Dollars and sense - recipe for a brighter future

Global business is already plying its trade from our shores, but our venture capital spending is tiny compared with other countries. Should we support new businesses - is it corporate welfare or a necessary leg-up?


From a beach on Waiheke Island, John Eyles manages a business operating in more than 90 countries.

His day starts with two hours at the computer screen in his beachside house, reading e-mails from English language teachers and schools that use lessons supplied over the internet by his company, English-to-Go.

Then he walks along the beach for an hour, clipboard in hand, jotting down notes about how to handle the issues raised by his correspondents.

"It's a virtual company," says Jenny Morel, whose Wellington-based venture capital fund, No. 8 Ventures, recently put $2 million into the business in return for a 45 per cent shareholding.

"It doesn't have an office. The chief executive is on Waiheke. The other people are in Mission Bay, the UK, and other people that contribute from around the world."

Mr Eyles, a sculptor and artist who spent many years teaching English in Japan, says everyone writing lessons must do a certain number of hours every week of real "chalkface teaching."

Even the "virtual" lessons are designed to be printed out by English language teachers, photocopied and used in face-to-face classes.

But using the internet to transmit the lessons means that English-to-Go is a prototype for the kind of high-income business that can do well in New Zealand by making our physical distance from world markets irrelevant.

Christopher Wragge, a former property investor who is now a consultant to the company, says the internet can have the same impact for New Zealand in the 21st century that refrigeration had in the 1880s - if we take advantage of it.

"All we used to do before that was wool, and then we could do meat and dairy products," he says.

He believes that to capitalise on the internet we need to be creative, break out of the orderly obedience expected in hierarchical companies, and think strategically about what the world will want to buy five to 15 years out.

"Our cultural impediments have been the underlying malaise which has resulted in our steady loss of wealth over the past 40 years," he says.

"We denigrate lateral, creative, independent thinking and artistic/techno perspectives."

He advocates a much more creative educational policy, installing high-speed broadband phone lines for internet use throughout the country, and ensuring that everyone has the skills to use the net.

"Real jobs," he says, "are created by investing in those growth industries and marketable knowledge for which the world economy is prepared to pay a premium."

In fact, New Zealanders are already creating quite a few such jobs - without any help from the Government.

No. 8 Ventures, for example, has put $1.5 million into Penrose-based Wilson Brown Associates, which has developed an advanced organic waste-processing technology, and $3 million into Takapuna's Tacit Group, which has developed software for insurance and managed funds.

It has put $2 million into DoctorGlobal.com, a worldwide internet health advisory service founded in New Plymouth.

Auckland venture capital fund Caltech has invested more than $33 million in what managing director Wendie Hall describes as helping Australasian businesses "migrate into the larger markets, predominantly the United States and Europe."

It put $4.5 million into Zeacom, an Auckland-based company that developed software for call centres. Although its development work is still done here, its chief executive has moved to Los Angeles to be close to the market.

Another software company, Prism, still develops its programs for the printing and packaging industries in Auckland, but has moved its head office to London. Its $5 million from Caltech helped to build sales from $3 million to $30 million a year in the past three years.

Albany-based International Building Systems has used $2 million from Caltech to develop the American market for a steel framing system that saves time and money on building projects.

A listed venture capital company, Strathmore Group, last month spun off its first investment, telecommunications software company Comm-Soft, through a float on the Australian and New Zealand sharemarkets.



Strathmore chairman Phil Norman says the number of people working for CommSoft went from 15 to 100 in 12 months.

The 23 software developers remain in Auckland, but the head office has moved to Sydney.

Another listed company, IT Capital, put $1.5 million into Auckland e-commerce software developer exo-net a year ago, used its worldwide networks to help Exo-net expand, and sold its stake to an Australian company in August for just under $13 million.

IT Capital has also financed Hamilton-based Deep Video Imaging, which has developed three-dimensional computer screens, and Virtual Spectator, the software company that built a computer-simulated version of the America's Cup.

Keith Phillips, IT Capital's Zimbabwe-born managing director, says it is hard to attract local investors into such exciting New Zealand companies because of a national inferiority complex.

"They are all focused on going offshore," he says. "Getting overseas people to be interested in the creative innovation going on here is not a problem at all - so we have capital moving out while other capital is moving in."

There is also a labour swap as young New Zealanders head out to Australia, Europe and the United States, while there is still a big net inflow of immigrants from Southern Africa and Asia.

Mr Phillips believes New Zealand attitudes will change when there are a few more success stories like Exo-net to tell.

But the next problem for people with ideas and ambition will be raising capital. On this front, the picture is mixed.

On one hand, most venture capitalists confirm a July report by Infometrics for the Treasury which found "no clear evidence" of any shortage of capital for good projects.

Ms Hall estimates that the total New Zealand venture capital market is now worth around $500 million, and expects that figure to double in the next five years - with 60 per cent of the extra money coming from overseas.

AMP alone has committed $300 million to New Zealand's private company sector.

But on the other hand, Ms Hall says the ratio of available venture capital to the demand for it is still "considerably below that of Australia, which is considerably below that of the US."

Ms Hall and Mark McGuinness, who manages the Government-backed Greenstone Fund, say few venture capital firms are interested in investments of less than $1 million, because they take more time than they are worth. Such projects depend on finding wealthy individual investors.

