Last year I visited Israel and California's Silicon Valley. I met innovators, venture capitalists, researchers, some smart politicians and officials and a few economic visionaries.
It was a visit that gave me some of the most fascinating and inspiring days I've had as a minister.
After Silicon Valley and Massachusetts, Israel is the third most intense centre of venture capital activity in the world. Outside this room probably not a lot of people know that.
Over the past decade that venture capital activity has helped make Israel a hotbed of high-tech industry. The boost to the economy has been huge.
Silicon Valley is extraordinary as an example of an innovation centre that grew up largely without parental supervision. Government was not irrelevant - it never is - but it can't take the credit.
Israel is the opposite. It has a thriving venture capital and high-tech scene largely because the Israeli Government decided it wanted one, set out to get it, and succeeded.
I went to Israel and California to learn from what happened there. I went because this Government wants to transform the New Zealand economy - and because technology, and the capital to back it, are going to be a crucial part of that transformation.
As a Government we keep talking about economic transformation because we mean it. It is shorthand for a vision that informs much of what we're doing as a Government - in economic and industry development, in education and training, in research, science and technology policy.
New Zealand is unusual amongst developed nations in having an economy still heavily reliant on primary sector commodities. Most countries with that kind of economic profile are in the second or third world. That's one of the reasons why we've been sliding steadily down the OECD rankings since the 1950s.
To halt that slide, to start climbing back up, we need to add more value to what we produce as a nation. That doesn't mean giving up on primary production. It means enhancing and renewing its products. It means trading in expertise, intellectual property, technology. It means making more money out of stuff by adding knowledge to it, and making knowledge itself into stuff we can sell.
That's the transformation we're talking about.
To help us get there we're working with the idea that New Zealand has an innovation system. It's the infrastructure that allows an idea, a scientific discovery, or a technological breakthrough to be turned into a business or an industry.
Key elements of that system include the education system, public and private sector research and development, our technological infrastructure, venture capital and development finance, intellectual property protection, incubators, and most importantly our human resources - in both innovation and the skills to commercialise it.
The Government is focused on making New Zealand's innovation system work as well as it possibly can. There's no single measure that will achieve that. We have to tune up the whole by paying constant attention to each part. In each case we have to work out first if it's something a Government can help with. Then we look for the best way to get a result.
That's the context for the Government initiative I want to tell you about today.
We are going to become actively involved as an investor in New Zealand's venture capital market, specifically at the seed capital stage. We will be doing this in partnership with the private sector, not in competition with it. Our objective is to accelerate the development of this country's seed capital market, then get out when we are no longer needed.
We are doing this because seed capital is a vital part of new business formation. New businesses based on technology and on high value-added products and services will be a necessary part of New Zealand's economic transformation. They will need seed capital, but that end of the venture capital market is presently under-developed - both in comparison to the rest of the venture capital market and to overseas capital markets.
The effect of this is that valuable innovations go begging for investment. The Government is frequently getting the message that good ideas in Crown Research Institutes, universities, businesses or even garden sheds are not being turned into new businesses the way they are elsewhere. New Zealand can't afford that. We need to pull those ideas out into the commercial world and make the most of them.
One way of helping that happen is by addressing shortfalls in management skills and capabilities. That's why we've introduced programmes like Industry New Zealand's Investment Ready Scheme, which gives entrepreneurs advice on how to find investors and make a pitch to them. Addressing the seed capital market gap is another way to help coax those ideas into play.
I believe there is general agreement that although we have a growing venture capital market in this country, there is a shortage of visible, organised seed capital. The evidence has been stacking up.
A consultation process carried out in 1999 by what was then the Ministry of Commerce highlighted the relative difficulty of raising seed capital.
A study by Infometrics for Treasury in July last year said venture capital formation is doing pretty well but there are gaps in our fund management skills base, a relative shortfall at the seed capital end and therefore a case for Government policies to ensure the market worked well.
A review late last year by a private sector venture capital firm said the seed capital supply was increasing but there was a role for the Government in filling gaps and accelerating the market's development.
And a report to the Science and Innovation Advisory Council last December identified a shortage of firms equipped to manage seed capital, if not a shortage of capital itself.
