Cullen Speech to NZ Venture Capital Association
Michael Cullen Speech to NZ Venture Capital Association 2nd Annual Conference
Robert Laidlaw Room, The Heritage Hotel, 35 Hobson Street, Auckland
Thank you for your welcome and for the opportunity to address this second annual conference of the New Zealand Venture Capital Association. I would like to congratulate the association on the progress made during the last two years. With the appointment of Chris Twiss as Executive Director, and the publication of the first "NZ Venture Capital Monitor" the Association is well on the way towards becoming an essential part of the New Zealand investment market.
My session is entitled ‘Public policy and the development of the New Zealand venture capital and private equity industry’.
It is worth recalling that, even as late as five years ago, there would have been very little to say on this subject. Under the logic that drove public policy in the late 1980s and 1990s venture capital was seen as a quintessentially private enterprise, and hence not a matter for direct government involvement.
Instead, the role adopted by successive governments extended no further than attempting to run a sound economic policy, maintaining a tidy framework of commercial law and taxation, and cheering from the sidelines as the invisible hand of the markets moved capital around to its most efficient distribution. Or failed to do so, as the case may be.
If – as happened with annoying frequency – New Zealand businesses were not able to access the venture capital they needed to turn new technologies and products into successful business ventures, then there was nothing government could do except wring its hands and hope for more propitious circumstances in future.
Thankfully, public policy has shifted. The intellectual debate has moved, such that we now understand much better how, in small trading economies such as ours, there needs to be cooperative interplay between capital markets and government initiatives. A well-functioning venture capital market is as much about culture as about economics. It requires interaction between research scientists and engineers, entrepreneurial business people and investors who are willing to commit long-term to a new venture.
That may happen spontaneously in a large economy. (Although the respective histories of Silicon Valley, Oxfordshire, Northern Italy and the Bangalore region of India suggest a more complex chain of causation.) In a small economy such as ours, however, it is more likely that a successful venture capital market will be made rather than born, and it will be made by the concerted effort of investors, researchers, industry and – last but not least – government.
The policy shift then is towards a smarter style of government intervention; intervention in partnership with the private sector, addressing specific structural and cultural obstacles to the growth and maturity of the venture capital market in the New Zealand economy.
No-one in my government is advocating a return to the days when ministers of the Crown acted as venture capitalists themselves, spending large sums of public money on best guesses and hunches. As I said, partnership is the key to our approach, without any slackening of the rigour that any diligent investor would put into research and analysis.
During our term of office, we have sought to develop a balanced set of policies that create an environment in which the local venture capital market can grow and mature. There are three main elements:
First of all, creating a stable macro-economy, and hence strengthening the fundamentals which will make New Zealand an attractive place to invest;
Secondly, remoulding our tax and regulatory regimes to provide greater clarity and certainty for investors; and
Thirdly, becoming an active player in the process of bringing new ventures to the market, by a combination of better targeted expenditure on research and technology and a new partnership with the private sector aimed at boosting the level of venture capital available to New Zealand businesses.
On the macro-economy, we now have a stable platform in the form of a robust and growing economy. The New Zealand economy has been one of the best performing economies in the OECD in recent years.
The headline numbers tell the story. The economy grew by 4.3 per cent in the year to March 2003. Employment has grown in each of the last twelve consecutive quarters, so we now have an unemployment rate of 4.7 per cent, which is the lowest since 1987 and is very low by OECD standards. To give you a benchmark, the unemployment rate was 6.3 per cent when this government took office at the end of 1999. Inflation is well under control. Consumer prices rose by a very modest 1.5 per cent in the year to June.
This strong performance has not been a result of any fiscal stimulus. We are running strong surpluses, and spending and debt are falling as a percentage of GDP. In the 1999 fiscal year spending in the core Crown sector was 33.8 per cent of GDP. In the current financial year it is expected to be 31.1 per cent. Gross debt was 33.8 per cent of GDP. This year it is forecast to fall to 25.7 per cent.
What is interesting about these results is that our economy has not been impacted by a prolonged period of international uncertainty and stagnation. Normally, our economic fortunes are largely determined by external factors. But not only has our recent performance been much more stable than that in most other countries, it has been stable at the upper end of relative international economic performance.
Time will tell whether we have succeeded in creating an economy that is less prone to external shocks. From the present perspective things look good. We are moving towards the kind of economy that is better able to attract and sustain investment, including venture capital.
However, this needs to be combined with tax and regulatory regimes that provide clarity for investors and reflect international best practice. That is why, on the regulatory front, this government has embarked upon a review of securities legislation, and why we have been quick to review tax rules that impact upon venture capital.
I have recently announced broad proposals aimed at encouraging venture capital investment in New Zealand companies early in their life cycle. There are two major areas of change.
The first is a proposal to remove barriers to international venture capital investment by providing certain non-residents with an exemption on any tax that they may face on the profits they derive from realising shares in small, unlisted New Zealand companies. The exemption will be available to non-residents that are tax exempt in their own jurisdiction and, as a result, cannot claim in their own jurisdiction a credit for New Zealand tax paid.
The exemption will be available to residents of the majority of countries with which we have a double tax agreement.
To target venture capital, it is proposed that the exemption will be available only for equity investments in small, unlisted New Zealand resident companies that are not involved in certain excluded activities, such as property investment.
