Are we there yet

I get asked fairly frequently for my thoughts on the New Zealand innovation ecosystem.  Given the big wet across New Zealand this weekend I took the opportunity to try and consolidate them.   My basic conclusion is “we’ve made great progress but we’re not quite there yet”.

If we’re not there yet, what’s the destination?  For me it’s –

“an eco-system that enables brilliant innovation to become great businesses, generating jobs and wealth for New Zealanders, without allowing the best  to slip through the cracks or disappear offshore”

So how are we going?

Innovation (A+)

We’re world class innovators and there’s plenty of evidence to support this:  Rocket Labs, LanzaTech, Xero, PowerByProxi, Weta Studios, 8i, Aroa Biosurgery, Pushpay, Vista to name a few.

We have a vibrant early stage support system for innovation:

  • Govt research funding – Callaghan Innovation plays a vital role in supporting research into new technologies that would otherwise be unlikely to see the light of day. We could go further, though and I’d like to see the scope broadened to co-fund development, more shortly.
  • Incubators/accelerators – we have a network of incubators and accelerators up and down the country that are helping Kiwi entrepreneurs to develop their ideas into scalable businesses. The accelerators are mostly public/private partnership funded by Angel Investors, central government, and local government.  The fall out rate is high but there are signs that some stars might be emerging.  That said, we’ve overdone it and have too many of these programmes running in New Zealand now.
  • Angel investor networks – on a global basis our Angel Investors punch above their collective weight. They, including me, can be a difficult mob to corral but they’re doing deals at a level that puts them in the top quartile globally.  They’ve been well supported by NZVIF and the Seed Co-investment Programme over the last 10-years.  This has been incredibly useful but is it still needed?

The combination of these factors contributes to what I consider a “world class hatchery”.

Execution – from idea to a world-class business (B-)

This is where we face several significant challenges.  But, let’s be realistic, the leap from a great start to a great ($100m+ revenue) business is huge, there will be lots of fallout and that’s natural.  There is a shortage of capital in New Zealand but my experience is the best business do get funded.

That said, NZ Innovation Inc. could do with some additional limbs.  Here are some thoughts:

  • Expand research support to include development.   Via a range of programmes, we spend nearly $1.5b a year supporting research activity across the public and the private sector (the majority spent in the public sector).  However, in most part, the help stops at the completion of the research phase.  As soon as a company tips over from research (invention) into development (commercialisation) accessing funding becomes much, much tougher.  From an investment perspective, this doesn’t make a lot of sense, typically you’d back your winners, you don’t stop supporting them when they’re showing signs of life.  I’m not advocating a mass expansion of grant programmes, just better targeting of what we have today.  There are certain types of endeavour that are very difficult to fund in a meaningful way in the early stages from New Zealand.  Particularly those with a deep science element and those that require material investment in gearing up for manufacturing.  For these businesses expanding support from research into development will significantly increase their chance of success.  In making this tweak there is no reason why the mechanism shouldn’t change as well – funds advanced for development purposes could be repayable along the lines of the loans made under the Callaghan Technology Incubators programme.
  • We have no “Pure Venture Capital Community in New Zealand” and no plan to address. What we do have is a nascent “Growth Capital Community”. Growth investors, including Movac Fund 4 focus on companies that have proven product/market fit and have established “revenue momentum”.  We don’t have consistent pools of capital for great technology or IP led companies that have a longer path to revenue. Companies like Rocket Labs, Lanza Tech, Avertana, 8i, PowerByProxi, Aroa Biosurgery etc.  The good news is that the very best of them are getting funded, the bad news is the funding and eventually controlling ownership is heading offshore.

So…what I don’t get is that successive governments have committed huge amounts of our money into science based innovation, provide miniscule support in the development phase and there is no domestic venture capital to fund the next step.  Why would you even start?…..unless you’re going to follow though?

  • We have meaningful pools of “Growth Capital”.  Hard to believe but “yep we really do”!  I estimate that we have $500m+ in dry-powder in this part of the market today, with approximatelty $100m aimed at companies under $10m in annual revenues.  We need more at the lower end but there is enough depth in the New Zealand ecosystem to take companies with a proven story through to global scale.  The market can support $10m rounds, $20m rounds, $50m+ rounds.  This wasn’t the case 5-years ago but it is the case today.  We could always do with more but my sense is that this pool of capital is getting deeper and will continue to get deeper.  This part of the market is becoming more popular with New Zealand’s leading institutional investors, Iwi groups and Community Trusts.  It’s also the part of the market most preferred, in my experience, by private investors.  Unfortunately, these investment groups have little or no comfort with “pure venture funds”

Pure venture remains a challenge for New Zealand.  Investors don’t like it as the return story remains unproven.

