Callaghan Innovation’s second CleanTech report highlights the enormous potential for our sector to develop bold new solutions to climate change. We want to build hugely profitable businesses that disrupt dirty industries, reduce emissions and showcase New Zealand’s technological prowess to the world.
This Government has a golden opportunity to accelerate this transformation by resolving fundamental issues within New Zealand’s venture capital and private equity landscape.
Successful global venture capital and innovation ecosystems are fuelled by substantial private investment. That must be our goal here as well, as the performance of any innovation system is primarily dictated by its key constraint—in this case, the capital available for investment. Here are our seven proposals to achieve this step change.
1. Remove Tax from Unrealised Gains in Employee Share Schemes
We’re not the first to call for this – it’s an obvious problem that makes it harder for start-ups to give their employees shares. People should be taxed on their actual income, not their potential earnings. This change would align New Zealand with global best practices, making it easier for startups to attract and retain top talent.
2. Align Tax Treatment of Venture Investment with Australia and the UK
We can make venture and growth investment more appealing to a broader base of individual investors through tax incentives. Australia’s Early Stage Venture Capital Limited Partnerships (ESVCLP) scheme, offering up to 10% tax concessions, has significantly bolstered their VC sector. A recent review by the Australian Treasury has found that ESVCLP has been a key factor in the vibrancy of Australian venture capital.
The UK has equally encouraged individual investment into higher risk companies through listed Venture Capital Trusts (VCTs), which provide tax relief for investment, dividends, and capital gains. HM Revenue and Customs evaluated the VCT scheme in 2022 and concluded that they have been successful in helping start-ups grow, attracting additional investment into start-ups, and bringing in additional investors.
Some have argued that New Zealand doesn’t need these tax incentives, as our capital gains tax only falls lightly upon venture capital gains. That’s not been our experience we’ve had multiple potential Australian investors consider New Zealand funds only to turn us down due to our harsher tax treatment. It would be good to see a coordinated approach between the two countries.
A side point here is that the tax treatment of returns from venture capital is unclear. Are these covered by capital gains tax? Some have argued yes, as investors into all limited-duration venture capital funds are investing for returns. We’d like a bright line test where returns from long-term investments into approved venture funds have a clear and beneficial tax treatment. IRD’s current position on this isn’t clear and that’s holding back investment into New Zealand venture funds.
3. Encourage KiwiSaver Funds to Invest in Local Growth Businesses
KiwiSaver funds should play a pivotal role in supporting domestic innovation, much like their Australian and UK counterparts. Australia’s pension funds play a huge role in driving Australian innovation. The Mansion House reforms encouraged UK pension funds to commit 5% of their assets into domestic high-growth businesses.
The Centre for Sustainable Finance’s Investing in Private Assets report explores in detail why our KiwiSavers have comparatively little investment in private assets. We’ve seen for ourselves three barriers pushing KiwiSaver funds away from venture capital: liquidity requirements, fees for external managers, and higher fees for higher return asset classes.
- Liquidity Requirements: KiwiSaver’s high liquidity demands are incompatible with the long-term, illiquid nature of venture capital investments. These requirements need to be relaxed for higher-risk KiwiSaver funds. This may be a matter of a perceived barrier – while savers can switch their funds between KiwiSaver funds, few do.
- Management Fees: KiwiSaver managers receive fees based on the assets they have under management. Here we suffer from the usual New Zealand requirement for generalists. KiwiSaver funds are small. Their management staff must be generalists. The expertise to manage alternative assets is rare, hence investment into alternative assets is rare. KiwiSaver managers could make more use of external managers with specialised skills but putting assets under external management reduces the fees to the KiwiSaver managers. This issue needs addressing to incentivise investments in alternative assets.
- Fee Structures: The current emphasis on KiwiSaver fund fees needs to be correctly reframed. Right now, KiwiSaver managers are driven towards asset classes with low fees because of the FMA’s test for “reasonable” fees. High fees for high-return asset classes should be justified by performance. The focus should be on net returns after fees rather than low management fees alone.
