately three to four weeks after the prospectus is lodged.

It is customary for founders and major pre-existing shareholders to agree to mandatory escrow restrictions for a period of approximately 12-24 months post IPO (and where the company doesn’t meet minimum revenue thresholds of approximately AUD20 million, the ASX imposes mandatory escrow restrictions for a similar time period on all shares, though there are exceptions or reductions in those requirements).

This is really dependant on the nature of the entity and its register, as well as the length of time it has been in existence and the extent to which it will be feasible to include a sell-down during the IPO process. Typically, an IPO will involve a sell-down by existing shareholders (in part, this is often to increase the overall offer size as a means of ensuring that the spread requirements can be met). If ASX mandatory escrow restrictions apply, a sell-down at IPO is not possible (unless there are exceptions to those restrictions available), and this would, in turn, make a pre-IPO sell-down desirable.

“Structured liquidity programs” tend to be uncommon in Australia.

The main regulatory challenges to pre-IPO secondary sell-downs are as follows:

• company-led buybacks involve some complexity; for example, there are shareholder approval requirements and an inability to undertake these will materially prejudice the company’s creditors;
• since an offer of shares to retail investors requires an IPO-grade prospectus, any sell-downs carried out ahead of an IPO are limited to institutional and other professional investors.

The offer, issue and sale of securities in Australia is regulated by the Corporations Act 2001 (Cth).

Generally speaking, an offer of securities in Australia must be made under a disclosure document such as a prospectus or offer information statement), unless an exemption applies.

There are a range of potential exemptions, but in the context of venture capital equity fundraisings, Australian early-stage companies most often rely on the “sophisticated investor” and the “professional investor” exemptions to offer securities to investors without disclosure. These exemptions are summarised below.

Sophisticated Investors

If the minimum amount payable by a person for the relevant securities is at least AUD500,000, then the person is deemed to be a sophisticated investor. This amount can be aggregated with any amounts previously paid by that person for securities in the relevant company in the same class.

A person can also qualify as a sophisticated investor if they give the company a certificate from a qualified accountant no more than two years before the offer is made certifying that the person has:

• net assets of at least AUD2.5 million; or
• a gross income for the last two financial years of at least AUD250,000.

Professional Investors

Certain persons will be deemed to be professional investors. Persons (including companies and funds) who have or control gross assets of at least AUD10 million and companies that carry on a business of investing in financial products will be deemed to be professional investors.

Most venture capital funds will be covered by one of the above exemptions. However, there are other potential exemptions which may be available to other investors, including the “small-scale exemption” and the “senior manager” exemption.

Small-Scale Offer Exemption

This exemption applies to personal offers of a company’s securities where:

• the number of people to whom securities of the company have been issued in reliance on this exemption does not exceed 20 in any 12-month period; and
• the amount raised by the company in reliance on the exemption does not exceed AUD2 million in any 12-month period.

Offers made under this exemption must be “personal”. A personal offer:

• may only be accepted by the person to whom it is made; and
• must be made to a person who is likely to be interested in the offer, having regard to:
1. previous contact between the person making the offer and that person;
2. some professional or other connection between the person making the offer and that person; or
3. statements or actions by that person that indicate that they are interested in offers of that kind.

Senior Manager Exemption

This exemption applies to offers made to a “senior manager” of the company offering the relevant securities. A “senior manager” for these purposes is a person (other than a director or secretary of the company) who:

• makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the corporation; or
• has the capacity to affect significantly the corporation’s financial standing.

If an offer of securities is made under one of the above exemptions, the company will be exempt from the requirement to make the offer under an offer document. However, various other laws will still apply, for example restrictions concerning advertising the offer.

The primary restriction on foreign VC investors investing in Australian companies is the application of Australian foreign investment rules.

In general, the following investments relevant to venture capital would require approval:

• the acquisition by any foreign person of an interest of 20% or more, of an Australian company valued above the current monetary threshold (that is AUD330 million for 2024, or AUD1,427 million for certain treaty country investors);
• the acquisition by any foreign person of an interest of 10% or more (and sometimes less than 10%, including where a director is appointed) in a national security business; and
• the acquisition by a foreign government investor of an interest of 10% or more (and sometimes less than 10%, including where a director is appointed) in any Australian company, regardless of value.

Key points to note are:

• many foreign VC funds would be deemed to be “foreign government investors” due to the volume of investment from sovereign wealth funds, public pension funds, public university endowments and the like;
• having any veto rights over board or shareholder matters is an automatic 20% interest; and
• the definition of national security business is extremely broad – it covers certain investments across a range of 22 sectors considered to be critical to Australian security including obvious things like defence and less obvious things relating to economic security, security of critical infrastructure and data security.

As foreign direct investment in Australian VC has increased in recent years, it has become more common for company funding rounds to get held up by foreign VC funds’ foreign investment approval requirements, and for funding rounds to have to be staggered to bring in domestic investors first.