There's still a big gap in the market for traditional venture capital, with long lead-ins, writes James Penn

The average transaction value in New Zealand's venture and early stage capital sectors more than doubled from 2015 to 2016, according to a recently released report. However, concerns about the fragility of the sector remain.

The New Zealand Private Equity and Venture Capital Monitor, published by EY and NZVCA, paints a rosy picture for the venture and early stage sector, with growth of 47.7 per cent in the value of deals -- which don't include angel investments -- compared with 2015.

Interestingly, despite this growth in total investment value, the number of transactions has declined. This has resulted in the average transaction value growing from $906,000 in 2015 to $1.85 million in 2016, suggesting a maturing of the sector.

A similar, albeit more moderate, story can be observed for angel investments.

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A recent report by the New Zealand Venture Investment Fund (NZVIF) stated that while the number of investments by angel groups and funds decreased 15 per cent, the total value of investment increased by 13 per cent, reaching $69m in 2016.

Willingness to invest larger sums in each individual company is indicative of investors having more confidence that those companies have strong, often international, growth potential.

However, this means that the sector is highly focused on growth capital -- for companies that have already generated a significant level of revenue.

"A big gap remains in the market for more traditional venture capital targeted at businesses that have long lead times and deep intellectual property," says Colin McKinnon, Executive Director of NZVCA. "We don't have a New Zealand fund in the market at the moment that would be likely to invest in (say) Rocket Lab or 8i while they remain pre-revenue."

Managing Partner of Movac, Phil McCaw, sees fragility in the early stage capital sector, arguing that New Zealand needs at least a couple more significant funds around the $150 million mark. Movac for its part recently raised $110 million for its Fund 4, and has already made a significant investment from that fund in retail software developer Vend.

"My vision for the venture industry is to see that we've got three or four long term sustainable funds that are $150 million type funds," says McCaw. "We've got to find a way to lift this industry to get to that position."

Engender Technologies, a Kiwi company that has developed laser technology to sort livestock sperm by sex, is illustrative of the benefits that come from these growth-focused capital sources.

After closing a $4.5 million capital raise -- led by Kiwi venture investment firm Pacific Capital -- in June last year, Engender has started growing its footprint globally. To date in 2017, Engender has announced a $1 million deal with Asia's largest animal genetics company and has been named one of the five most innovative Agtech start-ups at Agfunder Global Innovation Awards.

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The positive headline figures are also reflected in a flurry of activity among old and new specialised funds. In March this year, for example, NZVIF announced its 17th partnership for its seed co-investment fund with ArcAngels, a group of private individuals focused on investing in female-led start-ups.

Meanwhile, the NZ Super Fund broadened its scope of investments over the past year, with investment in funds that target a spectrum of companies, from early to late growth.

"New capital commitments for funds including Movac and Global from Day One were complemented by on-going fundraising by Punakaiki Fund," says McKinnon, "Crowdfunding platforms Snowball Effect and Equitise, and the public listing of Powerhouse Ventures also raised capital."

KiwiSaver is nowhere to be seen in venture or private equity which is disappointing.

McCaw says "I'm more confident than I've ever been. There's more cash in the market and there's more opportunity, and I don't see those things changing in the next few years."

Despite this dynamism, there remains work to be done to foster a deep early stage and venture capital market that can satisfy the needs of rapidly scalable ventures.

Public funds and institutional investors need to play a greater role. While the Super Fund has taken a step in this direction, it has taken some time and the industry would welcome other funds following suit.

"KiwiSaver is nowhere to be seen in venture or private equity which is disappointing. International investors prioritise larger markets," explains McKinnon.

"Creating a framework that incentivises the early-stage growth market until a long-term track-record is developed should be considered. The industry is close, but not quite there yet."

McCaw also sees a need for policy change in this regard, noting the success of recent Australian policy changes and the subsequent growth in their sector.

"If we want a growth economy that grows from entrepreneurship, you've actually got to put in place a policy framework that supports it across the spectrum," says McCaw. "And I think there's an absence of policy at the moment in the venture and growth capital class that is not enabling the scaling of funds."

And the age-old question of returns still remains. Yet again, there was an absence of divestment within the venture and early stage capital sector in 2016.

According to the Capital Monitor, just one of the past six years has seen any divestment, and that was a mere $400,000. However, McCaw says this is the nature of the beast and the early stage capital sector is always expected to have long pay-off timelines.

"It is still a developing story. Around the world, that's a story that takes 20 years to create, across a couple of fund iterations," says McCaw. "But it's coming."

"You can kind of justify the growth that's incurring inside of these companies, because there really is some really fast revenue growth occurring -- so there's definite signs that the industry is investing in things that are creating long term value."

"The rate of return at the moment in terms of cash back is not fast enough," accepts McCaw. "But it's getting faster."