New businesses with big ideas are fighting to stay aloft as the money runs out, Karyn Scherer reports.
For Christchurch company Martin Aircraft, it was the kind of publicity that money can't buy.
Two weeks ago, Fox News solemnly announced that the Los Angeles Police Department had decided to buy 10,000 made-in-New-Zealand jetpacks for its staff.
At least one of the Fox presenters was outraged. At US$100,000 each, jetpacks seemed a mighty extravagant purchase for a State government that was effectively bankrupt, she grumped.
As CNN gleefully pointed out, the report was laughably wrong. The LAPD, a spokesman noted, wasn't even buying new squad cars any more - let alone spending US$1 billion on jetpacks.
When it was revealed that the source of the story was the Weekly World News, a "satirical" newspaper which specialises in UFO-Lands-In-Utah-type stories, Fox was suitably embarrassed. But for Martin Aircraft chief executive Richard Lauder, it was a chance to once again plug his company's progress on CNN.
"Thanks to that story, I've received at least 40 emails in the last two days from people saying: 'I want to invest'," he chuckles.
Whether anything comes of those queries is another matter. Since it was officially unveiled two years ago at America's biggest airshow, the Martin Jetpack has attracted more than its fair share of both acclaim and ridicule. But one thing it has not yet attracted is a serious wodge of cash.
According to Lauder, professional investors have assured him it's nothing personal. "We continue to get the same story from everyone: 'the market is tough and there's been a flight away from everything that's risky'. Some investors have shut down everything. They're almost saying 'there's no valid investment anywhere out there in the world for us at the moment because the market is so bad' - which is ridiculous."
Martin Aircraft's main backer, fund manager Jenny Morel, is the first to admit the jetpack is not exactly a typical example of a clever Kiwi start-up. But there are many other entrepreneurs in much more traditional sectors such as software and biotech, she notes, who are grappling with the same problem.
In the wake of the global financial crisis, investors have become extremely risk averse, she agrees. And in New Zealand in particular, funding for fledgling companies that need more than just pocket money from wealthy benefactors has almost vanished.
While the very early stage of funding known as angel investing has taken off, somewhere well below the stratosphere, in the space where venture capitalists tend to hover, the fuel is running out.
Ten years ago, New Zealand had just one major venture capital fund. After the Government decided to get involved, there are now more than half a dozen funds. But nearly all are now fully committed.
"I'd say 80 per cent of funds aren't doing new deals. It's really, really tough," says Morel.
For an outlier like Martin Aircraft, it's even tougher. Lauder can cite an impressive list of organisations and individuals who have already registered a genuine interest in the jetpack, including major military and defence organisations, Hollywood producers, and the organisers of several global sporting events, including the FIFA World Cup and the IPL Cricket series.
"We had our first contact from the Rugby World Cup the other day," he notes.
The problem is, the jetpack still needs a lot of work. It's a catch-22 situation, as development is proceeding at a crawl because of a lack of money.
The company's founder, Christchurch biochemist Glenn Martin, originally envisaged the jetpack as a plaything for wealthy people bored with their jetskis. But everyone working on it is now convinced it has far more practical uses, says Lauder.
"We've got this great commercial position out there and we just need to cross the gap to that, and that gap is a funding gap and that's where we have a massive frustration as an organisation."
Over the past few months, the team have managed to automate the jetpack, making it suitable for a potential spin-off - an adventure tourism business. Detailed plans, which would allow paying customers to fly the jetpack indoors, are sitting in his top drawer just waiting to be pulled out as soon as someone is prepared to provide the funding. But so far, no local tourist operators have shown any interest.
Meanwhile, a foreign government has agreed to a joint venture which will supposedly produce 500 jetpacks a year for emergency services. Further details are still under wraps, but Lauder confirms the joint venture will not involve any sort of cash injection.
"It's frustrating for all of us, and we live on tenterhooks, because we're always about to go broke, then we get a bit more money to last another six months, then we're about to go broke and we find something else somewhere. It's a very difficult work environment, and all the things we want to do, we just can't do."
He insists the team are realistic about the challenges they face. "The sad thing is, I don't think there's any worries about it happening technically... We've had a bit of staff turnover in the past five years, and of the 10 or 12 very clever engineers that we've been able to employ, none of them have walked out and said: 'It can't be done'. They all know that with some further work it will be finished."