We shouldn't be surprised at this. Most OECD countries have gaps at the seed capital end of their venture capital markets. And many of them have taken steps to fill that gap.
Governments actively involved in venture capital markets include those of Australia, the United States, Ireland, Denmark, Finland, Norway, Belgium, Canada, Germany, Italy, The Netherlands, Sweden, the United Kingdom, Taiwan, Singapore and Israel.
Australia, for example, has something called the Innovation Investment Fund, set up in 1998 with $130 million for early stage investment in small new technology firms.
Singapore's Economic Development Board created a venture capital fund in 1985 for direct investment in start-ups and young companies. Its National Science and Technology Board has a couple more schemes.
Israel has the outstandingly successful Yozma fund, which began as a Government-driven fund and has since been privatised. I'm pleased to be able to tell you that Yigal Erlich, the brain behind Yozma, is returning to New Zealand in a couple of weeks as an adviser to the Government.
We have chosen, quite carefully, a private sector model for our involvement in seed capital.
The Government's capital contribution will go into a fund of funds, managed by Government-appointed private sector managers. We will give those managers some criteria to inform their investments. The private sector is being invited, now and over the next couple of weeks, to assist in drawing up those criteria.
Criterion number one, clearly, will be along the lines that investment should be in the national interest. This is, after all, taxpayers' money we are talking about.
The managers of this fund of funds will, over time, invest in a series of drop-down funds. We anticipate being a minority investor in each of them.
The Government does not wish to have a direct say in who is contracted to manage these drop-down funds, although the managers of the parent fund certainly will. Indeed we have chosen the fund of funds model deliberately to keep the selection of the appropriate expertise a step removed from the political process.
We don't wish to be overly prescriptive about the number of drop-down funds, their size or their preferred technology for investment, if they have one. But we anticipate several funds, with taxpayer investment in the order of $10 million in each.
If a fund wishes to focus on environmental remediation, or Crown Research Institutes, or IT, or primary sector innovations, or links with the pharmaceutical industry, that's fine by us. If the managers of a fund want to take a portfolio approach, that's fine too.
An important part of our strategy is that we will have exit plans for these funds. We do not see an ongoing role for Government in venture capital formation. Our job is to act as an accelerant. When New Zealand's seed capital market is humming, we wish to withdraw. We anticipate investing over the next year or three, and we anticipate a programme exit a few years after that.
The criteria for exit, for putting our share up for sale to other investors in drop-down funds, are also up for consultation. It isn't often that a Government announces its intention to privatise on the day it announces its intention to invest, but that is what we are doing.
We wish to involve the private sector internationally as well. For two reasons.
The first is linkages - to markets and to other venture capitalists. Venture capital investment tends to be based on personal relationship building. There is a global network to which we are already linked but should be better linked.
The second reason is to increase links with experienced operators. Commercialising technology is hard. New Zealand venture capitalists routinely link with overseas experience in one form or another.
There is general agreement that there are too few skilled venture capitalists in New Zealand. A fair chunk of our nation's skill base is here today, in one room. New Zealand has rapidly increasing international links and we wish to play our part in strengthening those further.
Besides Yigal Erlich we have a list of overseas venture capitalists we're consulting on our policy. We're maintaining links with North Americans on both coasts, whether they are America's Cup fanatics or not.
Our fund of fund managers are likely to be given a criterion to the effect that most or all of the drop-down funds should include international investment, or advice links, or both. After all that's what New Zealand's private sector does.
You will see that we have a clear idea of the framework under which the fund will operate. You will see that all the important detail is something we wish to discuss with you, soon and at length.
Commentary on our approach has thus far been favourable. Hearteningly so. We have had two distinct criticisms. One is that we may invest too little, and a fainter one that we may invest too much. But there is general agreement that it is important for the Government to declare its willingness to play its part.
I'm releasing today a paper based on the decisions the Cabinet took on this matter on Monday. It explains in outline what we intend to do, as I have just done. We're looking for feedback now.
I look forward to ongoing discussion and correspondence as we move to nail down the detail of this initiative, then begin to implement it.
Thank you.
Pete Hodgson's address to the IIR Corporate Venture Forum
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