Finance Minister Steven Joyce was warned three years ago an investment deal struck with surprise Kiwi Peter Thiel was problematic, documents show.
A 2014 report commissioned by government agencies said the inclusion of a controversial buy-out option - allowing Thiel's Valar Ventures to risk millions of taxpayer dollars making investments but claim all profits - "creates some difficult optics".
"In the Valar Ventures example, the taxpayer is offering an American billionaire a loan at less-than-market rates," the report said.
The deal between Thiel and the government-backed New Zealand Venture Investment Fund has come under scrutiny after a investigation by the Weekend Herald revealed it had last year been quietly wound up.
The NZVIF's investment of $9m was returned in October when Thiel activated the buyout clause to claim all profits from the venture - mainly comprised of a large stake in NZX-listed Xero shares - netting him more than $30m from his initial contribution of only $6.8m.
Joyce, Minister of Business, Innovation and Employment when the deal was struck in late 2011 and bought out last year, defended his handling of the affair.
Joyce said while he directed NZVIF to stop using the contentious buyout clause in deals in 2015, the earlier report had prompted a pause in its use as wider reviews were undertaken.
"It was discussed prior to that point , and it was not used in the interim," Joyce said of the buyout clause.
The minister said the buyout option had been intended to encourage growth in New Zealand capital markets and it had not presented obvious problems earlier.
"It's a little bit - and I'm not defending the buyout - disingenuous that this was a guaranteed slam dunk. Not every investment is a Xero," he said.
The NZVIF said in a statement it was satisfied with the outcome and its handling of the deal.
"Valar Ventures' entry into the local market had a number of benefits and was very beneficial for the companies in which the fund did invest. It was a highly credible group," the spokesman said.
Questions sent to Thiel's representatives in the United States went unanswered, an identical response to five previous requests for comment sent over the past two months by the Weekend Herald.
The critical report was contained in a cache of documents released by NZVIF under the Official Information Act.
NZVIF declined to release any correspondence with Valar, citing confidentiality obligations and claiming releasing the information would prejudice their and Valar's commercial position.
A report prepared in March 2014 by Wellington-based capital advisory group Woodward Partners, who had been tasked with assessing the NZVIF, criticised the buyout clause generally and its inclusion in the Valar deal specifically.
Woodward Partners calculated use of the buyout would see NZVIF exchange $30m of Xero shares for just $6.2m. (Shares in the accounting software company in early 2014 were at a historic high, but had reduced in value by the time the buyout was exercised.)
"Our view is that the only loser from a buy-out option is the taxpayer - who stands to incur all losses but lose many of the profits," the report concluded.
NZVIF flagged to shareholding Ministers Joyce and Bill English in August last year that Valar had triggered the buyout, noting the funds' primary asset was Xero shares.
"Significant value will transfer from NZVIF to Valar Ventures as a consequence of this option," the fund said in a monthly update to MBIE.
An update issued the next month confirmed the buyout had taken place, but said it would be kept quiet. "Valar have asked it not be announced publicly, but we expect it to become known through the market."
The spokesman said NZVIF's confidentiality arrangements with Valar were similar to those it had with other public-private funds.
The buyout was only made public last month following a Weekend Herald investigation into the circumstances surrounding the "exceptional circumstances" behind then-Internal Affairs Minister Nathan Guys decision to grant Thiel citizenship in June 2011.
The documents show Thiel approached the NZVIF in early 2011 about getting state-support for his venture capital activity. The timeframes show he was applying for citizenship at the same time he was negotiating the lucrative terms of the public-private joint-venture.
NZVIF said it was unaware of the citizenship application at the time the deal was struck, but it would have made no difference.
"NZVIF's decision was made purely on the basis of Valar Ventures meeting NZVIF's investment criteria," the spokesman said.
The NZVIF-Valar deal has attracted criticism from the local venture-capital industry over investing almost solely in Xero, a listed company had already evolved beyond a startup.
Local investor Jenny Morrel this week said the deal simply allowed Thiel to double-down on his earlier investments in the company at no cost: "It's an interesting argument that he needed a NZ Government subsidy to buy listed shares."
A 2014 post-election briefing to incoming minister Joyce noted the NZVIF joint-venture had invested in only one new startup since its formation and it was also "unlikely to make new investments".
Joyce said the government was discussing the future of the NZVIF, and said exit options were being considered for its holdings.
"We've been clear for some time we don't want to put any more money into it," he said.