Brian Fallow: Giving new ventures a leg up

Can taxpayer funding grow more success stories, like billion-dollar plus A2 Milk. Photo / Supplied

COMMENT:

The Government plans to stump up $300 million to address a chronic funding gap in the venture capital market.

But while the market failure is pretty clear, the proposed policy fix is not without its critics.

Legislation now before Parliament's finance and expenditure select committee would establish a Venture Capital Fund (VCF) with two objectives.

One is to get capital to promising innovative enterprises which have survived the start-up phase — nurtured by angel investors and seed capital from the New Zealand Venture Investment Fund (NZVIF) — and which need millions of dollars invested in them to grow and flourish. Officials estimate the funding gap at this venture capital stage is around $150m a year.

The other policy objective is to "build a sustainable venture capital market that has capability and connectivity, crowds in private domestic capital including institutional investors, and ensures that future start-ups have a more accessible capital pathway."

In its latest annual report, NZVIF notes that over the past decade 10 "billion dollar-plus" companies have originated in New Zealand, in one form or another. Namely: a2 Milk, Xero, Pushpay, Diligent, Trademe, Telogis, Anaplan, FNZ, Allbirds and Rocket Lab.

"Collectively this equates to, at the time of writing, in excess of $27 billion of shareholder value created from what were once start-ups," it says.

But those companies defied stiff odds. NZVIF cites research by the Start-up Genome Project which found that in New Zealand only 10 per cent of angel-funded start-ups went on to secure "Series A" venture capital — which locally is reckoned to be in the $2 million to $5m range — when the global median rate is more like 25 per cent.

Or as the explanatory note to the legislation puts it, "Many early-stage high-growth companies continue to struggle to access the capital they need to develop to their potential. This leads them to being either constrained in their growth or having to seek foreign investment to overcome this funding gap and may require start-ups to sell down prematurely or move abroad."

The VCF would operate as a fund of funds, selecting and investing in fund managers which specialise in venture capital. They are thin on the ground in New Zealand at the moment.

NZVIF would be the investment manager of the VCF, holding the reins, but with the Guardians of the New Zealand Superannuation Fund riding shotgun, so to speak, providing oversight and governance. The Super Fund itself would not be affected.

Under this rather elaborate structure it would be the fund managers which choose which ventures to invest in, and which would have to raise the private capital to at least match the input of taxpayer funds.

There is a tension, or at least a tricky balance to be struck, between the two objectives of the fund.

From the standpoint of maximising the flow of money to ventures which need it, it makes sense to encourage the involvement of established foreign venture capital funds which have expertise, connections and scale to offer.

NZVIF notes that over the past decade 10 "billion dollar-plus" companies have originated in New Zealand, in one form or another. Photo / File

But the risk is of that crowding out local venture capital fund managers.

As Lance Wiggs, co-founder of Punakaiki Fund, one of the very few homegrown sources of private venture capital, told MPs: "the way a New Zealand fund is defined, it would be quite easy for an Australian fund to come and take our money".

Colin McKinnon, on behalf of the New Zealand Private Capital Association, also warned that as the legislation is drafted, the purpose of the VCF could be satisfied by importing foreign funds and fund managers to the exclusion of domestic ones, undermining the second objective of developing a domestic venture capital market.

The Angel Association advocates a stronger legislative focus on developing capability. In the jargon currently in vogue, it is human capital as well as financial capital that is in short supply.

Wiggs goes further. He argues that a picking winners approach would mean that every time the VCF picks a fund to invest in, every other fund (which he suspects will include Punakaiki) will find it harder to raise money.

A lengthy and cumbersome process will mean that funds which are raising capital are uncertain whether the VCF will invest, which will make it harder for them to indicate to potential private investors how big the fund will be.

Overall, Wiggs contends it will create a dominant Government-owned player in the venture capital market.

The counter-argument to such concerns is foreshadowed in NZVIF's appraisal of the failings of the status quo.

In short, the local venture capital funds established to date are just too small.

The result is "an inability to attract appropriate institutional capital, failure to adequately capitalise companies and/or fund their journey, inability to achieve appropriate portfolio diversification, generation of insufficient management fees for appropriate teams, and in many cases first time teams with no company building or early-stage investing experience."

Steve Outtrim, an experienced venture capital investor now at Auckland University's Centre for Innovation and Entrepreneurship, warns in his submission against parochial and unrealistic thinking about the scale of investment needed in VC these days.

In Silicon Valley, what counts as a Series A early-stage investment averages more than $20m, he says. The $2m-$5m envisaged here would — to borrow a phrase from the late John Clarke — mean the mustard remains uncut.

Outtrim also argues that the design of the VCF underestimates how patient venture capital needs to be, in anticipating the fund will invest its $300m in the first five years and liquidate its holdings entirely within 15 years.

"Rather than planning the liquidation of the fund in the future, why not make it perpetual and continue to invest the funds in New Zealand start-up businesses?" he asks.

"Over a 50-year horizon an initial $300m seeding into the venture capital industry has the potential to become one of New Zealand's greatest assets. At 15 years we would just be getting started."