  • Don’t rely on international investors taking up the slack. There is an argument run that international funds will take care of New Zealand companies needing “pure venture” funding and there is certainly a story emerging around this. Rocket Labs  – majority funded offshore; LanzaTech – majority funded offshore (with help from NZ Super); 8i – majority funded offshore; Xero – majority funded offshore.  Australian Venture is undergoing a renaissance – seven funds raised $568m in 2016 and a further $1b of intended VC fundraising was announced in 2016.  Generally, these funds have an 80% allocation to Australian business and a 20% allocation to offshore, this can be invested anywhere in the world.  We will see some of this money in New Zealand and some of the funds are active here now – One Ventures invested in 8i, AirTree invested in 90seconds, SquarePeg has been a long term investor in VendHQ.  However, I see a couple of challenges in relying solely on international sources of capital in the “pure venture” space:
    • Do we really want our greatest innovations majority owned offshore, with most of the value exported? That’s not the destination I think we’re aiming for.
    • International investors are unreliable, they’re “fair weather friends”. I don’t know how many meetings I’ve taken with international investors over the years.  They’ve all been very personable and interesting folks.  Their networks would appear to be potentially invaluable.  But, none of them has put down roots.  These funds seek investment opportunities globally, they move to the best sources of innovation and the most supportive economic environments at the time.  They “fly in, fly out”, some deals get done, but in my experience, they don’t stay.
  • Talent is scarcer than capital. I worry more about developing and finding the right talent for the companies that we invest in than I do about capital.  We rely on the teams we invest alongside to execute well.  When they trip up the costs are unbearably high.  There is no magic wand for creating a deeper pool of talent (capable people with experience) over-night.  The long-term answer involves a mix of:
    • Developing people from within – very few of our early stage companies have the tools to do this. We need to and can fix this.  I’d like to see leadership programmes developed and offered, at relatively low-cost, that can help grow our future leaders.
    • Attracting corporate execs into growth companies – execs with corporate experience have a key role to play in bringing structure to growth companies. It’s this structure that enables them to scale.  The challenge in New Zealand is that these execs are paid handsomely by our top corporates and government departments.  This isn’t a phenomenon limited to New Zealand.  What we need to do is demonstrate greater consistency in the outsized value that can be created through Employee Share Schemes as a  way of attracting this group.
    • Continuing to promote NZ Inc. as a great place to live and work – we’re doing a great job of this and several government-supported initiatives in this space look like they’re making a difference. For example, the Edmund Hilary Foundation global impact visa (www.ehf.org)

What we should do (IMHO):

Given the above, here are a few thoughts on what I think we should tweak:

