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The Tax Guru the WSJ says has Wall Street’s “Strangest Hustle”: w/ Andy Lee, Parallaxes Capital – EP237

Post author By Alec Krishna
Post date April 25, 2024
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According to the Wall Street Journal, this episode’s guest Andy Lee is “The Tax Whiz With the Strangest Hustle on Wall Street”. He’s the founder and CIO of Parallaxes Capital, and he joins us to talk about tax receivable agreements (TRAs). Andy explained what TRAs are, how they come about for companies going public such as Shake Shack in 2015, and why he’s investing in them. Disclaimer: Nothing in this episode should be construed as financial or investment advice.

Please contact us with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcast and Spotify.

About this episode’s guest: Andy Lee, Founder and CIO of Parallaxes Capital

Andy founded Parallaxes Capital in 2017. Previously, he was with Lone Star Funds, focused on investing in the Americas. He began his career at Citigroup.

Andy graduated from the University of Illinois at Urbana-Champaign with a Masters in Accountancy and a Bachelors in Finance and Accountancy.

Andy has been featured in publications including Wall Street Journal, Capital Allocators, Institutional Investor, NBC, Forbes, ReOrg Radio and Fitch’s LevFin Insights. He has spoken at events and conferences for organizations such as the Association of Asian American Investment Managers (“AAAIM”) and leading academic institutions including the University of Illinois, University of Pennsylvania and Texas Christian University (“TCU”)

When Andy is not working, he enjoys taking his corgi (Taco) on long walks.

Fun Fact: Andy, rarely one to back down from highly ambitious goals, ran a marathon less than 180 days from ACL, MCL and PCL surgery.

Source: https://parallaxescapital.com/our-team/

What’s covered in EP237

Introduction. (0:00)
TRAs for companies going public in the US. (6:18)
TRAs agreements and their value for private equity investors (i.e. pre-IPO owners). (12:52)
Tax refunds, risk management, and investment opportunities. (19:57)
TRAs and investment strategies. (24:47)
TRAs and their potential as a diversified investment. (30:55)

Takeaways

TRAs convert future corporate tax savings (e.g. from depreciation expenses) into current income streams.
TRAs provide long-dated, typically 15-year income streams that can be sold by pre-IPO owners (e.g., private equity investors).
Private equity firms use TRAs to increase their earnings from the sale of businesses they’ve invested in.
Ideal Candidates for TRAs are large, stable companies with predictable long-term profitability (e.g. Shake Shack), rather than high-growth tech startups which often lack immediate profitability.
US tax expertise is required to properly analyze and invest in TRAs.

Links relevant to the conversation

WSJ article about Andy, “The Tax Whiz With the Strangest Hustle on Wall Street”: https://www.wsj.com/finance/investing/tax-whiz-strange-hustle-wall-street-d51ddbc6

Parallaxes Capital: https://parallaxescapital.com/

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Transcript: The Tax Guru the WSJ says has Wall Street’s “Strangest Hustle”: w/ Andy Lee, Parallaxes Capital – EP237

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Andy Lee 00:04

Tax is the largest asset class in the world that no one’s ever heard of. It’s a very much part of the fabric of our society. Like there are so many avenues through which tax assets are expressed and are monetized.

Gene Tunny 00:26

Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you could join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, and welcome to the show. In this episode, I talked to the man that the Wall Street Journal has described as the tax whiz with the strangest hustle on Wall Street. It’s Andy Lee from parallaxes capital and we’re talking about tax receivable agreements T RAS. What on earth rtra is and why has Andy invested in them? How did companies like Shake Shack end up bound by T IRAs? Stay tuned to find out. Please be aware that Andy’s firm parallaxes capital is a big investor in TRS and nothing in this episode should be treated as financial or investment advice. I would love to hear your thoughts on the discussion that I have with Andy today. So please get in touch and let me know what you think. And if you have any questions, my contact details are in the show notes. As sponsor this episode is Lumo coffee a seriously healthy organic coffee with three times a healthy antioxidants of regular coffee. Lumo coffee offers a 20% discount for economics explore listeners until 30 April 2024. Be sure to check out the show notes for more details. Without further ado, let’s dive into the episode. Enjoy. Andy Lee from parallaxes. Capital, welcome to the programme.

Andy Lee 02:09

Thank you for having me.

Gene Tunny 02:11

It’s a pleasure, Andy, I’m keen to learn about this very exotic, very interesting, and, you know, asset class I hadn’t heard of before before I learned about what you’re doing these tax receivable agreements, so keen to chat about that to start with? Could you tell us about parallaxes? Capital? What’s the idea with the name? How did you come up with the name? Absolutely.

Andy Lee 02:38

So a parallax is an astronomy term. Whereby you look at a planet from a different vantage point to arrive at a different perspective of an object. So there are several meanings in the name, the first being an ode to my old firm, it was called Lonestar funds. And so looking at a person having a different perspective, the more secular meaning around was that many people look at problems from a singular point of view. And in order to solve an equation, like you need to look at it from multiple perspectives, to arrive at multiple solution sets. And so the plural of parallax parallax cysts. And so that was as parallax was unavailable. parallaxes was, and so that was helpful. But also it talks a little bit to my faith. I’m a Christian. And as a Christian, and we’re not so much focused on the here and now, but more focused on eternity. So a very long term perspective.

Gene Tunny 03:41

Very good. Yes, it’s a it’s a good name. I always remember those that classic 1970s film with I think it was Warren Beatty, the parallax view, which is one of those great 1970s conspiracy films that I’d recommend. So yeah, very, you know, top marks on the name. So well done. I’ve got to ask me, what is parallaxes? Capital? What? So if you’re a, you’re a fund manager of some kind, or what are you actually doing?

Andy Lee 04:10

So we’re an investment manager based in the in the US and we have raised six funds dedicated to the strategy of monetizing tax receivable agreements. So a tax receivable agreement, think about it, like a long dated annuity that is not too dissimilar from a streaming royalty on metals or mining, musical royalties of pharmaceutical royalties. So long data annuity like cash flows, that we provide upfront liquidity for to holders of these assets in order for them to have to recycle that capital to do other more productive items.

Gene Tunny 04:55

Gotcha. Okay, so, a couple of things there just immediately long dated how long and by the upfront liquidity? I mean, what is this? Is this a repurchase agreement? Or are you? Are you buying them outright? What’s, how do you how are you? What’s that involve?

Andy Lee 05:16

So are the two questions the first duration lies? It’s typically a 15 year piece of paper. Just to provide a perspective on it, we actually have fun one was a 21 year of fun to hold the paper. I know I look very young as an Asian American, it’s a gift, as I’ll call it. But people weren’t sure if I was even 2001 When I went out to raise our first fund. On the second question, it is the latter. Do what you suggest that we buy these outright from counterparties, including the likes of private equity, their CO investors, management team as well as founders, providing them upfront liquidity for what is otherwise a unloved and misunderstood asset.

Gene Tunny 06:02

Okay, gotcha. Right. And what is the asset itself? So there’s obviously a stream of income coming from somewhere for this to be valuable, what is the actual underlying asset? Absolutely.

Andy Lee 06:18

Think about it almost like a tax refund, that one might receive after they file their taxes. So some here in the US, every April 15, individuals have to file their taxes, fulfilling their tax obligation to the United States. Oftentimes, many of these individuals have overpaid their taxes. And so on April 15, they would file your taxes, the US government would say, hey, Jean, you’ve overpaid your taxes by 100 bucks, we’ll pay it to you in two months. For many individuals, they might want the money immediately. And so there are businesses such as the likes of an h&r block, that would say, June instead of waiting for $100, in two months, we’ll give you $95. Today, a Buy It Now price, we do the exact same thing. But not for consumers. We do it for corporations, where they have 15 years of refunds available to them, that would come due. And so instead of waiting every year to get that annuity, they want that money today. And so we prospectively provide them that factoring solution upfront proceeds.

Gene Tunny 07:37

Ah, okay, I think okay, this is starting to make sense. Right. So what type of companies are we talking about? I mean, what from my reading? And looking into this, it looks like is this is this highly relevant to the tech sector to startups?