But at the current rate of progress, it will be 2018 before the company really cracks it, he says. With $20 million, he reckons it could build a production model within two years.
"Visually, when people look at our website they probably don't see that much difference, but we know internally we're far slicker and much more capable than we ever have been. But for us to move to the next phase, which everyone wants to see, which is a Martin Jetpack flying around in the sky with a person in it, we've got to secure the funds to deliver all the R&D projects to make that happen."
A record $31 million was ploughed into young New Zealand companies from angel investors in the first half of 2010, taking the annual total to $52.2 million, up significantly on the previous year.
Much of that money is going into technology. And across the entire sector, there are still plenty of optimists. In its latest report, the Technology Investment Network expanded its top 100 companies to include 200 battlers hoping to see technology surpass the dairy industry as our prime earner of export revenue.
Collectively, technology companies are said to already account for $5 billion in exports. These are statistics worth celebrating. However, Angel Association chair Phil McCaw acknowledges the future is uncertain for many budding businesses.
"The growth in angel investing is helping to build the pipeline of young companies, but it is also creating a new key challenge for our capital markets - which is to ensure investment capital is available as young companies grow beyond the capacity of angel investors," he warns.
Morel has a list of about 50 other projects she would love to back, but can't. While her investment company, No 8 Ventures, has some money left for its existing investments, her attempts to set up a new $100 million fund have so far come to naught.
These days she spends most of her time running Rex Bionics, the company developing robotic legs for people who can't walk. It's another hugely ambitious business which has predictably attracted both praise and scorn.
But she is quick to note that her investment portfolio also includes more traditional technology companies, such as the telecommunications software company OpenCloud.
OpenCloud has so far sucked up millions of dollars, but she is confident it is well on its way to success. Among other things, it has recently announced a deal with Finnish phone giant Nokia. But compared to its global peers, it has also had to survive on the proverbial oily rag, and with almost no support from local partners.
A lack of local support is a common complaint among New Zealand start-ups, she gripes.
Last month, the founder of struggling 3D graphics company Right Hemisphere criticised the Government for not doing enough to ensure the company's cutting-edge software was benefiting the local education sector, as well as other businesses.
"It seems the US and Australia are faster adopters of our technology than New Zealand - a shame for New Zealand children," Mark Thomas told the Business Herald.
The irony was not lost on anyone - in a highly controversial move, Helen Clark's Government gave the company a $14 million interest-free loan, and provided another $7 million to set up a business incubator at its premises.
Morel is reluctant to point the finger at politicians, but even she is still dismayed at the lack of support from large institutional investors. While ACC has made some investments, the Government's huge Super Fund has so far refused to get involved.
Once again, it appears to be a catch-22: large State-owned funds are reluctant to put taxpayers' money into the fledgling industry given its lack of a track record; but a lack of institutional support is starving the industry of the scale that might help boost returns, and harming the industry's credibility in the eyes of potential offshore partners.
"The Super Fund has explicitly not engaged in venture capital this year," says Morel. "They put out a proposal but they made it pretty clear they were only interested in private equity, not venture capital.
"We were prepared to redefine it and say: 'We'll only do companies that have revenue - we'll exclude those companies doing exciting things like the jetpack and Rex Bionics and OpenCloud and focus on the $2-10 million space'. But they just don't want to go anywhere near that. They just see it as too high risk, whereas we see it as a normal part of a large portfolio."
A prominent US investor recently told Morel he was astonished that any New Zealand start-ups managed to survive on such meagre funding.
"He said to me: 'I know that you Kiwis are smart, and I know that you bootstrap... but there's a difference between a diet that keeps you trim and actual starvation'."
Morel acknowledges that some of her own investments badly need another $10 million to get them to the next stage.
"That's beyond angel investors. And there are enough challenges in the world without thinking you're going to reinvent the business paradigm. We really do need to learn from the rest of the world what works. We can try and do it cheaper, and be flexible in the way it works, but my view is we still need a lot more money to build most of these companies into great global businesses."
She admits her own skills have improved dramatically over the past decade. "We have learned so much about international partnering, which is really crucial from early on. Our international networks are now really good. They can always be better, but compared to where we were 10 years ago, they're amazing. It would be a real shame for New Zealand to lose that learning."
As head of the Government's Venture Investment Fund, Franceska Banga is all too familiar with such issues.
