New Zealand: Venture Capital Investment Incentives

The classical venture capital model applies in New Zealand, with the costs of investment being deductible during the growth phase, while the eventual returns in the form of capital gains are tax-free. The tax authority has general anti-avoidance legislation which it uses to counter artificial tax shelter schemes, but venture capital is normally so 'high-risk' that it is not vulnerable to anti-avoidance.

The venture capital sector didn't develop especially quickly, but is now thriving, and the government's involvement could be described similarly - slow to get started but now quite active.

The tax position in New Zealand for venture capital investors, whether private individuals or companies, is quite straightforward and reasonably positive, since there is no capital gains tax for the types of investing they are likely to do. The consequences in general are that there is a full range of types of venture capital investor, from individual 'angel' investors, through private equity or venture capital funds to corporate venturing. However, the VC industry complained for years that there is no totally suitable corporate form for VC investors to use, and the government eventually responded with the creation of a Limited Partnership regime.

A normal limited liability company is problematic from a tax perspective, because gains from the sale of venture capital investments will generally be subject to tax. General partnerships may give rise to a permanent establishment for the non-resident partners, which could expose them to local tax on their gains.

Limited Partnerships

The cause of venture capital in New Zealand took a major step forward in May 2008 when after many years of discussion The Limited Partnerships Act 2008 came into force, enabling registration of Limited Partnerships and Overseas Limited Partnerships.

The Limited Partnerships Act replaces Special Partnerships that exist under Part 2 of the Partnership Act 1908. Special partnerships are considered obsolete as they do not provide the appropriate structure preferred by foreign venture capital investors.

The government believes that the introduction of an internationally recognised Limited Partnerships regime will remove barriers to foreign capital investment which provides a valuable source of funding for new companies and early stage expansion capital. The Act will enable New Zealand businesses to compete internationally on a level playing field for venture capital funds.

Features of New Zealand Limited Partnerships include separate legal personality, an indefinite lifespan if desired, a list of activities that the limited partners can be involved in while not participating in the management of the Limited Partnership (safe harbour activities).

An Overseas Limited Partnership is a partnership that has been formed in a country other than New Zealand but because it is engaged in business activities in New Zealand it must register as an Overseas Limited Partnership.

Limited partners will not be taxed at the partnership level. Instead each will be taxed individually at their personal marginal rate in proportion to their share of the partnership's income. Limited partners’ tax losses will be restricted to their economic losses in that year. There is provision for limited partners to have a say in how the partnership is run, without being treated as participating in the management of the partnership and thus losing their limited liability status.

Government Support For Venture Capital

There are a number of targeted Governmental grant programmes which are often applicable to venture capital investee companies, and are described below.

The budget in 2001 included a number of measures aimed at supporting the venture capital sector, including the development of an innovation strategy, a move to 100% deductibility for R & D expenditure, the establishment of a $100 million seed capital 'Venture Investment Fund' and funding to help develop strong sectors and incubators. It also provided more funding for regional development, enterprise awards, established businesses, skills development, the New Zealand Industrial Supplies Office, R&D and for attracting overseas investment. A number of these initiatives are being delivered by Industry New Zealand.

By the end of 2005, the VIF had invested about 75% of its $100m.

In 2005, the VIF introduced the 'Seed Co-investment Fund', a Government investment programme aimed at providing seed funding for early stage businesses with strong potential for high growth.

The key features of the Seed Co-investment Programme are:

• the Fund invests alongside selected private investor groups ("approved investors")
  the Seed Co-investment Fund acts as a passive direct co-investor;
• seed-stage and start-up investments are eligible for the Seed Co-investment Fund;
• investments by the Fund are limited to a maximum investment of $250,000 in any one company or group of companies;
• 50/50 matching private investment is required for the Fund to invest.
• the Fund will operate for a period of 12 years in total, with an expected investment period of 5-6 years;
• a total of $40 million is available for investment by the Fund over a 5-6 year period.

In March, 2006, a tax bill with implications for the venture capital sector sailed through the New Zealand parliament. Revenue Minister Peter Dunne claimed that it would give businesses NZ$1.1 billion (US$672 million) in tax cuts over the next four years.

According to Mr Dunne, the Taxation (Depreciation, Payment Dates Alignment, FBT and Miscellaneous Provisions) Bill would give businesses "the most comprehensive business tax cuts for nearly two decades".

The Revenue Minister explained that: “the tax depreciation rules have been changed to encourage more productive use of capital by reducing biases in the rules that distort investment decisions. Most of the changes to the depreciation rules will apply from the 2005-06 income year."

“To reduce biases, depreciation rates for buildings have been lowered and the rates for short-life plant and equipment have been raised."

“The cost threshold that determines which assets must be accounted for on fixed asset registers has been raised from $200 to $500, which will reduce both the number of assets that must be accounted for and the number of tax adjustments required when a business disposes of an asset. The new threshold is effective from 19 May 2005, the date of the bill’s introduction."