Andy Lee 07:55

I wish I’m the only one, it may not be the most relevant that attack sector is primarily driven by the fact that many tech firms here in United States are very focused on growth at all costs, relative to profitability, many of them, or the vast majority of the tech sector runs unprofitably Primarily because the market prior to 2020, to value them on growth, more than they did on cash flows, primarily because they believed that these were long data annuity streams. And the SAS businesses were long data annuity themes, and that whenever they stopped growing, they will become incredibly profitable. That obviously then come to fruition whenever growth stopped. So that’s not the where we primarily transact names that we’re are associated with, include the likes of a REMAX, a Shake Shack, yeah. Duffin Phelps, so large corporates that are investment grade near investment grade businesses, there’s also the Edit element that as quickly as a tech business disrupts a industry itself is vulnerable to being disrupted. And so for an investment manager like myself, focus on the space that we’re in, like, we don’t focus on the next year or next five years, we have to believe that a business is going to be a going concern for 15 years. So that’s a very different perspective or lens that you have to look at a opportunity, primarily because you might be a great business today. Do I believe that you’re gonna be a great business in 15 years, if you’re not a great business? Senior, you might be a great business for five years that will result in me getting a return of my capital. Ultimately, I’m in business to get a return on my capital. And if you’re no longer in business in your six, I got my money back. And then I just wasted a huge opportunity cost for my investors.

Gene Tunny 10:08

Yeah, yeah, gotcha. And how does this tax receivable agreement? come about? Then? And also, I mean, okay, so I guess maybe I need to go back a bit. What’s generating this, this tax refund primarily? What is it that that is generating these potential tax refunds that will be coming in the future and that you’re able to then you buy you effectively buy those tax refunds off the companies? So I guess I’m interested in what’s generating them, if there are any sort of commonalities. And also then how do you go about making that agreement? What’s the contract look like? Is it regulated? Or is there a standard form? Can you tell us a bit about that place? Andy?

Andy Lee 10:55

Yeah, absolutely. So the most common version of that is, whenever a company is going public, they enter into a specific tax transaction in the US transforming their business, from what we call a flow through, which is a partnership or an LLC becoming a C corporation, that transaction is known as the up seat transaction, that transaction enables the company to be a beneficiary of large tax assets that will become available to them over 50, typically 15 years. So that’s an incredibly valuable asset. As a result of entering to these transactions, they enter into the agreement, the agreement is relatively rote. It’s while it’s a cottage industry, much of it has been rinse and repeat it over 30 years has been around since the 1980s. And so something that as well Warren precedents, as well as presidential documents for them to follow. And so for us, these are ultimately ended up in the hands of what we call a natural holders. So in the private equity context, private equity firms have tenure fun lives. So they take a company public, and oftentimes, they sell down the equity within the 10 years that their funds allow for them. These, if you took a company public in your A these assets, then start a 15 year clock. So in your two to three, it will be your 11 for private equity fund, you’re looking to move on and sell these positions. And that’s where we stop at we’re a second during market liquidity provider for these

Gene Tunny 12:51

assets. Rod okay. And I mean, you talk about large tax assets. What if, if I understood your terminology correctly? What are you talking about? Are you talking about what is it is a depreciation or is it the things that Yeah, Okay, gotcha

Andy Lee 13:10

items that can be depreciated or amortised. So raw. What what what’s an item that depreciate a car? A building on land is not depreciable because like obviously land is the land. But things are amortised include things that aren’t intangible in nature. So customer relationships, among others, that might be available intellectual property, among others.

Gene Tunny 13:37

Gotcha. So this is a way for these companies to to get well to get to get cash to reinvest in their operations or to you know, for working capital, whatever. Can you explain what is it? What’s in it for them? Because I mean, they they sacrifice this, you know, the this tax, you know, this expense that they can use to reduce their, their tax liability in the future? They get the upfront cash, what is it? Is it is it out of desperation that they’re going into these agreements. So how

Andy Lee 14:11

I would make a slightly different connotation. Remember, I mentioned that the sellers are private equity firms, or investors among others. So at the time of the IPO, these assets are owned by the company. Remember, pre IPO, the Board of Directors got our fiduciary duty is to maximise value for pre IPO shareholders, the public markets, we as in the US have seen a massive move away from active to passive investors. active investors are very focused on understanding what intrinsic value are, and so they’re very focused on understanding the free cash flow capabilities and generation of a business. However, on the other side of the equation passive Investors are more algorithmic, algorithmic or systematic in nature and are focused on among other things, revenue, multiple growth rates, EBIT, da multiples, price earning, none of which really captured the value of tax assets, primarily because they’re less standardisation across things such as capital expenditure, and intensity of a business, working capital, cash taxes. And so as a result of not necessarily the attributes that they seek being captured by the evaluation metrics, these tax assets are ignored. And so private equity firms are saying, Look, this fundamentally improves the free cash flow generation of a business. If you’re not going to give us an incremental value, incremental value for it, we’re going to extract it for ourselves by entering into a tax receivable agreement. So the holders of these cash flows are more sort of private equity firms. As a result of the finite fund lives, we step into the breach to provide liquidity to.

Gene Tunny 16:12

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker 16:17

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Gene Tunny 16:47

Now back to the show. What’s an example of a private equity firm as a Carlyle Group? Is that the sort of group you’re talking about, or KKR?

Andy Lee 16:57

Yeah, all of these massive mega funds all have trs, primarily because they had it for the investment manager themselves when they went public. And subsequent to that the principals realise the disconnect in how the the various markets private and public markets think about it differently. And if they’re extracting value from their portfolio companies, as private equity got more and more competitive?

Gene Tunny 17:25

Yeah. Yeah. I mean, it’s, it’s interesting to me, it’s one of these, these niche types of investments. I mean, honestly, I hadn’t heard of them before. You know, actually, there’s not Nishioka. Well, tell me more.

Andy Lee 17:42

Tax is the largest asset class in a world that no one’s ever heard of. It’s a very much part of the fabric of our society. Like there are so many avenues through which tax assets are expressed, and are monetized. In the US, we have the concept of tax credits, that are now that were historically transferable or monetizable. And now they have direct pay. I don’t know you’ve been to Europe, with your significant other, and may have gone shopping in that regard. In the in Europe, there is what they call it the value added tax for which is a foreign or you can get a refund at the airport. Yep, there’s a huge business, global blue, that’s currently owned by Silverlake, that generates hundreds of million dollars of EBIT da by running the VAT tax refund programme at the airport. Similar to the example I gave you on individual taxes, that in commercial business that basically says to travellers whenever to depart in the EU, hey Jean, instead of waiting to get a check to Australia for that 1000 euros will just give you $700 Today, and they earn a sweat relative to that. There are so many businesses like that, across that run the gamut. And the lack of understanding creates the opportunity because it is the single largest opportunity set that doesn’t have commercial elements to it. And intellectual capital that has been brought to bear. Why is that? primarily driven by the fact that tax professionals here at least here in the US, when people hear attacks, they literally run away all the plug your ears, that like that’s the last thing they ever want to talk about. Every year we have to file on April 15. People consider it like being worse than going to the dentist. So like it’s something that is a very misunderstood and underappreciated even though there’s clear value add that can be created an economics that can be derived from it. Yeah,

Gene Tunny 19:56

yeah, for sure that that example you gave is a very good one. And that’s really helped crystallise in my mind. And so you’re, you’re doing what they’re doing. But with, well, you can compare what you’re doing with what they’re doing, you’re doing it for big corporations or for the private equity companies that have invested in them, they want to get out, you come in, you provide some liquidity, and you take this stream of these, these benefits that they can get from reducing their taxable income so that they will pay you that benefit associated with that in the future. You’ll get it from you get it from the company itself, too. Can you tell us what the agreement like who’s the contract or the Yeah,

Andy Lee 20:42

the agreement is between the TRA holder, then the private equity firm, now parallaxes. And the company every year, yeah, post tax filing season, the company has obligated to deliver a notice to the holders, if they utilise the asset, and the calculation of the refund, at which point of time, they have to repatriate the refund to the holder of the TRA. And so for which every q4 is a little bit like Christmas, we a little bit of an early Christmas, where we started collecting payments for the underlying payment stream. Gotcha.

