Dialogue: The push and pull of working capital

By HOWARD H. FREDERICK*

New Zealand is one of the world's most entrepreneurial countries, but the survival rate of our young firms is moderate to low.

The gap between the start-up rate and the success rate must be filled with policies, programmes, education, research and development that focus on the needs of entrepreneurs. The most important gap-filler is financial support for new and growing firms.

Entrepreneurs respond to both incentive ("pull") and support ("push") mechanisms. The previous Government's policies were biased toward "push" measures such as grants.

Too many push programmes can perpetuate the safety net mentality rather than encourage innovation and risk.

"Pull," however, operates on the principle that entrepreneurs and their financial backers are attracted by strong social and economic incentives such as technology incubators, tax incentives and higher rates of returns on venture capital. That's what is so impressive in Michael Cullen's budget. Ministers have been persuaded that "pull" mechanisms such as equity, debt, loans, venture capital and even changes in taxation have their proper role.

Those who argue that lowering the corporate tax rate is more important than a venture capital scheme miss the point. Both are pull mechanisms.

Foreign direct investment is modestly successful in New Zealand because outside companies see the corporate tax rate as average and stack it up next to New Zealand's lower wage costs, virtually no payroll taxes (except ACC) and no capital gains tax.

Ministers are expected to decide whether to increase resource taxes or lower the corporate tax rate. Right now the focus is justifiably on incentive pull mechanisms such as venture capital and technology incubation.

The new Venture Investment Fund is modelled on the Israeli Yozma fund, where private venture capital matches the Government's contribution and the Government exits once the seed capital market is strong.

Amazingly, the Australian and New Zealand venture capital market is experiencing a counter-cyclical vitality compared to the United States. Venture capitalists invested a record $A1.14 billion in new ventures in Australia and New Zealand last year..

New Zealand saw a 50 per cent increase in the number of deals and was the second most popular investment destination behind New South Wales, and even surpassed Victoria in the fourth quarter of last year. So the problem is not availability of funds, it's the funding stage.

Kiwi entrepreneurs face a conservative and risk-averse financial community when they start businesses. So-called first and second rounds of venture capital come only after a firm demonstrates a proof of concept.

Venture capitalists especially like the third round, after there is a viable product and when a firm can show sales and a cash flow. But what they really love are pre-IPOs when the firm is profitable and expanding. Term co-investment is the proper role of government to reduce private capital's risk and simultaneously increase its success rate and the size of the deal flow.

Where is the deal flow coming from? The answer should be the state-owned enterprises and crown research institutes themselves (out of which the money was taken to set up the new fund), the tertiary sector, defence, new immigrants, repatriated New Zealanders, spin-offs from corporations and R&D centres of excellence.

The deal flow comes from technology incubators, for which the present budget has tripled funds. It also must come from entrepreneurship education programmes.

The debate is not about venture schemes versus tax incentives. They are both incentive pulls. Shouldn't the private sector give incentive pulls to the Government? If given $30 million for technology incubation, for example, it could generate $200 million in taxable business. That's a sure bet and it's a pull incentive to which Dr Cullen would respond.

* Dr Howard H. Frederick is the director of the New Zealand Centre for Innovation & Entrepreneurship at Unitec.