  1. Fewer, better Accelerators – in my view we’re over accelerated in New Zealand and focussed on the wrong stage of development:
    • We’re doing too many Accelerators – we don’t have enough depth in the investor and mentor community to support the number of Accelerators we’re running today, well.  Let’s do fewer better.
    • We’re doing too many greenfield startups – the term “accelerator” would suggest that you have something to accelerate when you enter the process.  Unfortunately, most of the teams in the Accelerators are forming leading up to the accelerator programme.  This makes them extremely hard for mentors to engage with.  They don’t have a business and are still trying to settle on the core proposition.  As a consequence the focus in the programme shifts from accelerating the business to making them world-class at “investment pitching”.  They achieve the latter but rarely the former.
  2. Continue to grow Angel Investment – find a way to continue to support and promote Angel investment, but remove government from the process of picking winners or investors to back.  I’m drawn to the model being pursued in the UK and Australia where tax incentives have been used to stimulate large inflows of capital.  I prefer this to the New Zealand SCIF model which has government “picking the groups” it’s prepared to back and places arbitrary limits on how much SCIF can invest on a deal by deal basis.  I think this approach has had its day and all we need now is a system that follows the private capital, relatively indiscriminately.  Arguably the same logic could be applied to research and development funding – if the private sector is prepared to back it then co-fund it.
  3. Realign the balance between taxpayer supported research vs development funding – instinctively, it feels to me that for every $1 we commit to research we should have at least $1 available for development, but on more commercial terms.  We’re a long way from that as a metric…if it is the right metric.   I’m not suggesting more money into Callaghan but a better balance of risk/reward and expansion of non-recourse loans to support development stage companies, alongside private funds.
  4. Continue to build and support a domestic Venture Capital industry – create the right environment for private and institutional domestic funds to flow to Venture and Growth investment.  This involves several elements:
    • Promote the emergence of hybrid growth/venture investment models – funds live or die on the returns they deliver to investors. It is nearly impossible in an economy the size of New Zealand to start as a “Pure Venture Fund” and deliver these returns with any level of certainty. What we need to emerge, in my view, is a Hybrid Fund model.  Movac 3 operated that model but was sub-scale.  Hybrid Funds would make a relatively small allocation to Pure Venture, say 30%, and a larger allocation to the safer Growth capital market.  Investment portfolios can be structured that balance the risk/return across this spectrum.  Such funds would work together domestically and internationally to spread the risk of the higher risk/reward “pure venture” investments.
    • Incentives for the hybrid model – generally I don’t like incentives as they can create unsustainable short-term distortions that will potentially collapse a market when they’re removed. But we have a market failure in early stage Venture Capital in New Zealand that is compounded by an addiction to property and a Kiwi Saver market addicted to short-term liquidity.  As mentioned earlier, I think we should look at the UK and Australian model that has stimulated significant investment into Venture oriented funds, without the need for new Government institutions.
    • Remove roadblocks to Kiwi Saver investment – I’m perplexed by the near complete absence of Kiwi Saver funds (Milford excluded, who are active) from investment in New Zealand Private Equity and Growth Capital.  At the PE end of the spectrum, it’s particularly perplexing considering the long-range returns for these funds have averaged greater than 30%1.  I’m told that this is driven by the requirement to maintain liquidity to enable Kiwi Saver clients to easily switch between funds.  I doubt that this is the real reason as it would point to a disturbing lack of competence in portfolio construction in the New Zealand savings industry.  I’d suggest that the government should review the regulatory environment in this industry to identify any arbitrary constraints impacting capital flows.
    • Tune up the Investor Migrant programme – I’ve met and worked with some fabulous wealthy migrants that have come to New Zealand under this scheme.  They have made significant investments in the New Zealand innovation ecosystem and added material value to these businesses.  Unfortunately, however, the majority of the money that flows into New Zealand under this scheme ends up invested in government bonds and property.  The scheme does not favour one form of investment over another.  I’d like to see adjustments to this scheme that promoted investment in the New Zealand innovation ecosystem.  Perhaps this could be as simple as attributing more “points” under the programme for investment commitments in this sector over other investment options in New Zealand.
  5. Don’t constrain New Zealand funds to New Zealand only investment – under the NZVIF model New Zealand Venture funds have been constrained to only investing in New Zealand companies. I strongly support this sentiment but New Zealand fund managers need the ability to work with offshore funds domestically and internationally.  We can’t build one-directional relationships, we need our foreign co-investment partnerships to flow both ways.  By doing this we build depth and capability in New Zealand managers and open New Zealand investors up to some fantastic offshore opportunities.  We don’t need much, a 20% allocation to offshore would do the trick.  Interestingly New Zealand Government agencies are putting in a big push to secure a chunk of the offshore allocation that the Australian funds have.
  6. Establish a public/private partnership to help develop our Great Founders into Great Leaders – we need to invest in developing our entrepreneurs and providing them with the tools that enable them to become great leaders.  These tools are a mix of basic management skills through to deeper personal tools that promote greater self-awareness and identification and resolution of the things that hold us back.  Many large corporates and government departments have these programmes running inside their organisations but we don’t have anything that’s systematic and right-sized for small entrepreneurial companies.  Let’s create it.

So there’s a few of my thoughts.  Apologies, in advance for any “alternative facts”.  Let me know where I’ve got it wrong and what you think.   If we get a decent debate going, who knows, someone might notice?

Take care, Phil

 

1 New Zealand Private Equity Returns, 1994 -2012, Aaron Tregaskis, New Zealand Venture Investment Fund, 2012

 

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