Gene Tunny 21:24

Okay, so with the example you gave of the business was a silver like the global blue that does the refunds, or they will pay you up front? The VAT or the VAT refund? And they there’s a there’s a discount applied? So they get a benefit they’re taking on? Suppose they’re probably taking on less risk if they’ve got receipts? How do you think about that risk? I mean, what risk is there from, from your point of view? And how do you manage that risk? Yeah,

Andy Lee 22:00

yeah, three primary forms of risk that we manifest. The first and foremost is credit risk. So in global blues example, the EU governments failing and choosing not to, or stepping them on the pavement. For us, it’s more, it’s entirely around is the business going to exist? To the point about do I believe that this is a durable franchise, and will be around in 15 years. And so I have to believe that the company is a going concern will be a going concern, profitable and will exist in earnest. And so that’s a big part of our underwrite. And our focus on these businesses, we’re not looking for a flash in the pan, were looking for long, durable franchises. One on credit risk. The second risk is you never lose your tax asset. Like in the same way, if you don’t go, you don’t use a global blue solution, you still are eligible for the refund for multiple years. So you can go, you can fly back to Australia, on your next trip to Europe, you can file your tax refund. And that has we can do it’s the exact same thing, tax assets never get lost. They’re merely deferred. And so that has the potential to impact our IRR, which is a time weighted measure. But obviously, it’s an extent we collect it, then it doesn’t hurt our total profit dollar or mo YC on the opportunity. The last aspect is around corporate tax rates. So think about a tax acid as being the derivative of two variables, one at the tax asset itself, the notional value of a tax asset, so think about a net operating loss of 100. Think about the tax rate being your price to let’s just say 25% 100 by 25 results in a $25 cash flow. To the extent that tax rates went down and to 20%, then the tax acids 100 by 20, or $20 to the extent and went up 100 by 40, then you get $40. And so relative to most other asset classes, we have an inverse relationship to the primarily because if tax rates went up, equities likely would see some form of a correction downwards. Conversely, on the way up, ever when tax rates went down, equities would likely rally. We have an inverse relationship to that. And so for many of our investors, they view it as a nice tail hedge relative to potential policy changes here in the US.

Gene Tunny 24:47

Gotcha. Okay. So you mentioned a term before MOC. So that is multiple on invested capital. So just clarify that. That makes sense. Right? So, yeah, just thought I’d ask you about that, that risk. Because, you know, whenever you’re swapping these, or you’re taking on these, or that the stream of benefits and you’re providing upfront money, that can be risky. And we saw what happened with Lex Greensville, from the green cell family, which is a dime in Brisbane and Queensland, which is south of Bundaberg, which is where the green cell family farm is. And, you know, he was he was doing great things, but then, you know, he got into got into trouble because he thought he found this, you know, this this thing, this part of the market that no one really was properly servicing before and was providing, you know, he was buying the invoices, I think, wasn’t he and then we’re providing that supply chain finance. And then, you know, it was all working until the pandemic and and companies started delaying payments, and then the whole thing fell over for him. So he was in. And that was a real shame. What happened there real, real, real shock. So yeah, I just just wanted to ask you about the risk, because I like I just wonder, is there a risk here that? Yeah, I just want to make sure you’re I mean, I’m sure you are, you’re crunching the numbers, you’re highly experienced in this in this industry?

Andy Lee 26:22

Yeah, I think for Greensville, I mean, Dale had on the asset side of the equation, to your point, there started to being deferrals or delays to the cash flows that they were receiving, there was a little bit of an asset liability mismatch, whereby they was the liabilities they borrowed heavily, and would deliver at an incredibly aggressive rate. And so that resulted in them being unable to fulfil their obligations on the liability side of the equation today. We have also achieved securitisation. Today, our book is unlevered as we have paid it off, but that is something that we are incredibly conscious about. And look, there’s always that under inherent tail risk. The point is like you should never have too much of a mismatch. And so inherently, it’s we’re always very concerned about not having too high of a leverage level that we will be unable. Should there be shortfalls in our expectations or under writings. Yeah, yeah.

Gene Tunny 27:30

Right might have a look at some of the, what you’ve got on your website. There are some interesting things here on your website here. So I’ll put a link to that in the show notes. So parallaxes capital is an alternative asset manager and as a market leader in monetizing tax receivable agreements. Okay, so I think I’ve got a much better understanding of what that’s all about. And the stats you’ve got on your website, I don’t know if these are still current, but it says 20 Plus tax receivable agreements, purchase so they’re, so they could be large companies like Shake Shack or whatever. REMAX you mentioned that you’ve got these tax receivable agreements from and then it’s $750 million of an discounted principal balance purchase? Could you explain a bit about what what that seven 50 million figure means? Please, Andy,

Andy Lee 28:25

absolutely. Remember the example that I gave you as to the value of a tax asset such as a net operating loss multiplied by a tax rate of a 25%. We own across our portfolio $750 million of cash effective tax assets. So if you want to understand what our notional number is, you do that 750 divided by a 25% tax rate. And you would end up with like $3 billion of notional. So 30 million is what our portfolio over the next 15 years will deliver back to us should deliver back to us. Rod,

Gene Tunny 29:06

okay. And do you provide any indication of what the potential rate of return to investors is?

Andy Lee 29:14

on a net basis? We deliver call it a 15% return. Ron, okay.

Gene Tunny 29:21

Gotcha. And, Ron, so that’s obviously going to compare favourably to to more traditional asset classes, but of course, you know, risk associated with that, and nothing we’re saying here is we’re not I’m not offering any financial or investment advice, of course. Right. And who’s investing in your funds? Andy? So you’re in New York City, I believe. Who who’s investing in your funds? Is it family offices? Is it is it investment, Marilee

Andy Lee 29:54

endowments and foundations as well as small pensions? Right and Oh, CIOs,

Gene Tunny 30:00

endowments, foundations and small, small pensions Did you say confirm

Andy Lee 30:05

as well as address or CIO firms?

Gene Tunny 30:09

Sorry, I’m not familiar with that acronym IC, sorry, what type of firms and

Andy Lee 30:14

outsource Chief Investment Officer firm. Think about smaller endowments may not have the sufficient scale to hire their own research teams to allocate capital. And so they aggregate capital into a larger firm, who then deploys money on their behalf in an outsource format. As a result of that bundling, they’re able to capture economies of scale as well as gain access to best in class managers,

Gene Tunny 30:46

broad Okay, without necessarily recommending, in particular, outsourced CIO, cio firms, you know, any examples of them? I’d be interested in following up on those I can’t say I’ve really come across many of them. There

Andy Lee 31:00

are some huge ones such as a partner’s capital. A Hamilton lane, a stepping stone. Yeah, a Cambridge associates. A RCEP.

Gene Tunny 31:15

Yeah, right. Now, it’s fascinating. I mean, one of the things that our previous guest on my show, David Bahnson, who’s with oh, gee, the name of his firm escapes me, but it’s quite a, he’s got quite a reasonable amount of funds under management. He’s over at over on the West Coast. I mean, one of the points that he makes on on his capital brief show is that the the capital markets in the US are just so deep. There’s just so much. So so much money, obviously, with so much talent and so much creativity and innovation. And, you know, this is what I’m learning today is what I’m seeing today. Is is part of that it’s part of that story. It’s it’s all it’s it’s really fascinating. Yeah, so yeah, thanks for thanks for all this. I’m sorry. So my questions might be, might be a bit bit basic, but I’ve, yeah, there’s

32:14

a lot. We’re all learning together.

