I’ve been asked recently to comment on the “state of the early stage investment scene in New Zealand”.  Despite the fact that the fog is yet to lift in terms of the global outlook,  I’m very enthused by what I see going on in NZ Inc. at the moment, but some big challenges are coming.  In summary:

• Deal flow and quality is excellent
• Angel investment is buoyant
• Venture / growth capital is sick and that might just prove to be a problem
• We need to speed up / get hungrier

Deal flow and quality

We’ve been investing informally since 1998 and formally since 2005.  On average we see 150+ opportunities a year and invest in two or three.  This year has been a stand-out in terms of quality:  more experienced teams (a couple doing their second or more venture); more advanced propositions (that have gone beyond planning, are up and running and market tested); and more founder or family cash risked earlier.  Opportunities presented with these characteristics get our attention and are much easier to assess.  We’ve made five investments of this nature this year.

It’s clear that the work that has gone in over the last decade to develop the sector through:

• the creation of formal Business Incubators;
• the government support for the New Zealand Venture and Angel communities;
• the research and market development grants available from FRST and NZTE; and
• the support of the CRI’s to early science based ventures

have collectively contributed enormously to the creation of a vibrant entrepreneurial community.  In addition, outstanding business and investment successes like  Trade Me, 42 Below, IceBreaker, HyperFactory, to name a few, have provided motivation and inspiration for aspirational young New Zealander’s.

Angel investment

NZ Young Company Finance reported that more than $31m was invested into approximately 30 young companies in the first half of 2010.  $50 million went into 63 new businesses in 2009.  This is an outstanding number for a country of 4 million people and demonstrates that Angel investors have remained very active coming out of the global recession.  With the formalisation of Angel groups up and down the country private capital for starting new companies is the most accessible it has ever been in New Zealand – IMHO.

Venture / growth capital is sick

Today, we have one Venture firm left in the market that is actively investing and they’re getting towards the end of their fund.  5 groups that i’m aware of including MOVAC are attempting to raise new funds but are finding it tough to achieve meaningful scale.  From what i see it’s likely that three of these (including MOVAC) will have modest size funds from the 2nd half of 2010 – i hope that we see more.  We need Venture firms to provide the funding to scale businesses that have been started in the Angel community.  The scale of funds does not need to be enormous, particularly if we focus on capitally efficient industries.  Our view is that we can get companies to decent exit points for between NZ$2 million to $10 million post early angel rounds.  There are few outliers to these numbers but this is the range that New Zealand can manage.

If we don’t have a vibrant Venture community I see a potential train wreck coming for Angel Investors.  Here’s the math, 60+ companies have received Angel funding since 2009, all require follow-on funding rounds.  To this stock we’re adding about 30 per year.  From this, assuming a rolling stock of 20 companies deserving of a growth round of approx $3m+, then we need $60m per year in organised growth funding to support the best companies being created.  WE DON’T HAVE THIS CAPITAL IN NEW ZEALAND TODAY.

The New Zealand Venture Investment Fund is doing its bit by calling for new applicants to create funds in 2011.  The process of raising a fund, though is slow and time consuming.  The challenge is compounded by a lack of institutional investor support, not helped by the poor performance of the venture investment market over the last 10 years.  Unfortunately while we wait to address this problem we’re losing the capability built up in the investment teams over the last 10 years.  I suspect that the government will need to do more – alongside private capital – if this problem is to be addressed and a sustainable early stage investment market created for NZ Inc.

The response from the Angel sector in 2011 is likely to involve a re-look at the nature of what is invested in, with a move to opportunities that are capitally efficient and can be built and exited quickly within a NZ$1 – $3million funding envelope.

We need to speed up, get hungrier

I had a great conversation with a Silicon Valley investor a couple of weeks ago who regularly travels through New Zealand.  While being thoroughly enthused at how buoyant the entrepreneurial sector was in New Zealand he was very critical of what he saw as lack of hunger, and slow pace in the development of New Zealand businesses.  He noted a tendency we have to protecting or hiding our toys before sharing them with potential offshore partners – a desire for perfection and a general risk aversion.  I’ve worked in the US and understand what he’s referring to.  In fact all of you reading this who have spent time working overseas in places like London or parts of the US all know that when you’ve returned home you’ve had to apply the breaks / slow down the pace that you used to work at.  It could be that due to our isolation we don’t see our competitors sitting next to us and hence we lack urgency.  We need to change this if we’re going to compete globally, we need to get offshore early, we need to partner with others who know more than we do with access to much larger markets, we need to network and get good at doing deals.  Intsilling this sought of passion, hunger and demand for quick results is one of the roles that investors must play.

