This is the second article in a series by our Research Intern, Odette Lees. The first article, “How Big is New Zealand’s Early-Stage Funding Gap?”, is available here: https://matu.co.nz/2019/09/how-big-is-new-zealand’s-early-stage-funding-gap?/
It is no secret that many New Zealand start-ups have found themselves deep in the “valley of death”, struggling to find the critical capital needed for them to grow and launch themselves out of this position1. This well-known struggle can be partially put down to a gap in available funding for these companies, a gap which has remained steady despite the growing innovation occurring in NZ.
Angel investors and early-stage Venture Capital funds have successfully funded hundreds of start-ups in recent years. However, when the needs of these companies outgrow the capabilities of investors they hit a wall. There are few VC funds with the capabilities to fund a complete series A round on their own, and with rounds ranging between $1.5-15 million2, there are few companies that can currently receive this funding locally.
We have previously identified that over the next 5 years we can expect to see the size of the funding gap shrink significantly. However, this can only occur with the right industry conditions and there is little room for industry change to occur. Scalable, long-term solutions need to be considered to prevent the gap from widening in addition to the interventions over the next 5 years. Below, three potential sources of capital have been identified which could help to support the growing start-up industry in New Zealand. It is important to note that multiple contributions will be needed to keep up with this dynamic industry; no singular solution alone will be enough to solve this on-going problem in its entirety.
Superannuation Funds and Government Incentives
New Zealand’s early-stage capital market is in what can be described as an ‘Activation’ phase3. This means that the ecosystem is steadily growing, but in order to progress into a more advanced phase, we need to make sure we can tap into our local resources effectively. A way of doing this is to ensure that our government can help to fill funding gaps and has set up structures to encourage local investor expertise. The government’s $300m market intervention, called the Venture Capital Fund (VCF), which was announced in the 2019 Wellbeing budget4 is certainly a good start to this.
The Venture Capital Bill has subsequently been created to manage the deployment of the $300m VCF. This money will only be placed into other VC funds, not directly into companies. Furthermore, the VC funds who receive this money are required to match the funding received and place 75% of their total funds (not just the VCF funding) into Series A and B deals of New Zealand companies. The remaining 25% of their funds can be invested however the fund chooses i.e. into seed deals, or non-New Zealand-based companies5. This will have a direct impact on the current gap seen in available funding for Series A+ deals and contribute to the predicted shrinking of the gap over the next 5 years.
The source of the intervention has been a contentious issue; for those who are unfamiliar, $240m will be provided by the Guardians of New Zealand Superannuation Fund and the remaining $60m from the New Zealand Venture Investment Fund. The argument against this move is that our pension funds shouldn’t be wasted on such risky investments. However, other countries with more developed investor markets utilize pension and super funds at a much higher rate. For example, in Europe in 2018, pension funds constituted 31% of total capital raised by funds, and sovereign wealth funds contributed a further 9% of that total capital raised6.
Furthermore, historical data from around the world shows that on average, private equity earns higher returns that the stock market7. In NZ, historical mean returns of private equity (33.7%8) are almost triple that of the stock market (10.75%9). It makes sense to utilise the huge pools of money that superannuation funds maintain (the NZ Superannuation fund manages $41.2b). While it is not suggested that the super fund invests all of its money into early stage companies, the $240m contributed towards the market intervention will make a sizeable contribution to closing the gap and is only about 0.5% of their total managed capital. Another example of a large pool of resources is the ACC fund, which manages $4b and has engaged in later stage investments (such as Rocket Lab’s US$140m Series E round in 2018), but has yet to dip its toes in to earlier-stage ventures.
This is already a fairly regular occurrence in NZ and therefore the most familiar. An estimated 37% of the start-ups funded since 2017 have had contributions from international VC funds or angels, and this capital has been relatively evenly distributed among Seed, Series A+, and exit stages of investment. More international investment at the Series A+ level could help companies grow faster than if they waited for local investment. However, the problem that can occur with encouraging this is that these companies are often pressured to leave NZ and establish operations in the country of the investor.
International funding is not all negative however; overseas investors have access to new networks of people, different markets and connections. For some companies, this is exactly what they need to succeed10. It is a balance between allowing companies to go off-shore if they need to and making sure that we can keep as much of the benefit locally as possible.
Several international funds, particularly a few from Australia, have indicated that they will be setting up offices in New Zealand. These funds will utilise their large access to capital to focus specifically on NZ investments while they’re here which brings confidence of increased capital flow from overseas. Because the capital will be based locally, it could capture some of those companies who are currently following money overseas.
Syndication is not necessarily a way of increasing the total available capital, but it can help increase investment activity by reducing the financial risk for each individual investor. Reducing the amount of capital required to participate in an investment round also enables more parties to participate. This encourages investors to make more investments, and thus gets more money into more companies. It also helps increase the company’s exposure to expertise and support11.
In New Zealand, syndication is not a new concept; based on Matū’s analysis of funding activity, almost all of the financings in the last two years have been syndicated with at least two sources of money. It is common overseas for VC funds to form syndication partnerships where the same funds will syndicate together on numerous deals.
However, strong partnerships where the same funds invest together repeatedly are still forming in New Zealand. Time will tell if these partnerships will allow for more successful investments and larger deal sizes, and whether or not investors can remain significant shareholders over multiple rounds of follow-on investment. Something we expect to see is that as the parties form relationships and trust each other more and more over time, rounds can be filled and closed more quickly, allowing companies will be able to get back to their core business instead of raising capital.
These potential pathways for generating the capital needed by growing start-ups are just some of the ways which could help to decrease the funding gap. With time, and the right measures at both a government and industry level, we will hopefully see more companies succeed in New Zealand.
Matū is a venture capital fund that
targets very early-stage science and technology projects being commercialised
out of research institutes and in the private sector. Following the principle
of mohiotanga, we seek to share insights from our research where possible, in
order to build on the knowledge already in the community and help enable people
1 “How Kiwis’ Preference for Property Is Starving Our Startups,” The Spinoff (blog), March 28, 2019, https://thespinoff.co.nz/business/28-03-2019/how-kiwis-preference-for-property-is-starving-our-startups/.
2 Matū’s own analysis based off Series A raises from 2017-2019
3 Startup Genome, “New Zealand Startup Ecosystem Analysis,” 2017.
4 New Zealand Treasury, “The Wellbeing Budget 2019,” 2019, https://treasury.govt.nz/publications/wellbeing-budget/wellbeing-budget-2019-html.
5 Simmonds Stewart, “Venture Capital Fund Bill,” September 6, 2019, https://simmondsstewart.com/blogs/venture-capital-fund-bill/.
6 Invest Europe Research, “European Private Equity Activity Report 2018,” May 3, 2019.
7 Kenneth M. Freeman and Leonard A. Batterson, “Why Should You Invest in Venture Capital?,” in Building Wealth through Venture Capital, 2017, 23–34.
8 Aaron Tregaskis, “New Zealand Private Equity Returns 1994-2012” (New Zealand Venture Investment Fund, November 2012).
9 Bart Frijns and Alireza Tourani-Rad, “The Long-Run Performance of the New Zealand Stock Markets: 1899-2013,” Pacific Accounting Review.
10 “Mind the Tech Sector’s Funding Gap,” Newsroom, November 7, 2018, https://www.newsroom.co.nz/2018/11/07/303453?slug=the-funding-gap-in-our-tech-sector.
11 Mike Wright and Andy Lockett, “The Structure and Management of Alliances: Syndication in the Venture Capital Industry*,” Journal of Management Studies, December 1, 2003.