Gene Tunny 32:16

Very good. Very good. There’s a lot I’m unfamiliar with in this in this space. So it’s really good. My final question and it relates to a book I’ve been listening to recently. It’s Tony Robbins, his new book, The Holy Grail of investing. I’ve been listening to it on Audible. I don’t know if you’ve come across it at all. But it’s, yeah. It’s very good. Because I mean, one thing about Tony Robbins is that he just knows all of these ultra successful ultra wealthy people and he’s able to pick their brains. So he’s talking to people like Ray Dalio and, and I think Paul Tudor Jones, I think was a client of Tony Robbins. But what he picked up from Ray Dalio is this idea of this holy grail of investing and he asked Ray Dalio for some advice and, and Ray Dalio is best advice to him was, what you’ve got to find is eight to 12, uncorrelated investments for your portfolio. So he’s talking about things that, yeah, they’re uncorrelated, so they’re not going to vary. You know, what’s the right way of thinking about this there? Because the returns are so I suppose unexpected or random relative to everything else, that if you get enough of them, then you should you can outperform the market. So even if the markets in a downturn, you can still be, you can still be doing okay. So I think that’s the that’s the basic idea. I probably haven’t explained that well enough to come back to that. But I think it’s an interesting concept. And, I mean, how do you see this your tax receivable agreements? How do you see them as part of a diversified portfolio or as part of trying to achieve this, this collection of uncorrelated investment assets that Ray Dalio would call the holy grail of investing? Do you have any thoughts on that?

Andy Lee 34:10

Yeah, absolutely. So like, look, there are so many different opportunities that are as a result of an inefficient and inefficiency, opaqueness of a market as well as size of markets that create incredible moats for one to be able to harvest what I might describe as alpha from it. And that alpha isn’t necessarily something that is academic in nature, is just driven by inefficiency. That can be an opportunities like what global blue does. They have a regulatory moat. Like, no one day Oh, there’s only one kiosk at any given airport. There’s only one way for you to get a refund unless you want to go Go home and send multiple stamps and mailing your refund, that inherently has have some exposure to obviously discretionary spending, among others, but you’re looking for opportunities where they’re just such inefficiencies and markets that you’re able to harness that operational alpha, um, that can be created as a result of sourcing. And so like, I think Elliott says, is incredibly well, that they seek to sweat their assets. What they do isn’t difficult. It’s just incredibly laborious. And so that’s what we try to do at parallaxes playing in non traded markets, ie there are no brokers. Unlike a, you can’t buy this on a Bloomberg or on your friendly broker, like those are things that that require you to go out and transact on a individual by individual basis. Is it hard to do? No. Is it something that many want to do? Also very much, that’s not something that many desire to do? The best and the brightest here in the US aren’t looking to make their living and become a master of universe and tax? That’s just not something that occurs? No,

Gene Tunny 36:14

no, certainly isn’t. I think it’s so fascinating. You mentioned I mean, alpha, so you’re going for that excess return, you’re talking about excess return relative to typical market returns. And then you mentioned Elliot, and I’m trying to remember the I don’t know, I can’t remember the name of the whole firm, but as Elliott, the is that the firm that buys distressed debt, and then Sue’s the countries that it’s that it’s bought the debt from

Andy Lee 36:41

most famous for Argentina. Yeah, gotcha. Or Argentina or seizing having seized a warship from Argentina. Rot.

Gene Tunny 36:48

Yeah. Wow. Okay, I’m gonna have to cover them in a future show. That’s fascinating stuff. Okay, Andy, that that’s been do

Andy Lee 36:57

something that many are unwilling to do. Yeah. How many investment firms are willing to confront a country and confiscate a warship?

Gene Tunny 37:08

Yeah, it’s, it’s bold. It’s certainly Absolutely. Right. Okay. And it has been terrific. I’ve learned, I’ve learned a lot. And yeah, so again, it’s an illustration of just those deep capital markets and just the level of, of ingenuity, the level of rigour that is being applied to finance Well, in the US and worldwide. So this is, this is terrific. Oh, finally, I should ask is this just is this mainly a, what you’re doing this? Is this mainly applies to the US, does it? Or do you see it happening in other countries

Andy Lee 37:50

that technology can occur all over the world? Um, that’s likely not something that I thought parallaxes can pursue. Primarily because tax is a very local domain of expertise. You’re not going to have a US tax preparer. help prepare your Australian taxes. They’re just not familiar. They’re barely familiar with Canadian bumper rules, or Mexican tequila taxes. They’re very much not familiar with Australian. It’s just a local domain of expertise. Gotcha.

Gene Tunny 38:20

Okay. Right, Andy, anything else before we wrap up?

Andy Lee 38:24

Nope. Thank you so much for taking the time. No worries, I

Gene Tunny 38:28

will put a link to parallaxes capital on your on the in the show notes. And yeah, refer them to to your material. So if you’re interested in you’re in the audience, and you want to learn more about tax receivable agreements, you can you can check out Andy’s website. Andy, you’re obviously one of the great authorities on this issue. So I would definitely refer people to us. So Andy Lee from parallaxes capital. Thanks so much for your time. I really enjoyed the conversation. Take care and be well rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting outlets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

39:47

Thank you for listening. We hope you enjoyed the episode. For more content like this. To begin your own podcasting journey head on over to obsidian-productions.com

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business, www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.

Tags economics, finance, investments, ipo, private equity, tax

Podcast episode

Democratizing VC Investment Opportunities w/ James Kwan, VentureCrowd – EP197

Post author By Alec Krishna
Post date July 20, 2023
No Comments on Democratizing VC Investment Opportunities w/ James Kwan, VentureCrowd – EP197

Show host Gene Tunny chats with James Kwan, in-house counsel at VentureCrowd, about venture capital. VentureCrowd describes itself as “Australia’s leading equity crowdfunding investment platform, leveraging the power of crowdfunding for investments that back a better future.” Gene and James discuss how VentureCrowd is bringing venture capital investment opportunities to a wider audience through equity crowdfunding. Tune in to learn about the significance of venture capital in financing and supporting innovative ideas and businesses, particularly in the early stages when traditional sources of capital may be less accessible. Of course, listeners are reminded to do their own research and seek professional advice before making any investment decisions.
Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP197

James’ thoughts on venture capital and what he does at VentureCrowd. (1:31)
Initial thoughts on government policy towards VC (6:26)
The valley of death for startups (12:05)
What’s the range of funding for startups? (13:07)
Challenges in accessing the private capital markets. (17:29)
Crowdsourcing VC investment – example of success: Be Fit Food (19:50)
What is VentureCrowd’s pitch to investors? (21 :41)
ESG investments and societal values. (24:13)
What are the different ways people can invest through VentureCrowd? Is it based on specific startups? (25:54)
Tricky legal issues in VC. (27:01)
What’s the impact of blockchain on venture capital? (32:04)
Government assistance for entrepreneurs e.g. Breakthrough Victoria Fund (37:51)

Links relevant to the conversation

Venture Crowd website: https://www.venturecrowd.com.au/s/

Transcript:
Democratizing VC Investment Opportunities w/ James Kwan, VentureCrowd – EP197

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. The transcript was then checked over by a human, Tim Hughes from Adept Economics, to pick out any clangers that otters may have missed. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny 00:07

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory, evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show.

Hello, thanks for tuning in to the show. In this episode, I chat about venture capital with James Kwan. James is in-house counsel at VentureCrowd. VentureCrowd describes itself as Australia’s leading equity crowdfunding investment platform, leveraging the power of crowdfunding for investments that back a better future. In this episode, you’ll learn about venture capital and how VentureCrowd is trying to bring venture capital investment opportunities to as many people as possible. Nothing in this episode should be construed as financial or investment advice. Wherever you’re choosing to invest, do your own research and seek advice from a professional financial advisor if required. Okay, let’s get into the episode. I hope you enjoy my conversation with James Kwan from VentureCrowd.

James Kwan, welcome to the programme.

James Kwan 01:31

Great to be here Gene, longtime listener, first time guess, so

Gene Tunny 01:35

yeah, very good. Well, it’s I should have had you on earlier. I’ve recently discovered you, you’re the in house counsel at VentureCrowd, and you’re involved in venture capital and venture capitals has been an interest of mine for a while or as a as an observer of it, and is keen to get your thoughts on venture capital and what you’re doing at VentureCrowd. So if you’re happy to chat about that, that’d be great.