Over the past seven years, VIF has invested around $100 million in 90 companies by partnering with private funds, and has already committed another $60 million. But it, too, was in danger of running out of money until the Government agreed earlier this year to underwrite a further $40 million.
In theory, the Government will not actually have to raid its piggy bank for that money. Instead, it has agreed to allow VIF to reinvest any money it gets back from its existing investments, and will guarantee funding in the meantime.
Banga is confident that even under a worst-case scenario, taxpayers will not have to write any cheques. But even VIF's own projections explain why institutional investors are still so reluctant to take a punt on VC funds at this early stage of their development.
It is a given in the VC industry that the majority of your investments will fail but that a few will succeed spectacularly, more than making up for the rest. But even VIF's most optimistic projections show it is unlikely to provide a return of more than 10 per cent over the next decade, and is more likely to make no return at all (see graph, next page).
VIF argues that its performance so far is typical for similar funds at a similar stage of development. And in any case, the whole point of setting up VIF was not to make a profit, but to encourage the private sector to develop its own capability.
According to a report compiled by the Ministry of Economic Development last year, taxpayers will probably have to keep propping up the industry for at least another 15 years.
The report, which has only recently been made public, notes that New Zealand has significantly improved its ranking within the OECD for the percentage of money spent on VC funding as a percentage of GDP, to the point where we are now ahead of countries such as Malaysia, Britain and Australia.
It has also been noted that annual early stage investment has risen from from less than $10 million prior to VIF's establishment in 2003 to over $80 million. And for every taxpayer dollar, the private sector is stumping up at least four times that.
But the report also highlights the same problems expressed by Morel and co - that institutional investors are vital to the industry, and so far they have been either unable or unwilling to become involved.
A big part of the problem is that there have been very few spectacular successes so far. Tellingly, so far, none of the funds VIF has invested in has chosen to exercise a buyout option, which would have seen significant sums returned to the Government well before the fund was due to be wound up.
There is no doubt that the global financial crisis came at a particularly bad time, and Banga is urging patience.
"We can make up all the feeble excuses we like, but if we're not actually finding ways to support these high-growth companies then we won't get the benefit from them in New Zealand," she says. "Many of them will still succeed, but someone else will benefit from that. And it's not an excuse to say the market will look after it, because the fact is if we want to scale our market we've got to put a rocket under it - that's what we're trying to do. We want to move things along more quickly."
She estimates around $200 million will need to be found from the private sector over the next few years in order to maintain the industry's momentum.
"There is an absolutely gaping gap in terms of capital. We've done a little bit of analysis on our portfolio and we think there is probably about $200 million required over the next three or four years on our angel portfolio. We're only probably 20 per cent of the market in general and so the estimation is that the gap is more like $200 million a year."
Plans for a new fund called 2Ignite have already fallen over. However, Endeavour Capital is proceeding with plans for a new $100 million fund and another, as yet unconfirmed, fund is also hoping to go to the market in the near future.
To help improve the attractiveness of the sector to investors, Banga is working on two potential initiatives. One is to revive plans for a "fund of funds" that would spread the risk across a variety of venture capital and private equity investments. Another is to persuade the Government to share more of the risk, either through partial underwrites or by allowing investors to offset any loss of equity against their tax payments.
"If we want to continue to support high-growth New Zealand companies and to ensure the best of breed have the capital to grow then there will need to be changes, either in the willingness of private institutional investors, and particularly those that have a long-term investment focus, or some change in the rules that makes it more attractive - and neither of those things are impossible to do," she says.
Endeavour Capital chairman and veteran technology entrepreneur Neville Jordan is hugely supportive of the job VIF has done so far.
But he agrees with most others in the industry that some huge challenges remain, particularly in persuading institutional investors that the sector is worth supporting, even at this early stage of its maturity.
"If you don't have any background in dealing with thriving, growing companies based on research and development then it all feels too risky. However, if you know what you're doing in that area, then it's actually not risky," he insists.
His own fund, he claims, is even outperforming some of the bigger players. Yet Jordan has also been unable to persuade any local institutions to match the $20 million VIF has agreed to give Endeavour for its new fund.
"Not one institution in the country is prepared to help us match that money - not one. So we are now getting creative and looking offshore to help match that money," he grumps.
