Seeding debate

Tuesday 1st May 2001

The Crown Seed Fund wins one thumb up from VCs

It's not that they don't like the idea. In fact, some even want to participate. But like so many things in life, whether it's cricket or sex, the success of a government foray into venture capital all depends on how it holds its tongue.

Or so say venture capitalists. "There's nothing wrong with the idea of the government getting involved. It's how they do it that makes all the difference," says Jenny Morel of venture capital fund No.8 Ventures.

The proposed Crown Seed Capital Fund - a $50 million pool for funding start-ups - is modelled on the scheme claimed to have kick-started the successful Israeli venture capital industry, the 1993 Yozma Fund. The fund, announced last month by research, science and technology minister Pete Hodgson, will be managed by a board from the private sector, as Yozma is. It will then invite fund managers to form subsidiary funds (so-called "drop-down funds") by combining local and overseas money with government funds. The two-tier approach keeps the government at arm's length, says Hodgson.

So far the scheme gets one thumb up from local investors and managers. One of the early contenders is the New Zealand Seed Fund, a privately funded $14 million fund launched last year by Auckland University, chaired by Telecom chairman Roderick Deane. It has funded three projects in the biomedical area and has another four in its sights.

The irony of running a partly government-funded investment programme is not lost on Deane. "I think it's well known that I don't believe the government should be spending taxpayers' money on investing in business. But if that's what they want to do, then we [the New Zealand Seed Fund] would be happy to co-operate."

Others are sniffing the public trough. IT Capital, a listed VC fund, is poised to launch a $30 million fund in conjunction with Ernst & Young, focused on IT. "We're just waiting for the government to finalise the details of how the funds will work, " says managing director Keith Phillips. Industrial Research, the Crown Research Institute, is launching an angel investor's network and told Unlimited it hopes to supplement any deals with Crown Seed finance. Pencarrow Funds - the manager of Greenstone, one of the few private/public venture funds - says it welcomes the Seed Fund idea. "Greenstone was a hell of a lot of work but if there's profit in it, then yes we could be interested," says chair Mark McGuiness.

What attracts the fund managers most is the government's generous stance on returns: it only wants to get its money back, plus interest. The way venture capitalists see it this amounts to a subsidy to fund managers, allowing them to cream a luxurious fee.

So why just the one thumb up, then? Well, says Deane, it's that government thing: bureaucracy. The last complication any fund manager wants is a set of bureaucratic rules. "Seed capital is at the risky end of a risky business. Does the government have the stomach for the time it takes for deals to come to completion, for the risk associated with them and for the culture that is required to manage those risks?" Would the government, for instance, be prepared to have a fund managed by an American, in America - as the New Zealand Seed fund has done by employing a New York-based manager, Jerry Balter? Can the government allow the managers to make a decision simply by conference call in a matter of minutes, as the private sector does? "The last thing we want is to have a bureaucrat slowing things down," says Deane.

Hodgson is at pains to emphasise just how long "arm's length" means. "The decisions about managing the funds is several steps removed from government. This will only work if it adopts a private sector model," he says.

There's another bugbear too. It just ain't big enough. Ross George of Direct Capital welcomes the initiative but says the fund needs to be $400 million to get overseas attention. "You've got private players investing that much in venture capital in New Zealand. So what is a government initiative of just $50 million telling overseas investors? 'Government signals only $US20 million worth of technology in NZ'. I'd hate that sort of headline."

George is backed by Yozma founder Yigal Erlich. By his reckoning, the total fund should be closer to $US200,000, creating five or six drop-down funds of $US30 million to $40 million. Yozma raised two-and-a-half times the government input of $US100 million. "You need this amount to create critical mass," he says (see "From Israel, with love").

George also disputes the need to focus on seed capital. He points to the significant venture investing being done by the likes of Tappenden, Todd Corporation, AMP, Morrison & Co, Orion (formerly SouthPower), Deutsche Bank, Jump, Grant Samuel, Direct Capital and individuals such as Stephen Tindall. "There's one venture capital deal being done a week at the moment. It's huge."

But this is venture capital, not seed capital, surely? George disputes the difference. "It's artificial to say 'this is seed capital' and 'this is venture capital'. In the US, successful VC funds do everything from early-stage to big expansion. It's not about the finance stage; it's about the quality of the technology and the business opportunity. Good technology and good business ideas come at all levels, not just at seed stage." If government wants to boost the VC industry, then it needs to be prepared to be active at all stages of development, he says.

Hodgson has heard it before. "It's a significant viewpoint we keep hearing, so we need to be careful not to be overly seed capital-y in our focus." The key will be in the flexibility of investment criteria, he says.

However, in regard to boosting the fund to $400 million, Hodgson's office was less enthusiastic. "You try asking Cabinet for $400 million and see how many others can find a good way to spend it," a spokesman said. Ummm, no thanks.

Vincent Heeringa
vincent@unlimited.net.nz

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