James Kwan 02:05

I’d love the opportunity. Look, can I just give a disclaimer, Gene? So yes, and I’ve loved you know, I’ve wanted to do this for a while so pilfered this from an American lawyer I listened to. Now what he says is, I’m VentureCrowd’s lawyer, obviously, I’m kind of swapping in a couple of different words, but I’m VentureCrowds’ lawyer, I’m not your lawyer. So anything I do say here, please don’t take it as legal advice. If you do need such advice, please solicit your own lawyer. So with that out of the way, I’d love to actually talk about venture capital.

Gene Tunny 02:34

That’s very good. Is that Jordan Harbinger? He says that on some of his podcast episodes, you know, the did you hear from Jordan Harbinger or from

James Kwan 02:43

He’s a bit of a new name. I think I’ve heard it from a couple of American lawyers speaking in the blockchain space. And we can talk about that as well, because that kind of feeds into the VentureCrowd vision, but it might just be an Americanism right?

Gene Tunny 02:57

No, it’s good advice, though. I mean, yep. I’m not your lawyer. So yeah, exactly. Get your own independent advice, professional advice. So and this is all for general information only. There’s no investment or financial advice in or legal advice in this episode.

James Kwan 03:12

Not even life advice, I think.

Gene Tunny 03:14

Okay. So James, to kick off with, could I just make sure I understand what we’re talking about with venture capital, we’re talking about financing for early stage businesses, typically startups they’re not they’ve got an idea. They might have a few employees, they’re looking to get some funding so they can can grow. What’s, how do you think about venture capital?

James Kwan 03:37

Yeah, look, the best way to probably explain it is that crazy uncle you’ve got in the garage, right? Who’s forever tinkering away on and, you know, a harebrained idea, they’re the people which you attract into the venture capital space, it is the idea, are the ideas which are crazy slash revolutionary, but really stand a chance at completely reforming, you know, how we think about doing life, because of the speculative nature of the ideas and the relative lack of business history behind a lot of, you know, these ventures, it’s very difficult for them to get funding from your traditional sources of capital, right? AKA, the bank. So what that leaves, for VC entrepreneurs really is four different options. You can go to your family and friends for a handout. Secondly, you could go to a benefactor with deep pockets, so high net wealth individual or their associated family office and the family office is just their army advisors to, you know, facilitate investments into the venture capital space. And lastly, I would historically have stopped at venture capital funds, so professional funds, who are looking to make an investment in a early stage venture on the prospect of a, you know, just hitting it out of the park in terms of you know, its financial performance five years down the track. VC funds do that on the understanding that, let’s say, the VC fund makes 10 investments, five of them go under, three of them break even and two of them really hit it out of the park. And I said, there are actually four options for VC entrepreneurs to go to for capital. And the fourth entrant into that are the government backed funds right? Now, the one people think about, I think, mostly in this space, just because it’s been so successful, is probably Temasek. Over in Singapore. So Temasek is Singapore’s sovereign wealth fund and they also have a ventures arm. But a little closer to home, there is an organisation a small organisation called Breakthrough Victoria with, I think, circa 2 billion funds under management. And they’re also looking to attract entrepreneurs in the VC space to the great state of Victoria. This probably because I know this is an economics podcast on that fourth source of venture capital, capital, probably a discussion to be had around whether or not that’s crowding out private investment, right. And to what extent you want the government maybe picking winners, but I leave it over to you as the host.

Gene Tunny 06:26

Yeah, exactly. Well, yeah. I mean, I mean, I’m not a great fan of government picking winners. And we might have to chat a bit later about how you think it’s crowding out. I mean, yeah, to the extent that the government gets involved in the deals, or does the financing rather than the private sector, then yeah, sure. I mean, that’s crowding out, I guess they would argue that they’re meeting, there’s a market failure, there’s not enough venture capital funding in Australia. And yeah, there wouldn’t be anyone else who would, who would fund it. Because I know, years ago, it was very difficult for startups in Australia, or people doing something innovative. So someone that Nick Gruen, and I both know, and I know you had a chat with Nick, recently, Anthony Goldbloom, who founded Kaggle years ago, he was at Treasury when I was there. And then he went to the Reserve Bank and he developed this Kaggle, the data science competition website, but he had to go over to the States to get the necessary financing. And you know, he ended up doing really well and selling to Google. So I think there’s been that view, historically, that we just haven’t had the the venture capital here in Australia. And if you want to get venture capital you for something that really innovative, really breakthrough, you need to go to the States to San Francisco to Silicon Valley to get it. What’s your take on that? James, do you think we’ve actually got an emerging private VC sector here?

James Kwan 07:51

I mean, it’s difficult to tell over the last decade, right, just because, I mean, on one interpretation over the last decade, there’s just been so much easy money, which is poured into, you know, people’s pockets, and it’s needed a home investment wise, right. So whether or not we have a working innovation framework in this country is probably something the jury’s still out. Right? There is, I think, good criticism, I think, and it’s, you know, was articulated by Kim Carr, who was the ex Minister for Innovation. And now, the, I think, believe the Chancellor of Victoria University, who says, in a nutshell, the innovation framework within Australia is just fragmented, right? It’s not that it’s nonexistent. But when you, you know, have to go to one arm of government to talk r&d tax incentive than another one to get something known as the early stage venture capital Limited Partnership, the tax incentives associated with that, that’s a particular structure, you can make VC investments through in order to obtain some sort of, you know, tax incentive. And then also litany of incentives. Like I said, you know, at the state level, think, Breakthrough Victoria, it’s very, very difficult for an entrepreneur who simply wants to build a business to tap into the government assistance in an aggregate way, right. So there is, you know, putting to one side, whether or not the existing architecture for innovation in this country is working, I think you could probably say, with a fair degree of certainty that it would substantially benefit from a degree of consolidation.

Gene Tunny 09:38

Right. Okay. Okay. So back to the, the startup. So you’re talking about what your uncle in the backyard garage or in the backyard shed, you know, as an example, I mean, are there any data or do you have a sense of who’s founding these startups? I know that, like the image of startup founders is that they’re all sort of just out Uni, they’re all sort of in their 20s, and if you don’t make it by 30, you’re a failure. But the reality is different. Is it? I mean, what what are you seeing in the startup space? Do you do have any observations on that, James?

James Kwan 10:13

Yeah. And look, I posed that early illustration of, you know, crazy uncle in the garage merely as an illustration. But really what I wanted to capture, and that was, the ideas which live and inhabit the VC space are just far fetched, right? They, you know, stand a minute chance to completely change the world and along the way to make an outsized financial return. But it is interesting that you touched on this. And I suppose to answer your question directly, I don’t actually have any data. But there is very much this dynamic, arguably perpetuated by Silicon Valley, which worships at the fountain of youth, right. So in order to be a entrepreneur in the VC space, you need to be somewhere between the ages of 18 to 35, you need to wear a black turtleneck. And I think, certainly from the VentureCrowd, side, we really want to expand people’s conception as to where great ideas can come from, because as we see it, VentureCrowd’s mission is simply to fund great ideas, and great ideas can come from anywhere.

Gene Tunny 11:23

Okay. So there are angel investors which are wealthy individuals who might give small amounts, I don’t know, whatever they give nowadays, bu you need a few angel investors, typically, to be able to get the funds, you need to scale up. And so they’re there. And then there are also the venture capital firms, so established ones, they might give you a bit more a larger amounts of funding. What are the different series of funding? Are you across that James, what they talk about?

James Kwan 11:55

Yeah, taking a step back from that, okay, I think some of the policy work, which has been done in this space to inform our innovation framework has identified something called the Valley of Death. And that’s simply a poetic expression policymakers have attached to that very early or infant stage in a company’s life, businesses life, which are very, very difficult to attract capital for the reasons we’ve just gone over, right? They don’t have a track record. And the idea is just far-fetched, it hasn’t been proven. So going to your question about you know, what do Series A, B, C, what does precede mean? These are essentially an effort by the venture capital industry to categorise that very infant stage in a company’s life. And they do that in order to introduce or inject funding in at defined milestones. So company would start a precede, there may be a couple of different stages before that before advancing to Series A, then to B, then to C. And then each stage at each progression, that the checks get bigger. And the prospect of a return gets hopefully more certain.

Gene Tunny 13:07

Right, gotcha. Okay. So so A is the first is that right?

