Been hearing more and more about how the recent Innovation Investment Follow-on Fund (IIFF) is working in practice and it’s not good.

You can see how the funding has been allocated HERE.

As a quick refresher, the IIFF was announced as an $83M boost to investment capital available from the Federal Government to incubators/VCs (fund managers) who participated in the first 2 rounds of the Innovation Investment Fund (IIF) program. The ideas, as the name suggests, was to provide follow-on funding to those organisations who needed it.  

We covered the announcement and some pros and cons here.

6 months on though, it looks like, as usual, what’s been delivered is not as attractive as it was made out to be at announcement time and what had the potential to be a good thing has turned into a massive headache for fund managers and startups alike.

Here’s a list of some of the issues:

• There appears to have been a $19M shortfall in the funding from $83M to $64M.
• It turns out the financing is actually a loan, not a grant.
• While the original plan was for there to be direct investment by the Government, based on an advisory group’s recommendations, into the startups requesting money, the Government has now loaned the Fund Managers the money instead – i.e. fund manager are responsible for repaying the money, not the start-ups.
• Some companies were allocated only 75% of their requested funding amounts. Because fund managers are now responsible for allocating the funding and repaying it, this means they have to reallocate resources amongst their investments independent of what was directly approved.
• The Government is trying to push retarded terms onto the Fund Managers. For instance after having borrowed the money and paid the interest the fund managers will only be entitled to 20% of the return on investment. This is akin to a bank saying “here’s a home loan, pay us interest, and when you sell your house we want 80% of the capital gain”. Dumb.
• The generally tough loan terms the Government is trying to put on the fund managers means that they, in turn, are having to be quite tough with the terms in their agreements with start-ups. For some start-ups that means being loaned money by the fund manager by way of convertible notes with interest that will be converted in 3 years based on the higher valuation of an EBIT multiple in the 3rd year or some other calculated value of the business. In this case, to minimise dilution as a startup founder, you’d be smart to try and maximise EBIT rather than invest back into your business. This may not be ideal for the long term success of many of the start-ups.
• The pressure to repay the loan means that fund managers are insisting on exit drag-along terms to ensure they can liquidate/sell the start-ups to repay the outstanding loans.

Admittedly, negotiations are still continuing, but the above is enough to show that the government still doesn’t get it.

Sad, but not unexpected.