I’m really excited at the prospects for 2011, particularly from an investors perspective.  There’s a great pool of exciting and maturing businesses emerging that are going to prove to be great investments for those who have cash to invest.

Take care and have a very merry Christmas.

Update: Click on this link to view Bill’s report: Bill Payne’s report

PRESS RELEASE

Angel investing in New Zealand is now on a similar scale to that of Boston – one of the United States’ prime angel investing hubs – according to noted US angel investor Bill Payne.

Mr Payne, one of the United States’ foremost angel investors, has concluded a five month stay in New Zealand as the BNZ University of Auckland Business School Entrepreneur In Residence advising investors, entrepreneurs and students.

Mr Payne prepared a report for the New Zealand Venture Investment Fund providing reflections based on his observations of New Zealand entrepreneurs and angel groups during his visit. According to his report:

• Angel investment in New Zealand is at about the same level as that in the Boston metropolitan area which is regarded as second only to California in scale of angel investment activity.
• New Zealand entrepreneurs need to hone their products and services in the local market before attempting to sell offshore. Once the product is robust and market traction is clear, then think about adding resources to export.
• The growth of business incubators has helped the growth of angel groups, but there is a danger that those incubator-linked angel groups overly rely on the administrative support offered by incubators.

The Payne report also looked at New Zealand’s venture capital sector and how it links to investing into angel backed companies. He encourages a focus on $60 million to $80 million venture capital funds which target making investments into young companies of around $1.5 million to $4 million to close the ‘capital gap’ which exists between angel investment and larger venture capital deals.

“Kiwi companies that require substantially more than $5 million would seek sales and marketing traction in US or European markets with money raised in New Zealand, and then raise additional capital in those larger VC markets, much as they do today.”

Mr Payne also suggests some small tax changes to encourage investment into early stage companies, but commented that the New Zealand government is much more engaged in start-up companies than is its US counterpart.

NZVIF chief executive Franceska Banga welcomed the report saying it was reassuring to hear from a United States expert that the recent growth of angel investing in New Zealand was proceeding in the right direction.

“The report contains useful insights which we will consider carefully. Bill Payne’s visit was a great success and many entrepreneurs and investors will benefit greatly from the insights and guidance he has provided.”

NZVIF media contact: David Lewis
Cell: 021-976 119 david.lewis@nzvif.co.nz

We’ve just got back from a great week in San Francisco attending the American Angel Capital Association Annual Summit and catching up with Kiwi’s doing great things in the Valley.  The week was stimulating and invigorating on a number of fronts but I will focus this post on my thoughts on the conference and key learning for New Zealand Investors and Entrepreneurs.

Firstly some background. Globally, Angel Investment is becoming increasingly organised and recognised for the significant contribution it makes towards innovation and economic development.  These conferences represent a gathering of investors drawn from a large number of organised groups across the US and the rest of the world.  They are a fantastic networking opportunity for active New Zealand investors and an opportunity to learn from investors across the world.  Approximately 420 people attended the conference with 70% estimated to be active investors.

Cross country investment.  There is an early movement from Angel Groups to start considering investment opportunities across borders.  I find this a bit of a conundrum, as most Angel Investors I know want to stay close to their investments so I’ve been concerned about how genuine this really is.  The perspective I’ve developed from an NZ inc. perspective is this – to truly grow and deliver the returns we want to see our businesses need to operate on a world scale; for us this generally will mean that we need to move our businesses or establish premises in offshore markets; the Angel networks are a great beach head for this activity.  Strategically we need to build these networks and find the right Angel Investors who can invest and get along side our companies in market. But here’s the kicker…relationships are a two way streak, if we want to make this work we’re going to need to start actively considering investing offshore as well.  The ball is already rolling, which is great, we have European and US investors both actively considering New Zealand opportunities, but I’m conscious that we’re going to need to reciprocate at some point.

Country initiatives to promote Angel Investments.  New Zealand does not do too badly in terms of the regulatory environment and government support for seed and venture investment.  Anecdotally New Zealand offers more support to the sector than that received in Australia and the US and less than that received in the United Kingdom and Europe.  In the UK and Europe tax incentives are offered to encourage investment in early stage companies – x% of your investment is allowed as a deduction from income and capital gains not taxed for qualifying investments.  Why is this important?  Early stage investment is critical to innovation and drives job and wealth creation.