James Kwan 13:12

Yes. So I think they call it following the alphabet in some circles. You would start off at A, well you would start off at precede nowadays and then you would go to A then to B, and then to C,

Gene Tunny 13:24

and is there any accepted understanding of what scale of funding is involved? I mean, so for precede, are we talking in the order of 100k? Or a couple 100k? Or under a million? Or what’s, is there an accepted range of funding term?
James Kwan 13:38

Yeah, look, that’s actually a really good question. It’s one I usually one I kind of leave up to our capital managers who might actually kind of slice that up. But really, they are kind of stages to know, you know, at what level or stage an early stage startup is at. And you know, that’s a way to, again, to kind of size the amount of funding investors would like to put into that company.

Gene Tunny 14:02

Yeah, I might look it up and see if there are any, any guides to that. Just interested. But I mean, one thing I’ve noticed is that, like, it’s so risky, isn’t it? Because one of the reasons banks don’t want to invest is because there’s, there’s not a lot of collateral there. I mean, banks want to lend against, you know, they want to lend you money to buy assets. So they’ve got something they can actually repossess, or foreclose on if, if you can’t meet the repayments. So yeah, startups are a really risky proposition, because you might end up with with hardly anything at the end if if everything goes wrong, if it …

James Kwan 14:39

absolutely. And yet we have this problem with lagging productivity, right. So you kind of you know, take that as a, you know, necessary ingredient to nurturing and expanding Australia’s economy into the future. These are the ideas which need to be funded in order to give that objective a real shot.

Gene Tunny 14:59

Right, Yeah, yeah, exactly, exactly. So it’s across, you know, it’s IT. It’s technology. There’s biotech. There’s I know that there’s a lot of discussion about medtech, biotech, particularly up here in Brisbane where I am medtech is quite popular, we’ve got the Olympics coming up. So everyone’s, sportstech too, I mean, there’s fintech, all sorts of things.

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker 15:31

If you need to crunch the numbers, then get in touch with Adept Economics. We offer you frank and fearless economic analysis and advice. We can help you with funding submissions, cost benefit analysis studies and economic modelling of all sorts. Our head office is in Brisbane, Australia, but we work all over the world. You can get in touch via our website, http://www.adepteconomics.com.au. We’d love to hear from you.

Gene Tunny 16:00

Now back to the show.

Could I ask you about Venture Crowd? Where do you fit in this constellation of venture capital, financiers or funders or however you describe it?

James Kwan 16:15

Good question. So go back to what I was saying, what I said a little bit earlier about VentureCrowd’s mission, because it has been around since I think 2013, has always consistently been to fund great ideas. And sorry, we’ll take the detour path to you know, the response to your question about where VentureCrowd kind of sits in the space. What we have seen as the two main hurdles to fund great ideas would be a lack of diversity of thought and imagination from the traditional sources of capital entrepreneurs would normally go to right. So if you can’t persuade a family office or a VC fund to fund you, I mean, you’re pretty much out of pocket in terms of, you know, getting someone to, you know, to back you. My boss loves giving the example of Airbnb, right, who faced rejection letter after rejection letter after rejection letter in Silicon Valley. One of those rejection letters, I think said, and I’m paraphrasing here, we just don’t think travel is a sexy idea. And yet, and yet, we know Airbnb is an eminently profitable commercial idea, because you see it everywhere, right? So entrepreneurs have had to contend with, you know, the biases in the people who they would traditionally go to for funding. On the investor side, investors have had to contend with challenges in accessing private capital markets. That’s happening in a context of companies, good companies staying private for longer, are not even contemplating listing at all. So what VentureCrowd want to do in this space is to really democratise access to founders, access to early stage startups for normal investors. And on the founder side, expand the investor base. So they actually have people with the right alignment of values, to really buy into the founders vision and to make it a reality. So where VentureCrowd sits, you know, in the constellation of VC funds, as you’ve put it is really, that idea of democratising access to private capital markets, both for founders and investors. It doesn’t have a particular mandate, although we have a number of products which align along those segments, which you just mentioned. So there’s a VentureCrowd Health Tech fund. But what we’ve seen is that investors, particularly in an area as speculative as venture capital, want to be able to invest not just in something which will make an outsize financial return, but also align with their values. And we’re actually seeing this in the suppose more conservative end of investments, right with the rise of ESG ETFs. We think the way to do this is by giving communities out there the tools to invest in a broader range of investment opportunities, which hopefully, engages that flywheel dynamic of more investment opportunities available for investors incentivizes more investors to come into this space, which incentivizes more entrepreneurs to come to VentureCrowd to seek capital raising activities through us. So that’s basically it in a nutshell. There’s a couple of nuts and bolts kind of sitting under that. I might just leave it at that.

Gene Tunny 19:43

Yeah, we’ll certainly delve into that. What are some of the successes so far James? Are you able to take us through any of those. I saw that you’ve got a there’s a meal prep business is there health.

James Kwan 19:54

Yeah Be Fit Foods is our one which we’re currently conducting a crowd source funding campaign for. So crowd source funding if you think Kickstarter, but for shares and equities, you’re basically right on the mark. So they’re doing really, really well over an established, you know, relatively new space for an established business. And the great thing about them seeking funding through the CSF, a crowdsource funding regime, is that really opens up the doors again to you know, the Mum and Dad investors I alluded to earlier.

Gene Tunny 20:27

So, yes, yeah, sorry, James, I’m just interested in that, because you’re talking about Mum and Dad investors. So normally, these type of opportunities would be for the wealthier individuals who could be angels or sophisticated investors, where you have to meet certain income or net wealth requirements. With Mum and Dad, are you talking about just ordinary people or people with which don’t, who don’t meet the normal, those requirements for sophisticated being a sophisticated investor or an accredited investor? Yeah,

James Kwan 20:58

Absolutely, I mean, there’s probably a kind of parallel conversation to this, right. But when you look at financial services regulation, you have that split between wholesale investors, and that includes sophisticated investors, investors with experience, investors with a certain amount of annual income, on the one hand, and everyone else who gets put in the retail basket. Now that’s fine from a regulatory perspective, if the objective is to have additional protections, which retail investors may avail themselves of, but increasingly what we’ve seen is the categorization of a wholesale investor actually allows you to access a broader range of investments. So go back to what I was saying about companies staying private for longer, and you know what that means in terms of, again, normal people being able to build wealth into the future. That’s really a big part of what’s motivating VentureCrowd to democratise access to these markets. Right. Because why should they be the purview of the already rich?

Gene Tunny 22:05

Yeah, look, I think I generally agree with that, that viewpoint and that philosophy, I mean, the the issue is, of course, that it is it is a risky, sector isn’t it and and I mean, potentially, there are much higher returns, but you don’t get that without taking on a lot of risk. So how do you explain it to investors? What’s your, what’s your promise? Or what’s your, yeah what’s your pitch to investors?

James Kwan 22:31

So the first thing probably to say is, and again, you know, not legal advice, not financial advice. But venture capital, probably, you know, again, because of its, you know, speculative nature, will probably only ever occupy a very, very small part of, you know, someone’s portfolio. But it’s interesting, you mentioned the riskiness of, you know, this area, and, you know, that is a deserved reputation. But when we look at, you know, the volatility in asset classes, which we’ve traditionally treated as less risky, and I’m thinking US Treasuries, right. I mean, as an economist, you’d probably be aware about the volatility that asset class has gone through over the last 24 months. So it’s interesting when we talk about, you know, these asset classes as having a permanent risk profile, and maybe that needs to be revisited. But parking that venture capital investments will, you know, tend to occupy a fairly small portion of an investor’s portfolio. It probably also engages that part of the investor, which, again, what I said earlier, wants to invest not just because of the financial value inherent within that company, but also the values which that company represents.

Gene Tunny 23:47

Yeah, do you find that, that is a, you know, people are really looking for that, that is something that, you know, that will affect materially affect people’s investment decisions.

James Kwan 23:58

I don’t think people can deny the fact that people bring their personal values to investments. I don’t think there’s any other way to describe the, you know, explosive growth in ESG funds over the last 12 to 24 months. I think as a society, we’ve just been, we’re getting less prepared to accept the cost to society, which traditionally had been externalised and separated out from the company’s financial performance.

