Nothing ventured, not enough gained

Neville Jordon says we need to recognise the talent on our own doorstep. Photo / Supplied

The New Zealand market is denying young companies development finance but there is no quick fix solution, writes Graeme Hunt.

New Zealand is turning its back on helping young companies expand, leaving the opportunities to offshore investors, Endeavour Capital chairman Neville Jordon says.

"Raising capital in New Zealand is very, very difficult indeed. The institutions see these [companies] as risky," he says. "It is not a risk - you have to deal with uncertainty, not risk."

Jordan, who founded, floated and later sold telecommunications company MAS Technology, says New Zealand needs to wake up and recognise the intellectual talent on its doorstep.

"The gap in venture capital is now being filled by angels. It is beyond venture capital and before you get to the big end of the market - private equity - that there are problems."

Jordan says typically young companies need funding of between $4 million and $20 million to expand and develop their research and development.

"It is not an area for the state [to fund]. They can be supportive, they can set the scene but it is up to private capital to invest."

Jordan says the interest in this middle market is strong in Asia-Pacific, especially North America, where the reputation of New Zealand is strong.

"They know enough about New Zealand, they track our general indicators and they see New Zealand in a fairly positive light.

"A lot of institutional people have a mandate to invest in Asia-Pacific and they are prepared to look at what New Zealand might have to offer.

"I continue to be very disappointed that New Zealanders will not invest in the economic fabric of their own country. Some people seem to think the country is going to grow by foreign exchange hedging and derivatives trading but these do not provide for economic growth or jobs for our graduates."

Jordan says there is no shortage of talent in the New Zealand young companies he comes across. "We are looking for companies that have definite intellectual property. They must be based on research and development and they must be able to scale up for exporting."

He says the real challenge is getting local funding but neither Jordan nor others in the fledgling venture capital industry are asking the Government to intervene directly or "pick winners".

Indeed, a recent report prepared by international consultacy LECG for the state-run New Zealand Venture Investment Fund (NZVIF), specifically warns against governments interfering in the market or prescribing how investments should be structured. It says that internationally such over-engineered programmes have proved counter-productive and have "hobbled fledgling venture capital industries".

"Moreover, potential foreign institutional investors and co-investors, often critical to the growth of a young venture capital industry, are often scared away by such provisions," the report adds.

NZVIF chief executive Franceska Banga is upbeat about the New Zealand venture capital market, despite the challenges. The record of the NZVIF, which was formed in 2003, seems to support her.

Compared with earlier state-directed attempts to create a sustainable venture capital market - - the failed DFC Ventures (formed as the Development Finance Corporation in 1964) and the Greenstone Fund (formed in 1993 and wound up in 2007) - NZVIF is making headway.

From 2003 - 2009, nearly $75 million of total NZVIF capital was invested. When matched with private investment, the total Venture Capital Fund capital exceeded $220 million. Forty-eight companies were funded over the period and total capital raised by portfolio companies exceeded $437 million. NZVIF estimates this generated portfolio company revenues of nearly $674 million, portfolio company exports of nearly $564 million and portfolio company tax paid of nearly $63 million.

On the face of it, if NZVIF's figures are accurate, the Government's investment in the venture capital market is partly self-funding. Take into account NZVIFs Seed Co-investment Fund (SCIF), formed in 2006, and the role of the state as a catalyst for a venture capital market looks even more impressive. The problem for NZVIF, as Jordan sees it, is the failure of the New Zealand private sector to venture fund enterprises by between $4 million and $20 million - sums that would be seen as trifling in a robust venture capital markets like that in the US,

Franceska Banga says there is no quick fix. "Our market is still developing. It is a 20-year process. We have some very good people [investors] but not enough of them yet. We have all the elements to build that over time.

"The New Zealand capital market in terms of investing into high-quality, high-risk companies is very thin and it is the major challenge we have at the moment.

"Our market is still developing and institutional investors are not interested in any meaningful way. There is a big gap for institutional support."

She says the absence of institutional support is not helped by the cautious approach institutions are taking following the global financial crisis. Banga says NZVIF is working hard to lift industry standards and create a market that international investors feel comfortable with.

"We are part of a global marketplace and we want these companies and investments to be globally accepted rather than [as] a cottage industry ... We will be able to look back after 10 years and see that we have made tremendous progress."

She says New Zealand is entering a "potential golden age" for venture capital with opportunities in food, health, energy efficiency and green technology leading the way. But young companies will have to cross the "valley of death" over the next two to three years first.

Andy Hamilton, chief executive of Auckland-based business growth centre The Icehouse, says the expansion of angel investing is "going very well". But the market is struggling to attract growth funding. "If we are going to build companies to grow offshore and bring their foreign exchange [earnings] back here, we need capital to fund expansion - $4 million to $20 million. Without that, these businesses will run out of cash and go offshore."

The funding needs of many young companies are beyond what The Icehouse can provide directly. Its Seed Fund provides early-stage funding for residents in the Ice Accelerator incubator where successful applications are matched by the NZVIF Seed Co-Investment Fund, enabling them to attract up to $150,000 for their project.

Ice Angels provide funding for early-stage, high-growth start-up companies and limited growth funding for small and medium-sized enterprises is also made available under the University of Auckland Business School Entrepreneurs' Challenge programme.

For those lacking confidence in the venture capital market, turning to the New Zealand sharemarket is not necessarily the answer, as Hamilton chief executive David Thorrold discovered last year when the float of his company, BioVittoria, failed.

The company, which has developed a natural sweetener from fruit grown in China, tried to raise up to $20 million in an initial public offering but failed to even make its minimum $8 million. This was despite having experienced venture capitalists on the board.

The Dominion Post reported that BioVittoria's issue seemed to fall into a classic venture capital gap - too big for angel investors but too small for private equity. Thorrold was reportedly planning to the raise the necessary finance offshore. The irony is that had BioVittoria been a profitable family company around for a few years, it would have been a sitting candidate for the country's robust private equity market.

Ross George, managing director of private equity company Direct Capital founded in 1994, blames the absence of development finance in the $4 million to $20 million area on over-pricing.

"There is a massive amount of money [available] for that middle area but none of the owners price it correctly. Often the issue is priced about 10 times what the value is."

George says his company is interested in profitable non-listed companies that want to expand..

"There are 1500 private companies of turnover of $25 million and above and 850 profitable companies in that category, and to put that into perspective there are 70 profitable companies on the stock exchange.

"The value of the private capital market is high: the New Zealand Institute of Economic Research estimated it as seven times larger than the stock market."

Direct Capital has successfully raised seven funds since 1994, with total capital available for investment, according to George, of about $750 million.

VENTURE FORTH

*Angel investing boom with more wealthy Kiwis giving young companies seed money or start-up funds.

*Shortage of New Zealand development funding (typically $4 million to $20 million), forcing young companies to seek offshore help.

*Strong private equity market (top end), outstripping listed investments several times only.

*Attractive investments include IT, biotechnology, food, health, energy efficiency and green technology.

*Companies must have strong intellectual property and capacity for export