Council of Trade Unions economist Peter Conway argued last year that the Government should invest in selected start-up companies because it was in the country's interests to take more risks than any private investor would.

The country was big enough to spread its risks over a lot more investments, with a good chance that the profits of the "winners" would easily outweigh any losses.

A recent Ministry of Economic Development paper on research and development put the average return on investment to society at 20 to 50 per cent, while returns to private investors averaged only 10 to 20 per cent.

The Government already "picks winners" by investing $415 million a year in business-related research and development.

A state-backed venture capital fund or development bank could finance similar risky investments in new buildings or equipment or for expansion into export markets - perhaps on a last-resort basis and at high interest rates reflecting the level of risk, so that less risky projects will still seek money in the private sector.

In Israel, the Government invested $US100 million ($240 million) in 1991 in a venture capital fund which has since spawned 10 new funds, initially partly and now wholly funded privately. Although its population is small - 5.5 million in 1994 - Israel now has more than 50 venture capital firms with total funds of $US4 billion ($10 billion).

The Israeli Government also invests $US30 million ($73 million) a year in technology "incubators" at 25 locations.

These give base funding and support for their businesses in return for 20 per cent shareholdings.

Finland also has a state agency which provides venture capital, with stakes in 102 companies worth $700 million at the end of 1998.

Using grants rather than investments, Ireland has been the most extreme recent example of a Government going all-out to support business - and reaping the reward of easily the highest economic growth rate in the developed world throughout the 1990s.

Sweden, Norway and the Netherlands have all recently introduced lower flat taxes on income from capital, including interest, business profits and capital gains, while keeping steeper progressive taxes on wages and other income.

Like Ireland, which charges foreign investors only 10 per cent, they are effectively subsidising all capital investment to stop their investors going overseas. But doubts exist about whether grants are the best strategy for long-term growth.

In a recent book, Civilising Global Capital, Australian Labor MP Mark Latham was scathing about such "corporate welfare," noting that industry support by Australian federal, state and local governments totalled $A17.7 billion ($23.6 billion) a year - almost two-thirds of what they spent on secondary and tertiary education.

"Crude bidding wars between political jurisdictions do not favour nations or their workers," he wrote.

Jonathan Lee, of the Auckland investment company Montem & Co, quotes a British friend who worked for Courtaulds and accepted a state grant to open a factory in South Wales.

"He ran it for the period of time, three years or so, that the grants were available. He then closed the factory and got an export grant to export the machinery to India and a grant for the redundancies."

In principle, New Zealand has less reason than some countries to subsidise investment, as in most years we invest about the same proportion of our national income as the Western average, around 20 per cent. In the year to June 2000, it was 19.5 per cent.

Our problem, therefore, is not that we invest too little. It is that we have invested in things that have failed to yield strong economic growth.

This is partly because in 1997 we put 5.7 per cent of our income, or more than a quarter of our total investment, into building and renovating our homes - somewhat higher than the Western average that year of 4.9 per cent.

As a result, we put only 13.8 per cent of our income into non-residential investment, slightly below the Western average of 15.5 per cent. But our effort is still higher than non-residential investment in the US, Germany, Britain, Ireland and six other countries which all grew faster than we did during the 1990s.

So our problem is even more specific. One clue is that in the year to August, only 14.2 per cent of the money we put into non-residential building went into manufacturing, compared with 55.4 per cent for other commercial buildings and 30.3 per cent for education, health and other social buildings.

In Ireland, manufacturing accounts for almost half of all non-residential building. And statistics usually show productivity growing faster in manufacturing than in services, partly because it is much easier to measure the output of physical goods than it is to measure services.

Analysis by the ANZ Bank suggests that a key part of our problem is that our businesses have managed our assets badly. The bank estimates that between 1991 and last year, the top 40 companies on the NZ sharemarket collectively lost $15 billion in economic value, after taking account of the real cost of their capital.

Telecom earned its shareholders an increase of $3 billion in real economic value during the period.

But Fletcher Challenge alone lost $8 billion, compared with what its shareholders could have earned by investing their money in other businesses of comparable risk.

"To my knowledge, there is no marketplace anywhere that would tolerate that kind of performance," says ANZ Investment Bank's Joseph Healy.

He says New Zealanders have been been "fixated" on receiving dividends rather than monitoring the real value of their investments. In New Zealand, 95 per cent of companies on the sharemarket pay dividends.

By contrast, only 20 per cent of American companies pay dividends. Most reinvest their profits in growth areas which earn their shareholders real economic value.

Mr Healy suggests that companies should gear executives' pay to changes in the value of businesses.

English-to-Go consultant Christopher Wragge believes we need something like the Canadian Venture Exchange, which was set up last year for companies raising up to $C20 million ($33 million). The exchange maintains details on the performance of all its 2300 companies on a public website (www.cdnx.ca).

"As an investor - because I live off investment income in the NZ sharemarket - for a minority shareholder, all we know is that we are not going to get a straight deal," he says.

Bridget Wickham, who has been running the Great NZ Business Venture contest, says most new businesses such as English-to-Go need advice and "mentoring." As a new board member of Industry NZ, she sees its Investment-Ready and Enterprise Awards schemes helping to fill that gap.

Associate Economic Development Minister Pete Hodgson says the Government will "suck and see" whether its initial measures will be enough. It will then be up to the public to decide whether we are willing to go further and risk taxpayers' money.

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