Gene Tunny 24:25

Yeah, fair enough.

James Kwan 24:28

Yeah. I wouldn’t read into that, though. So the qualification there, Gene would be that I am not an absolute supporter of ESG. I think there are a number of important questions which need to be asked in terms of how you reconcile the values which ESG is intended to stand for on an internal basis. So how do you reconcile the E standing for environment with the S which is for social with the G right when those things come into conflict? And I certainly do think those values aren’t always in alignment. Certainly that broader proposition of people investing, because they see something which, you know, they see a value as in a social or an ethical value they want to advance, in addition to the financial value they hope to realise in the future, I don’t think anyone can really deny that.

Gene Tunny 25:18

Right. So how does this work at VentureCrowd? Do you have a specific investment vehicle or a specific fund that is making ESG investments? Is that what your, is that the case?

James Kwan 25:30

We don’t, and you’d have to ask the people developing products as to why we don’t. But what we do have, and again, getting going back to what I was saying about ESG, having a couple of internal inconsistencies, it’s perfectly fine to invest on the basis of your values, but it probably needs to be a little more specific than something as amorphous as ESG.

Gene Tunny 25:54

Yeah, good point. Yeah. Well, what are the different ways people can invest through VentureCrowd James, just interested in that you have specific funds? Or is it based on specific startups? There’d be a startup, and you, you were mentioning before you went and crowdsourced for Be Fit, was it? Is that right?

James Kwan 26:12

Yeah Be Fit Foods, so probably the best way to think about and I think this kind of applies broadly, is you can either invest into a single asset, or you can invest into a portfolio, right? A number of our investments right now would fall into the former basket. So investments directed into single company. But we do have and the example which I gave earlier being the VentureCrowd Health Tech fund, that would be one which grants people exposure to you know, a number of companies playing in a particular sub sector of the economy, namely Health Tech.

Gene Tunny 26:44

Yeah. Yeah, gotcha. Okay. Okay. Very good. And James, you’re a lawyer, aren’t you? You’re the in-house counsel.

James Kwan 26:53

For my sins, they never take me out of the dungeon.

Gene Tunny 26:55

Right. Yeah. So, I mean, what sort of, are there tricky legal issues involved in VC? I mean, what what are the, can you give a flavour of the types of issues that people in your sector or, you know, in venture capital have to think about please?

James Kwan 27:11

On any given day, you will have, I think this is the way I would describe it, you would have work which is driven by the broader economic climate. So when, yeah, when times are good, no one ever looks at the contract, but when interest rates are rising, and people are finding it difficult to put food on the table, you know, that’s when people actually, you know, start taking, you know, a magnifying glass to the investment contracts and seeing whether or not they can withdraw their money at a particular time noting that venture capitals, you know, tends to be a mid to long term investment. You have companies who you may have, you know, I’m not singling anyone out, in particular, I’m just kind of painting this sector in a broad brush. But you may have companies who, who you got along famously when you’re raising capital for them, but as soon as that capital is raised and transferred into their account, you no longer hear from them. So you having to chase them up. So there’s a lot of things of a transactional nature, which are driven by again, the broader economic climate. The other parts of my job, what really the other half of my job really would be dedicated to standing up the technology platform, which VentureCrowd wishes to move its financial services and financial products onto and that’s a way of engaging online communities to make investments. We think, within that the, so I again alluded to blockchain has been a bit of a part of the VentureCrowd strategy. And we think, so putting aside cryptocurrency, which is a particular, you know, use case of blockchain, we think that there is something within that technology, which neatly aligns with this idea of democratising investment, because what blockchain allows you to do is to represent ownership in a virtual context. And it allows you to do that as potentially as seamlessly as sending an email, you know, between you and I. So, we have, you know in the works, a development of a blockchain platform, which we hope to leverage to facilitate investments in a virtual slash digital context. And there’s a long list of items of a regulatory nature which we’ll need to tick off before we can do that in a compliant and safe way. So that’s probably the other part of my job, which is probably a little less applicable to other VC funds and more specific to the job I currently occupy right now at VentureCrowd.

Gene Tunny 29:54

Right, and so is this why you’re in, you’re based in Canberra aren’t you James and is this why because you have to talk to Treasury I guess and maybe APRA, the Australian Prudential Regulation Authority.

James Kwan 30:04

So APRA does actually have I think it’s a little known secret. But APRA does actually have a Canberra office. But you know, the headquarters are still very much ensconced in Sydney CBD.

Gene Tunny 30:15

Right, gotcha yeah,

James Kwan 30:16

I’m actually in Canberra, because I’m a born and bred local, so this is kind of in the personals. And, you know, it’s probably safe to say that, but for, you know, the broad based acceptance for remote work, which has happened over the last 12 to 24 months, because of COVID, I probably wouldn’t be where I am right now that, you know, we now live in a world where you can work in a, you know, industry where, you know, you are very much separate, except for a virtual connection with your employer, and pros and cons, but it’s working out pretty well, for me.

Gene Tunny 30:48

Ah very good. This blockchain platform sounds terrific. Would this be a first to the world? Do you know if anyone else is looking at this worldwide? Are there any examples of this sort of thing?

James Kwan 30:58

Yeah. So there’s a couple of people who, you know, have also twigged to the idea of blockchain being, you know, a potential, you know, next generational platform to make investments. So, you know, the effort to tokenize, they call it, you know, real world assets. But, you know, you could also include shares traditional financial instruments into that definition, definition of real world assets. And there’s definitely a couple of people doing that, again, over in Singapore, which, by the way, I should probably mention VentureCrowd’s also recently announced that it’s established a branch office over in Singapore, which is why I know about this. There’s a couple of companies, the one which comes to mind is ADDX, which is an exchange, which is hoping to tokenize a bunch of financial instruments and put them onto the blockchain. And it’s just, you know, again, there are certain efficiencies which you know, businesses see, which make developing, you know, a market exchange on that technology on the blockchain and attract a prospect.

Gene Tunny 32:04

Yeah, I’ll have to look more into that. I know, that wasn’t ASX looking at this. And then they had an issue that just didn’t work out for them. They blew a lot of, 200 million or something on investigating a blockchain exchange for the Australian share market. But you know, they had a go at it. I mean, you know, you may you’ve got your own tech guys and your own ideas. So yeah, I think it’s worthwhile looking at for sure.

James Kwan 32:28

The ASX post-mortem Gene is actually really interesting to read because blockchain at its heart is the idea that you can scale up peer to peer transactions, right, whereas the current model of financial services and financial transactions very much and the realm with which ASX sits in is very much based on intermediaries. So you know, how you reconcile a technology which promises peer to peer transactions with also the presence of intermediaries is somewhat difficult to reconcile. And I think that’s, you know, something which comes out in the post-mortem on a ASX chess replacement project,

Gene Tunny 33:09

I’ll have to have a look. So you were saying what they were trying to do if they, the way they were coming at it was never going to work? Is that what you’re suggesting? Because it was incompatible. There’s this incompatibility with their model and why would you use blockchain for that? Because they just, they didn’t want to surrender their role as the as the intermediary? Is that what you’re arguing?

James Kwan 33:31

I think that’s something which definitely kind of comes through quite clearly in the report, or at least if not quite clearly, and then reading between the lines, right, because ASX is, you know, an existing financial service has a number of stakeholders, which, you know, it needs to accommodate. And those, you know, stakeholders make money. You know, they have business in the existing financial system, which is predicated on money passing through different entities before it hits, you know, kind of, you know, the end investor.

Gene Tunny 34:03

Yeah you’re talking about the brokers as their stakeholders and the banks. Okay, gotcha. That makes sense. I’ll have a close look at that. I just thought of that then when you mentioned this, and just remembered ASX blew a, a whole bunch of bunch of money on that. But look, you know, there are going to be failures, in any when we’re innovating and before you get to the successes. I want to ask you about one thing you said before where there are concerns, sometimes the founders, they’ll get the money deposited, and then you don’t hear from them. But one of the things with venture capital, I mean, the way I understood it is that, I mean one of the benefits of this approach is that the the founders can get the benefit of these people who’ve been in venture capital like the or the angel investors have been successful business people, and they’ve got a lot of experience and the, and the venture capitalists have seen it before. And so they can provide them with the founders with the benefit of that experience. So will they sit on a board, they could be advisors, I mean, I know that someone like Tim Ferriss, you know, he would be an advisor to Uber or Shopify, and then they’d have an IPO and then, you know, make ridiculous amounts of money. Like, how does it work with VentureCrowd? Do you have a role in how the company runs day to day or the strategic direction?

