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Daniel Petre AO
AirTree Ventures

Daniel has had a 30 year career in technology related organisations including as a Vice President at Microsoft’s Corporate Office in the US and Managing Director of Microsoft Australia, as well as developing new businesses and business models.

Daniel has established and chaired two technology investment companies in Australia (ecorp and netus) which invested over $100 million in nearly 20 technology related start-ups, the majority of which provided significant returns to investors. He has now started a third fund, AirTree Ventures.

Daniel is an adjunct professor at both the University of Sydney Business School and the University of New South Wales, teaching innovation. He sits on several commercial and not-for-profit boards.

Q. What is AirTree Ventures?

AirTree’s focus is late seed, call it Series A round. We tend to invest in businesses underpinned by software, and with a bias towards marketplaces, e-commerce, and disruptions in health, education and financial services. Both Craig [Blair, Partner in AirTree] and I have built almost 25 businesses together over the last 15 years and separately before that. We think we know how to build businesses that leverage technology.

Our differentiation is twofold. One, we’re very globally focused. We were successful at ecorp and netus because we thought about what was happening around the world and how it plays out in Australia. The other thing is that we’ve actually run businesses. When we meet with businesses we ask questions like ‘What’s your differentiation vs others in this space? What are your unit economics? What’s your churn rate?’ Some like those sorts of questions – they think it helps them, some think they have the answer (or don’t think the questions are relevant) and so don’t want to talk to us. It’s quite crisp then.

Q. How would you describe the state or level of innovation in Australia?

Poor, there’s no question. Things are going on that are promising but on a pro rata basis, on a global basis, poor. We’re not an innovation-based economy. When you look at innovation-based economies like the US or Israel (although they have significant military backed R&D and you can’t always replicate that), there are some common threads: substantial venture capital base, universities producing quality research, and a corporate sector that is constantly looking and spending on true R&D. I don’t mean corporates spending money on what you’re going to ship next year, but what you’re going to ship in 5 years’ time. So these three things work together to create a virtuous cycle.

Australia’s venture capital industry – funds under management – is about one-twentieth the size it should be pro-rata compared to the US and we’re about a fourth of what it is in Canada, pro-rata. The numbers have improved over the last couple of years but it’s still really small. The guys missing in action are not the high net worth individuals – they’re well represented – and it’s not government; it’s the super funds. Part of that is not their fault. They invested in previous [Australian] VC firms, many of which just blew their money up in the late 90’s, early 2000’s. In many cases these funds were doomed to fail as the people running them had come from banking and finance, and not from running companies. Now if super funds want to expose themselves to VC they go into [US funds] like Benchmark, Accell, Andreessen Horowitz or Sequoia. You will get the super funds back into action by proving that the next group of VCs – Square Peg, Blackbird, AirTree…actually do a good job. Getting these guys back matters. With the billions of dollars in superannuation, a couple of hundred million dollars being allocated to Australian venture capital would dramatically change the landscape and it would be a rounding error to the super funds.

If you look at the university sector, we punch above our weight when it comes to the number of patents and publications per hundred million dollars of research money. However if you look at the commercialisation of that, we are down the bottom. What this points to is a cultural issue. First, our universities are not good at allowing academics to step outside their world, try their hand at commercialisation and then step back in again. If you leave, you’re the devil. In the US and the UK there’s a very fluid model between academia and commerce.

Also not delivering is the corporate sector. In Australia many industries are oligopolies with low levels of innovation or change. You only need to be as good as the guy next door, not the best in the world. That’s been the way it’s been for a hundred years (with a few celebrated counter examples – Resmed, Cochlear). Australian corporate investment in R&D, net of hardware, is incredibly low in world rankings on a pro-rata basis. We don’t invest in knowledge capital.

So we’re broken at all levels, it’s a multi-facted, multi-variate problem.

Q. We’re seeing a number of ASX 100 businesses setting up their own accelerators and incubators. Isn’t this a signal that things are improving?

It may be. It’s interesting, a fifth of all venture capital investments in the US in 2014 were corporate venture capital (CVC). Google Ventures and Intel Ventures tend to skew that, they’re serious players. So it’s good that our corporations are starting to establish venture arms but the problem is staffing them. Some people don’t know what they’re doing. They have no track record in investing in or operating start-ups. Then there’s the question of how they are managing them. Are they allowing them to be completely free or are they managing them to not compete with their corporate arm?