Jordan is also concerned that Government officials do not yet agree on the way forward.
"There's not really a united view on this, and I'd be looking forward to some leadership in this area. And I'm not talking about putting more money in it, or new legislation or anything. I'd just be talking about getting some people in a room and saying: 'Let's think about a strategy that is going to address this big gap'."
Renowned scientist Sir Paul Callaghan, in his book Wool to Weta, defined the direction we need to take as a country if we are to prosper, he says. If we don't work out how to get there, he warns, overseas investors will rob us of those opportunities.
While Britain and the United States are still grappling with major economic issues, the Middle East and central Europe are still ploughing plenty of money into young companies, he insists.
"Offshore money fills the gap and then ultimately the companies will follow that money. We'll lose not just the companies themselves, but if you think about the many hundreds of millions of dollars that have gone into universities and CRIs, and the development of the IP - all of that walks out as well."
There are already plenty of examples where that has already happened, including Synlait and NextWindow, he notes. In contrast, his own company, Mas Technology, has managed to keep its roots here while still expanding overseas, as have other companies such as Ectus (a distance learning company now owned by Cisco), ZyGem (a DNA analysis company which has a major contract with Lockheed Martin), and BioVittoria (a Hamilton company that has developed a fruit-based artificial sweetener).
BioVittoria is in fact a classic example of a company shunned by local investors, but succeeding anyway. Last year it had to abandon its plans for a public float because of insufficient interest. It has since made significant progress in China, and is poised to announce an important deal with a major international company.
Jordan is also reluctant to blame politicians, but he admits to a growing despair that New Zealand will ever walk the talk with which we have all become familiar over the past couple of decades.
"We are making progress, but it's just not fast enough. I'm getting more and more disenchanted about the attitudes here."
One problem with local investors is they tend to prefer regular dividends, he says, whereas overseas investors in start-ups are happy to wait for capital gains. As for the argument that New Zealanders simply don't have enough savings - what about the billions that have been poured into finance companies and investment properties, he notes.
"The big funds here can afford to invest wherever they want. But if they don't plant seed potatoes now, there will be nothing to invest in as these companies grow. So there is a looming issue here. Our scientists and engineers are world class and we remain optimistic about developing prosperity here, both economic and social, but we need a few other team players."
Back in Christchurch, Richard Lauder is seriously considering asking the public for money. He is sounding out local brokers to see whether they would support an initial public offer of around $10-$20 million worth of shares.
Many small investors have already offered to give him $5000 to $10,000 each, he says. But he is also acutely aware that many other technology companies of a similar ilk have already crashed and burned, or are in serious danger of doing so.
One which was a little too close to home was Flight Experience, a Christchurch company that developed a low-cost flight simulator used for both pilot training and as a consumer joyride.
The company had some of New Zealand's top businesspeople on its board and a slew of prominent investors, including Warehouse founder Sir Stephen Tindall, who is widely acknowledged as our leading supporter of young, entrepreneurial companies. However, that didn't stop its bankers pulling the plug.
It has since been bought out of receivership by Mike Pero's brother and one of its founders, and is reportedly back in the air.
Meanwhile, Martin Aircraft is sharing an R&D facility in Christchurch with yet another business with big dreams: the company behind the stunning electric bike known as the YikeBike. On one memorable day, staff could choose between three modes of transport to get around the facility: a Segway, a YikeBike and a jetpack.
History has yet to record which of these fiendishly clever inventions, if any, will truly take off. But there are more than a few enthusiastic engineers who hope it's not the Kiwis who will be left on the runway.
"We're supposed to be entrepreneurs, but we're not entrepreneurial investors," Lauder suggests. "And I think that reflects in our industries that we have. We make claims around things like the Hamilton Jet and the electric fence and how successful they are, but they could have been massively more successful if they were properly capitalised early on.
"We can't seem to produce a Nokia or one of those sort of industries. But Glenn and I and Jenny would love to have a billion-dollar industry based on jetpack technology - which is efficient, small, vertical take-off and landing aircraft - and do that in New Zealand. If I had $20 million, we could deliver in my opinion a very large New Zealand industry hinged around that technology."
While $20 million might sound like an awful lot of money, it's a tiny fraction of what the Government paid to bail out the investors in South Canterbury Finance, he notes.
"Just one per cent of that money," he sighs, "would get us all the way."