James Kwan 35:19

Again, good question Gene. So, ideally, the investment is tied also to some sort of ongoing engagement with the company. Right. And while that is the perhaps the ideal let’s say, it doesn’t always happen. And it really is kind of horses for courses right. Some founders, you know, may be reluctant to relinquish the control, which is represented by having, you know, an external person sit on their board. And it really is, I suppose, on investors VC funds, the onus is on them to actually persuade founders of the value of having a fresh set of eyes, an experienced set of eyes stewarding the company as it kind of goes through, you know, its various stages of maturity. And I suppose, where that doesn’t happen, right, where the company just, you know, takes the money and run that is, you know, a risk, which, you know, needs to be considered.

Gene Tunny 36:15

Yeah, I mean, just thinking about it, what I’ve seen with these, a lot of these startups is that it’s so long until they’ve actually got any significant amount of revenue, right. So for their first few years, they’re just burning cash. And they have a burn rate, don’t they? So they figure out oh, this is how much money we’re burning every month. And this means we can, you know, we’ve got to basically have the product up and running, earning revenue by this date. And, yeah, it’s, it can be tough that that sort of business. And if you’re investing in it, yeah, you’d have to, you really have to have nerves of steel, I suppose. Because a lot of it…

James Kwan 36:45

It’s not for the faint-hearted Gene

Gene Tunny 36:48

Yeah, that’s, that’s a good way to put it. Okay. Right. James, I should ask you about policy, you, you were talking about policy before. And Kim Carr, he was Industry Minister when I was in Treasury I remember. And he had an innovation review. And I think his idea was to try and connect everything up and have a more integrated system. And so he was Minister for Industry and Innovation for a while. So I guess he was probably trying to make, to improve the interconnectedness or whatever you want to call it when he was there, but you’re saying that there’s fragmentation? Is that, is that the case? You think that there are, that we could have better policy settings for venture capital here in Australia? Is that your view?

James Kwan 37:37

Yeah I don’t think I really have too much more to say, apart from you know, what I said earlier about fragmentation. But again, as I put it before, as an entrepreneur, right, your focus, the reason why you get up every day is to build a business. It’s not there to fill in a form. And so it is a little puzzling, that in order for people to access government assistance in this space, but it’s not just one form, it’s multiple forms. And those forms are Byzantine in nature. And you’ve got to deal with a host of government bureaucrats in order to access those those incentives, you know, those assistance packages, it may simply be, you know, a symptom of government being a complex creature, right. I mean, you would know that perhaps better than most people right Gene, but if that is the case, that the assistance is out there, it’s just not readily accessible. It’s not easily accessible, then perhaps one way of nurturing, you know, the venture capital industry in Australia, is to simply make it easier for entrepreneurs to do that on a personal basis with, you know, the least amount of friction possible in the least amount of time and attention taken away from building their own business.

Gene Tunny 38:55

Yeah, it sounds like what, is it about information, getting the information out there? Just trying to think how they can do that. Improve that accessibility? Maybe I’ll look into it and just see what the, yeah, I mean, I might have to try and connect with some founders and see what issues they’re, they’re facing moving. It’s, it’s a good point to, to make. I’ll also have to look at the break through fund and break through funding through Victoria, right BreakThrough Victoria. I’ll have to see how it’s gone. It’s, Ill have a look at its financial disclosures, and, gee, it’s risky for governments to do that sort of thing. And one thing that, it’s interesting it’s being done in Victoria, because Victoria, historically, I guess everyone’s forgotten it now but back in the late 80s and early 90s, there was the Tricontinental which was the merchant banking arm of the State Bank of Victoria. And it lost a lot of money on commercial real estate, if I remember correctly, and that basically led to the downfall of the State Bank of Victoria. And you know, huge issue at the time. So in, you know, venture capital’s arguably more risky than commercial property. So it’s it’s interesting that they’re doing that I guess they, if you’re upfront if you’re clear that you could lose money and it’s highly risky then, and they’ll argue that there’s a public benefit to it. Maybe you can, maybe you can get away with it if you limit your losses I suppose, limit yeah…

James Kwan 40:23

Yeah, what is it people say, Gene, don’t put money in to an investment which, you know, you’re not happy losing right, and I think that applies on the individual level. It probably also applies at the level of state governments.

Gene Tunny 40:34

Yeah, I think that’s a very good point James. Absolutely. Okay, James, anything. Any final points before we wrap up? This has been great. I’ve learned a lot about your business. And yeah, really appreciate your perspective, is there anything more you’d like to add before we wrap up?

James Kwan 40:48

No, I think you’ve done a pretty good job of covering everything. I’ve really appreciated the opportunity just to come here and have a bit of a chinwag. And you know, if there’s an opportunity to do it in the future. You know, who knows?

Gene Tunny 40:58

Absolutely. Okay, well, next time I’m in, in Canberra, and yeah, not during the winter, though. And it’s winter there at the moment. And I remember those Canberra winters, so stay strong, stay warm. Very good.

James Kwan 41:12

Thanks again for that Gene.

Gene Tunny 41:16

Pleasure. Thanks, James.

Righto thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

42:04

Thank you for listening. We hope you enjoyed the episode. For more content like this, or to begin your own podcasting journey head on over to obsidian-productions.com

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.

Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.

Tags blockchain, business, capital, company, crowd, esg, founders, fund, funding, idea, invest, investments, investors, james, space, startups, talking, vc funds, venture, venture capital

Podcast episode

EP65 – Behavioural Finance with Dr Tracey West

Post author By Gene Tunny
Post date December 13, 2020
No Comments on EP65 – Behavioural Finance with Dr Tracey West

The latest episode of my Economics Explored podcast considers the emerging field of behavioural finance, which is basically the application of behavioural economics to finance. It considers lessons from this field for households, investors, and governments. The episode features an interview I conducted earlier this week with Dr Tracey West of the Griffith Business School.

Tracey teaches behavioural finance to undergraduates and postgraduates at Griffith’s Gold Coast (Queensland, Australia) campus. She’s also an active commentator on economic policy issues. For instance, last year, Tracey wrote an excellent Conversation article on 3 lessons from behavioural economics Bill Shorten’s Labor Party forgot about, three lessons which Tracey and I consider in our conversation. Those lessons are:

1. People are loss averse

2. Limited decision-making

3. Now is worth more than later (and much more so than economists would typically assume using typical discount rates).

Tracey and I had a great discussion about behavioural finance theory and practice, including the need for regulation of financial markets and investments. The Storm Financial collapse, which wrecked the finances of many North Queenslanders, was given as an example illustrating the need for regulation of financial investments. I hope you enjoy our conversation. A transcript is available via my business website.

https://economics-explained.simplecast.com/episodes/behavioural-finance-with-dr-tracey-west-of-griffith-business-school-jC7vu6lU

Links relevant to the conversation include:

Tracey’s LinkedIn profile

Tracey’s academic publications via Google Scholar

Tags banks, behaviouraleconomics, behaviouralfinance, economicsexplored, financialcrisis, financialmarkets, gfc, investments, regulation, savings, stockmarket

About this episode’s guest: Andy Lee, Founder and CIO of Parallaxes Capital

What’s covered in EP237

Takeaways

Links relevant to the conversation

Lumo Coffee promotion

Transcript: The Tax Guru the WSJ says has Wall Street’s “Strangest Hustle”: w/ Andy Lee, Parallaxes Capital – EP237

Credits

What’s covered in EP197

Links relevant to the conversation

Transcript:Democratizing VC Investment Opportunities w/ James Kwan, VentureCrowd – EP197

Credits

Transcript:
Democratizing VC Investment Opportunities w/ James Kwan, VentureCrowd – EP197