Early exits.  If there was one theme at this conference I would say it was “finding and executing early exits”.  To that end I would encourage you to read Basil Peters book “Early Exits” found here.  Underpinning this thinking is research that indicates that most Exits for value in the US occur for under US$30 million.  The FaceBooks, Googles and Twitters of the world are anomalies and the statistical probability of getting one of these is under 1% i.e. you’d need to make 100 investments to get 1 Google.  But, contrast this with the high volume of M&A activity in the US market, for example I was told that Oracle made 70 acquisitions last year alone.  From an Angel Investors and Entrepreneurs perspective the hypothesis proposed was to find opportunities to build strategic value and then exit to a multi-national that can exploit it’s full potential – before you’re EBITDA positive (see Tom McKaskill).  Strategic value means not selling on EBITDA multiple but selling on the potential that the IP has in the hands of someone with established distribution and channels to market.  I heard the comment regularly in the conference that “it’s really expensive and time consuming to build EBITDA”.  My own experience supports this.  The take-away for NZ is simply this – make sure that there is an exit market for the opportunities we invest in, before we invest; work networks globally to position investments for an exit and don’t expect exits to happen unless you work it.

Venture Capital.  The health of the VC sector has improved from a D- to a D+  = still on life support.  Tech Coast Angels in the US have gone from having 20 VC affiliate members to 6.  VCs in the US are typically taking 10 years to exit and the nature of these funds is that they’re perceived as holding out for “big exits” and blocking “early exit” opportunities.  Consequently there is real debate amongst US Angels about whether they should target VC or not.  VCs will take a long time to exit and possibly forgo exit opportunities that do not deliver the magnitude of return; on the flip side they will drive the exit and “swing for the fences”.  All of that said, the discussions that we had outside of the meeting with Valley VCs indicated that there is still a significant amount of capital available for predominantly tech-based early stage companies, BUT competition is intense.  The question of whether to VC or not is a bit mute in New Zealand given the distinct lack of VC money we currently have in this country.

US IPO market practically dead. There were numerous comments made that the Post-ENRON Sarbanes-Oxley Act of 2002 has had a massive impact on the US IPO market.  The latest proposed financial reforms will compound these problems.  The impact of Sarbanes-Oxley has been to substantially increase compliance costs.  Only the biggest and best capitalised companies are progressing to IPO in the US at the moment.  In fact we had a presentation from the Toronto Stock Exchange promoting their market as an easier IPO path.

Let’s pause for a minute…what do these last three points mean, when taken together?  They mean that VALUATIONS are FALLING DRAMATICALLY in the US.  Valuations for both early stage investment and exit.  The  $10 to $50 million valuations for the partly built “next big thing” are dead!  First round Angel deals in the US are now being done for south of US$1 million pre-money.  Secondly, if you plan on exiting an investment…one day, perhaps…then you need to work offshore M&A opportunities and don’t rely on the Founder to do this for you.

Back to the conference:

Life Sciences.  This sector was well represented at the conference but the news was not encouraging.   Timeframes for Life Science based ventures are blowing out, driven by changes to FDA approval processes, particularly those required to go through the Pre-market  Approval (PMA) process .  Returns from these businesses are expected to now exceed 10-years and consequently venture dollars committed to the sector are expected to fall by over 50% over the next few years.  Increasingly US companies are looking to Europe as a launch market for new medical devices where the regulatory environment is considered less complex. Reimbursement was also highlighted for its complexity and the often incorrect assumptions made in business plans which have an order of magnitude impact on revenue potential. For New Zealand Ventures there’s nothing new here – study your regulatory and reimbursement pathways very closely; seek US expert assistance; don’t rely on VC being their when you need it; build relationships for your capital pathway early – in-fact hook-up as early as possible with Life Science Angels in the US (www.lifescienceangels.com).

Web 2.0.  Asia seen as the big, explosive growth market for Web 2.0 based opportunities.   The US market is topping out in terms of Internet penetration and use, while huge growth potential still exists in Asia – take what works well in the US and localise for China, India and other parts of Asia.  Real time data is also a key trend.  Real time data encompasses services like Twitter, YouTube, location-based apps and oddly purchasing history – Yes, people are now sharing their credit card data!  Time to get a life!  FaceBook is now seen in the US as an “operating system/ platform” with over 300,000 apps having been built and 350million users registered. Mobile internet now accounts for 20% of all internet use in the US and is growing exponentially.

That’ll do on the conference.  If you made it this far, then good for you.

Questions welcome, answers can’t be relied on.

Carpe Diem

PS.  The iPad is seriously cool – another game changer – but more on that later.