Sun, 19 Oct 2014 - 21:00
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Why Should Australian Policymakers Care About Startups?

In the technology sector around the world, ‘startup’ companies form a critically important part of the growth cycle.

A startup is a company formed, from scratch, typically with the aim of commercialising some technology. 

Very often it is software.  It might be medical or biotechnology.  It might be renewable energy technology.

The most successful startups grow at extraordinary rates. Facebook, for example, started in 2004; ten years later its market capitalisation is almost two hundred billion dollars.

On a smaller scale, Australia has had some similar successes. Atlassian produces software which helps software teams collaborate; founded by two UNSW graduates Mike Cannon-Brookes and Scott Farquhar in 2002, it now employs around 1,000 people and a recent transaction valued the company at $3.5 billion.

Why should policymakers in Australia care about startups?

I think there are three important reasons.

First, startups - particularly in the tech sector - have an outsized role in job creation. According to the OECD’s most recent Science, Technology and Innovation Report, one third of job creation in the business sector comes from young firms with fewer than 50 employees – even though these make up only 11 per cent of total employment.

A recent report from America’s Kauffman Foundation found that new business formation was 23 per cent more likely in the high-tech sector of the US economy than in the private sector as a whole (and 48 per cent more likely in information and communications technology.)

Second, startups are particularly important as a mechanism to introduce and commercialise new technologies.  In a world where economic growth and prosperity is tied ever more closely to technological progress, countries with low levels of startup activity are likely to miss out on the economic growth which technology can deliver.

Scott Farquhar, CEO and co-founder of Atlassian, gave a good illustration of this point when he gave the JJC Bradfield Lecture last week, on the topic of ‘Capitalising on the Software Revolution in Australia.’ 

After noting some of the things his company had achieved in twelve short years – including employing over 1,000 staff in high paying, stable, rewarding jobs, more than half of them in Sydney – he observed, “Just imagine the benefits if we had a hundred more successful software companies like Atlassian! Just think how would that benefit Australia!”

Third, if we do not have vigorous startup activity, we are likely to lose our best and brightest to other countries which do.  Already there is a conspicuous brain drain of Australians with IT skills heading to Silicon Valley or other places where they can employ their talents and obtain rewards greater than they see are possible in Australia.

Thanks to an ill-judged decision by the former Labor government, startups in Australia faced a particular hurdle because it was very difficult for them to offer share incentives to their employees.

It is standard practice for startups in the US and most other countries to offer employees options – that is, rights to purchase a designated number of shares in the company at a specified price – under what is usually called an ‘Employee Share Ownership Plan’ or ESOP.  If the company does well, the market price of the shares will be far in excess of the price the option-holding employee will pay. 

This can be an attractive form of remuneration for those wishing to take a risk and work hard on the creation of a new business. Equally importantly, for a startup with limited resources, it can issue options to employees and in exchange the employee will accept a lower cash salary than would otherwise be required, because of the potential for a generous pay-off at a later date if all goes well.

In the US and most other countries, options are taxed when the option is exercised. However, then Treasurer Wayne Swan in 2009 changed the law so that in Australia options are taxed in the hands of employees at the time of issue, rather than at the time they received the proceeds.

This means an employee must pay tax, in cash, when they are issued options, and then the options may prove to be worthless.  It effectively destroys an important mechanism to stimulate startups in the technology sector. 

Pleasingly, the Abbott Government has announced it is fixing this problem, as part of the Innovation and Competitiveness Statement issued last week by the Prime Minister and Industry Minister Ian Macfarlane.  We have said that we will ‘reverse the changes made in 2009 to the taxing point for options’ and that this will mean that ‘discounted options are generally taxed when they are exercised (converted to shares), rather than when the employee receives the options.’

The Statement specifically notes that a key rationale for this decision is the importance of giving startups the best chance of succeeding.  As one tech sector entrepreneur commented to me, it is refreshing to see the word ‘startup’ being used in an Australian government document.

There is no purer expression of entrepreneurial ambition than the startup.  Many fail; but some succeed; and a few succeed spectacularly.

A vigorous economy needs a vigorous startup sector.  The previous government’s policies actively impeded startups.  The Abbott government wants to encourage them – because we know the benefits they can bring.