Secondly, we are proposing some changes to the taxation of special partnerships. It is suggested that the tax provisions that prevent resident special partners from offsetting partnership losses against other income be repealed provided that the deferred deduction tax rules that are currently before the House are passed in their current form. This will remove a tax barrier to resident partners investing alongside non-resident partners via a special partnership structure.
These changes are similar in many respects to the recent changes to the Australian tax treatment of venture capital.
Officials are currently consulting on these proposals with interested parties. It is intended that the final proposals will be included in the first tax bill of 2004, with application from 1 April 2004.
The third element of this government’s venture capital policy has been active participation in the process of bringing new ventures to the market. We established the $100 million New Zealand Venture Investment Fund in 2001, with a mandate to accelerate the development of the venture capital market in New Zealand.
As you are aware, through VIF the Government is investing up to NZ$100 million in innovative New Zealand businesses with high growth potential. Importantly, the Fund invests through individual investment funds (VIF Seed Funds) operated by private sector fund managers appointed by VIF. These funds include capital raised from the private sector to at least twice the level of the VIF contribution.
VIF now has contracts with four seed fund managers and I think most of them are represented here today. Through VIF $139.5 million combined private and public sector venture capital has been committed for investment in young New Zealand companies so far, $93 million of it private funding and $46.5 million from VIF. Of the $53.5 million of VIF capital still available for investment, $25 million has been earmarked for biotech investment and the remaining $28.5 million will be invested either with existing or new VIF Seed Funds.
To date four companies have received capital through the VIF Programme, with a total of $12 million (of VIF and private capital) invested in the VIF Seed Funds.
Despite the perception encouraged by some portions of the media, venture capital is not easy money for risky business propositions. Given the level of risk involved, venture capital investments are made only after careful and rigorous analysis of the company concerned, the product and the market. This does not lend itself to hasty investment decisions. Scores of business plans and investment opportunities will be considered, before a decision is made to invest.
Having said that I, like you, look forward to seeing strong investment progress being made by the VIF Seed Funds over the next two to three years. It is vital that promising NZ companies with the potential to be global winners have access to the capital and the management skills to help them achieve this.
The last two years have been exceedingly challenging for raising venture capital. There has been a marked slowdown in global investment in the last two years, including the United States and Australia. New Zealand has not been immune to this.
But New Zealand is still doing exceedingly well. The Australian Venture Capital Journal recently pointed out that despite international conditions New Zealand has just had its 'second best year' in venture capital fund raising and it attributed that to the focus and stimulation provided by the VIF Programme and the VIF Seed Fund managers. The Programme has attracted a high level of private investment in challenging times.
The Journal also commented that the impact of VIF will next be felt in the level of investment activity in our market, because nearly all new capital raised is available for investment.
And the future looks promising for further new, institutional and pension fund investment in the New Zealand venture capital markets. Both the Government Superannuation Fund and the New Zealand Superannuation Fund have indicated that a portion of their funds will be invested in venture capital. Whether that investment is made onshore or offshore is a matter for them to decide. Both are at an early stage of implementing their investment strategies, and, of course, are required to make decisions independently on the basis of the best available advice. But the signs are promising. Availability of high quality investment products in the New Zealand venture capital markets will help them make that decision.
On the other side of the investment equation, there is still a need for young New Zealand companies seeking venture capital to demonstrate that the investment has good prospects for success.
Recent policy initiatives have been aimed at improving our game in this regard.
This year we announced a Pre-Seed Accelerator Fund of more than $19 million over the next four years to invest in pre-seed projects; that is, those that fall between grant-funded research and the seed stage of development, where venture capital would normally cut in. This will aid the commercialisation of research in Crown Research Institutes, tertiary education institutions and their subsidiaries, and over time it will boost the number and quality of projects seeking venture capital.
We also boosted the support programme for business incubators by $1.6 million, committing an additional $6.4 million over four years to lift the proficiency and scale of New Zealand incubators to internationally recognised standards. We now have 15 incubators, and the companies they support have in the last 18 months raised more than $10 million in private funds.
In addition, we recently launched a number of new initiatives in biotechnology arising out of the government’s response to the Biotech Taskforce. The taskforce recommended an ambitious 10-year vision of increasing the value of biotechnology exports from the current $250 million to more than $1 billion a year. The government has taken all but a few of the taskforce’s specific recommendations on board. For example:
A new $12 million fund will be established to support trans-Tasman joint ventures in biotechnology. This will offer partnership funding to New Zealand and Australian companies working together on biotechnology development, manufacturing and marketing.
A $2.3 million programme will support best practice in commercialising biotechnology research, to support the flow of good ideas from our laboratories to our markets.
We will also be spending $1.2 million over four years to get better statistical information on the biotechnology sector, to track its growth; since, as we all know, accurate information is the lifeblood of a venture capital market.
Today VIF will receive proposals from parties interested in establishing a VIF Biotech Fund. There is $25 million available for co-investment alongside private investors, in selected privately managed Biotech funds.
So, to sum up, we are firmly committed to the development of the New Zealand venture capital and private equity industry. We have, I believe, put in place a sensible set of measures which will bear fruit in the medium to long term.
I have to stress that this is still a work in progress. We need time to bed in initiatives such as the Venture Investment Fund and the Pre-Seed Accelerator Fund. And no doubt there are other issues to be addressed in tax and regulation.
We recognise the need to keep open the channels of communication in order to fine tune the mix of policies and remain alert to obstacles that may arise in areas such as taxation and business law.
For this reason I look forward to your questions and to receiving feedback from the rest of today’s conference.