Some KiwiSaver funds are investing in venture capital. Plaudits to Booster, Simplicity, Fisher Funds, and Generate. What’s different about these four is that they are all locally owned. They are investing locally so that their customers know that their money is being used to benefit New Zealand. Clearly that’s enough for these four funds to overcome the barriers but the total investment into venture capital is under 0.1% of total KiwiSaver funds. Venture investment in New Zealand could make good use of ten times that amount. That step change won’t happen without addressing the barriers above.
4. Reconsider Government’s Investment into VC
Let’s ask the hard questions about NZ Growth Capital Partners. Should the Government be investing directly in start-ups? Their direct investment arm (Aspire) is unquestionably crowding out private capital. Should the Government be investing through private funds? Their fund-of-funds support for VC firms (Elevate) has chosen seven funds with mixed results. We’d prefer an approach that lifts all boats and brings more capital into the whole ecosystem. That way, private investors can select which funds to support and strengthen.
5. Refine the Active Investor Plus (AIP) Visa Scheme
The AIP Visa scheme is working reasonably well so far. A goal is to bring in $300m of international capital and associated expertise to New Zealand. After eighteen months of operation, there’s some obvious and simple tweaks to make.
- Clarify Foreign Investments Funds (FIF) tax rules: Ensure there are no double taxation concerns for applicants. Allow Early Property Purchases: This would increase applicants’ commitment to New Zealand. The scheme intends for these people to become New Zealand residents, spending significant time in, and contributing to society during their four-year visa term, and beyond. The inability to have their own home is turning enough away that it is undermining the scheme. Despite the lack of evidence that a small number of wealthy investor migrants purchasing property will have any material effect on house price inflation writ large, it seems there is a longstanding fear of the political optics around such policies in our property-obsessed electorate.
- Prioritise Direct and Managed Fund Investments: Amend the AIP program so that investments into equities cannot happen before investments into companies or managed funds. Many managed funds have time-bound investment windows. To provide these funds with an equal opportunity and greater certainty around AIP as an investment channel, investments should be required into either of these options before an applicant can place the minimum required investment into equities. As it stands, many AIP applicants are choosing or are even being advised to place the minimum into equities and take the maximum time allowed (up to 3 years) before choosing their direct or managed fund investments. For many funds and companies that have invested time and effort in the AIP scheme as a fundraising channel, their fund’s capital raising window may close before this source of investment becomes available.
- Recalibrate the investment settings for each asset class: Money into equities isn’t going to move the needle much for the health of the NZX, whereas the same level of capital into companies or venture funds would make a huge difference. Let’s halve the maximum allowed investment into equities and/or assign a higher multiple to managed funds and direct investments than the current level.
These are simple changes with broad stakeholder support. Meanwhile, the Government is going to review AIP later this year, causing delay and uncertainty for all potential applicants. We recommend less reviewing, more doing. Just get on and make these changes.
6. Revitalise the NZX
The NZX suffers from low liquidity and institutional support, leading to fewer IPOs and more de-listings. Mandating or encouraging pension funds to invest more domestically would infuse the NZX with the necessary capital to thrive. This is crucial, as a robust domestic stock exchange is essential for providing growth companies with a viable exit strategy and for attracting more institutional investors. It’s a difficult problem to solve but we need to make it very easy for smaller, high-quality companies to attract investment through IPOs, and build a track record of success.
7. Overhaul the Science System
We need to change what we require our universities and public research organisations to do. Researchers should waste less time writing competing research applications into funding pools that are close to lotteries, and more time doing research—creating a steady pipeline of investable, potentially world-changing ideas.
New Zealand’s fragmented science system—with its numerous small universities and research organisations— contributes to this excess of overhead and needs consolidation. The average Russell Group university in the UK has four thousand academic staff; the average New Zealand university has closer to one thousand. This leads to higher administration costs, duplicated functions, and limited capacity for key activities like commercialisation. Our funding schemes already ask these organisations to collaborate because research works better at scale.
We call on the Government to be bold. Let’s have fewer, larger organisations to achieve economies of scale, reduce administrative overheads, and focus more on high-value research activities.
By implementing these proposals, we can create a more vibrant, innovative, and resilient innovation ecosystem in New Zealand.