Q. Is there a pool of people in Australia who could run those funds?

No. We need to breed them. We need to bring back people from overseas. We need to be very focused on performance. Our boards need to be held much more accountable about the global competitiveness of their companies. The media is a case in point. Everyone has stood back and watched the decline in our media companies for years and when you ask why wasn’t the board or CEO held accountable you get the answer, ‘We’re not worse than the other guys [competitors].’ That’s not the right answer! Why didn’t they buy into new technologies or invest overseas?

Q. What are the biggest errors you see people make when seeking support for their new products or services?

The major problem is that they haven’t thought it through in the global context. Are you solving a real problem, that someone cares enough about to part with money for and that hasn’t been done better somewhere else? Lack of depth of investigation is a major problem. There’s a lack of understanding of how to build a customer base apart from buying Google search words. You need a diversified marketing plan. And [the final error is] valuation. Perhaps you expect to hear a venture capital guy say ‘everything’s too expensive’ but the question we ask is ‘How have you benchmarked your valuation?’ Sometimes they have picked numbers from uninformed [previous funding] rounds and used those as benchmarks and that’s dangerous. They’re not thinking about the long term – how they’re going to have two, three or four rounds. You don’t want to have a lower round or you become toxic to the market. You want to show a steady upward progression. Just raise as much money as you need to prove yourself to the next level at a valuation that allows for value expansion next time.

If you look at the US, there are stacks of companies, some worth billions of dollars, that have stayed private, like Uber. Why? They’re still focused on building their business. In Australia, you get a guy with a one page business plan and he’s doing a pre-IPO round because he’s going to IPO in 3 months’ time! Everyone did that in the early 2000’s but in the US the market has matured and with this next round of tech you’re not seeing an explosion of IPOs. In Australia you get companies planning to IPO that haven’t proved their run rate, haven’t proved their product or their business model. They can’t get money at venture because their valuations are ridiculous so they decide the best path is IPO, or worse, backlisting into a failed shell [company]. Some investment banks are prepared to promote these inappropriate public listings because they get $2 million worth of fees. It’s not right. There’ll be a correction. Mum and dad investors will get hurt again. It’s not good for the sector.

Q. What is the biggest impediment for existing organisations seeking to be more innovative?

They can’t accept that the perfect outcome might be that they’re smaller tomorrow than they are today. Take banks. Australian banks are ridiculously profitable by global standards, perhaps unsustainably so. Three percent of their balance sheet is allocated to personal loans but 19 percent of their profits come from personal loans. One could argue it’s an unsustainable arbitrage and businesses like RateSetter, Zopa, Society One and MoneyPlace have an opportunity. If they can price risk well and give the borrower a better rate and the lender a better rate, they’re going to make money. When they get to scale the banks may go, ‘Gosh what happened?’ When it comes to peer-to-peer lending or small business lending the outcome might be that smaller businesses do better.

Q. Apart from cash, what can investors bring to emerging businesses?

Other than money what they need is expertise. ‘How do you build a sustainable business in the long term?’ It’s all about strategy and execution. We ask, ‘What’s your product offering? How are you segmenting your customer base? What’s your margin? What’s your blended cost of customer acquisition? What’s your churn rate? What’s your cohort analysis?’ It’s amazing how many businesses with customers don’t know their cohort analysis [assessing the value of different customer cohorts based on when they joined]. We looked at a business that was losing three percent of its customers a month. They have to be filling the top of that funnel really fast because customers were falling out the bottom really fast! We didn’t invest.

Q. Do you see much innovation in services?

What I expect is the Uber-isation of every service category where you have inefficient use of resources – either on the demand or supply side – and it’s made more efficient by the use of a platform. We’re seeing it in everything from laundry services to food to restaurant bookings to storage, even legal services. I think the problem with many traditional businesses is that the incumbents’ costs structures don’t support a change so they will not be very good at changing their business models.

Q. If you had one piece of advice for innovators or businesses seeking to be more innovative, what would it be?

Make sure you understand what is happening globally in your market – with your product offering – at a really deep level. Not just what’s being shipped today but what is going to be shipped in three to five years. How are [external trends like] machine learning and robotics going to impact your area? Too often you hear ‘Apple is shipping this today so that’s my competitor.’ No, what is Apple doing in R&D? Be very pragmatic about [finding out] where are things going and get your bias and heuristics out of it. Get your incumbency out of it.