Allowing overseas money to pour in and fill the gap left by a dearth of New Zealand investors is robbing us of employment opportunities and valuable tax revenue, Bill O’Boyle writes.
Anyone who’s spent time around the Kiwi startup scene knows that one of the biggest challenges facing our fledgling businesses is the dreaded ‘funding gap’, sometimes cheerfully referred to as ‘the valley of death’.
The scenario is this: New Zealand now has a strong ecosystem of angel investors and government grants that support promising entrepreneurs, but we are falling over at the next significant hurdle. Startups are risky by nature, and when the best (or luckiest) of these businesses survive and need further funding to become world-beating companies they face a dearth of specialised later stage investors willing to take them to the next level.
We need these young companies to expand because they create high-paying jobs and contribute significantly to the country’s tax revenue (unlike our friends Apple, Google and Facebook).
A partial cause of this conundrum is New Zealanders’ obsession with property and term deposits. Money gets invested into houses and banks rather than businesses that can grow our economy, and this preference leads to underdeveloped capital markets. It opens the way for large amounts of overseas money to flow in and snap up homegrown Kiwi enterprises, resulting in a steady procession of companies leaving the New Zealand stock exchange. Recent examples have included Tegel, Diligent and Trade Me.
The point at which our current environment falls down is when a company is doing around $1 million to $2m in annual revenue, and is looking for investment of between $1m to $10m to take things to the next phase. This is broadly known as the venture capital (VC) stage of investment, where businesses have a product to sell and are looking to grow sales, spend more on marketing and further develop their offering. These companies face limited New Zealand funding options despite having done the hard yards of proving they have a decent chance of making it big.
That’s not to say there aren’t investors who operate in the venture capital space in New Zealand. Depending on your definition of what stage constitutes venture there are a couple of players such as Punakaiki Fund, GD1 and Movac. These VCs pool capital from diverse groups such as wealthy individuals, iwi and the government, and invest it on their behalf. The funds referred to above total $180m and they would expect to invest the money over five to seven years (so roughly $30m a year of investment).
By most industry estimates this amount is not enough to truly move the needle. At the New Zealand Angel Association conference in Blenheim last year it was estimated that the funding gap is over $240m annually.
Punakaiki Fund founder Lance Wiggs, who also advised companies as part of New Zealand Trade and Enterprise’s ‘Better by Capital’ programme for many years, says he’s seen well over a hundred businesses with viable prospects struggle in this environment. They are often forced to economise in the short term at the expense of growth. This means New Zealand loses the opportunity for these companies to truly capitalise on the market opportunity in front of them and possibly become global successes.
Not everyone in the industry agrees. Rowan Simpson, a former early employee and investor in Wellington success stories Trade Me and Xero, is sceptical that there really is a shortage of capital in Aotearoa. Good companies with strong growth prospects that are executing well have always been able to raise the money they need, he argues.
He is right, in that some of the most promising ventures in recent times have been able to raise international money, and this reduces the need for any New Zealand-specific investment in this area. However it doesn’t necessarily mean all companies who could be a success have been appropriately funded. This also holds back companies that might be important in a New Zealand context but do not excite an international audience (this is particularly true for non-tech companies).
The other problem with being funded this way is that American investors eventually want the company to register as a corporation in the US to focus on growth there, thus reducing local job opportunities and tax revenue and defeating the purpose of building these successful Kiwi companies in the first place. Case-in-point is the furore over whether Rocket Lab really is a New Zealand company, when it is now registered in the US and the actual return to the government on what was spent in the venture’s early stages is questionable.
There have been a few moves to try and address the situation. The government set up the New Zealand Venture Investment Fund (NZVIF) in 2002, but hasn’t increased its funding significantly since. The Labour government has introduced a tax refund on research and development costs, which is a good start, but in the early stages startups don’t pay much tax (if any) as they generally lose money for their first few years of operation.
There is probably no one magic bullet solution. It will take a combination of all factors, from government incentives and a wider range of funds in the venture space through to bigger cheques being written, and of course time to build a sustainable solution.
Investing in private companies creates immediate jobs and investment back into the local economy. This goes hand-in-hand with the potential financial returns to investors.
When cidery Zeffer Cider raised $2m in 2017 it used the funds to relocate its operation from Auckland to Hawkes Bay, sub-leasing a local farm, implementing a new manufacturing fit-out, opening a taproom and in the process creating numerous regional jobs. On a larger scale, think about the role Trade Me and Xero played in the growth of Wellington’s CBD, from large scale property development to significant expansion of the employment market.
The funding gap should be seen as an opportunity. With the right government incentives and allocation of more private funds to the space, investing in Kiwi businesses at this stage in their development will deliver benefits to all New Zealanders.
Bill O’Boyle is Director of Private Capital at Snowball Effect, New Zealand’s leading online investment marketplace.