“From the 2005-06 year, companies that bring in new equity investors will have better access to tax deductions for research and development expenditure, a change that will suit technology companies in particular."

“In a similar vein, non-resident investors will be exempt from tax on gains on the sale of shares in companies they have invested in alongside the New Zealand Venture Investment Fund. The change will apply from the date of enactment."

Corporate Venturing In NZ

Over the last few years there has been an increase in the number of New Zealand corporates prepared to put capital, time and energy in higher risk ventures. They find ideas/concepts/products that are generated internally (by staff, suppliers), or externally from customers, competitors or anything that may fit in their investment criteria.

Corporate venture capital goes a step beyond traditional venture capital. It is distinctive because it brings not only capital but also the technical expertise and support of the sector's larger players. The benefits to investee companies include procurement leverage, technical assistance, international networks and credibility - which can be particularly valuable in the early stages of a business's commercial development. It can add value to a company, by empowering and stimulating employees, not to forget the huge profit potential that could be realised by corporates'.

Venture capitalists prime motivation is to make money, whereas corporate venture capitalists aren't solely focused on equity returns. Corporate venture capitalists have a strong strategic element to their investing - ensuring the new businesses they invest in have a good fit with their own business or reduce competitor activity.

Corporate venturing firms may create a fund and manage it internally, or they may outsource selection and management to a professional venture capital firm. Usually they will aim to take a non-majority stake in companies that look as if they might be future winners.

It was announced in September, 2007, that venture capital company, Endeavour Capital is committing $10 million for investment in the commercialisation of intellectual property developed at New Zealand's University of Canterbury, through an arrangement with the University’s commercial arm, Canterprise.

Under the arrangement, Endeavour Capital will set aside $10 million to what will be known as the University of Canterbury Dedicated Fund (UCDF). It represents the largest investment of its type in New Zealand, and will give Endeavour first rights to take intellectual property developed at the University to the marketplace.

Endeavour Capital and Canterprise have jointly invested in new ventures previously. Last year, Endeavour i-Cap and Ngai Tahu Equities entered into an agreement with Canterprise to take hand-held technology capable of detecting anthrax spores and other bacterial spores within minutes to the international marketplace.

Canterprise CEO Dr John Chang says that and another investment planned for later this year will raise Endeavour’s venture capital investment in UC projects in 2006 and 2007 to nearly $4 million.

UC Vice Chancellor, Professor Roy Sharp has welcomed the creation of the University of Canterbury Dedicated Fund, explaining that the task of transforming an idea into a commercial product can be fraught with difficulty, particularly in relation to funding.

“This arrangement will see Endeavour bridging that funding gap with projects that meet its investment criteria. We are very grateful for this huge vote of confidence in the intellectual property developed here and the work done by Canterprise."

The New Capital Market

The NCM was a New Zealand-based market for investment in new growth companies launched in 2000. The NCM attempted to make it easier and less costly for enterprising people with business experience and ideas to raise capital, and for growth-oriented investors to participate in new businesses. It also provided a suitable exit route for venture capital investors in small companies which which are not able to use the main exchange. The NCM was intended to replace "back door" listings and medium sized IPOs (Initial Public Offerings) as mechanism for listing on NZSE.

Rules for NCM companies varied from that of Main Board listings. For example, for a company to be listed on the New Capital Market they had to have a minimum of 300 shareholders who were members of the public and ordinarily resident in New Zealand, and initially no shareholder could hold more than 2% of the total shares on issue. NCM companies had to raise between $400,000 and $600,000 through an Initial Public Offering. Directors could put in more money but the total proceeds from shares issued under couldn't be more than $1,000,000.

The NCM was replaced in 2003 by the NZAX and the few remaining NCM listings were transferred to the NZAX. Said the stock exchange at the time:

'The NZAX Market has been developed with the following concepts in mind:

• NZX will ensure the market is sustainable and successful by attracting companies with strong principles of governance. NZX will work to place the onus on NZX Sponsors and participating brokers to list quality companies. Transparency – not artificial constraints – will ensure only quality companies are listed on the NZAX Market. Investors will have an increased level of information available on NZAX Issuers (via NZX’s website) and should feel confident of this market’s success.
• The NZAX Market has specific listing rules designed to minimise up-front compliance costs for new Issuers, and reduce ongoing costs through a less prescriptive regulatory regime. In addition, fees payable to NZX have been reduced to price the market competitively. NZX is confident that with this combined infrastructure, the cost of raising capital and remaining compliant on NZAX will be significantly reduced.
• NZX has launched a unique NZX Sponsor role, only available for companies seeking a listing on the NZAX Market. Designed to assist medium sized businesses access cost-effective information and support needed to become compliant, NZX will accredit Sponsors; experienced professionals capable of assisting companies through the NZAX listing and offering process. An NZX Sponsor could be a broker, banker, lawyer or investment banker, with relevant corporate finance or public offering expertise. Through the development of this accreditation status, NZX hopes to achieve pricing pressure in the market, delivering cost benefits to all NZAX Issuers.
• With a unique trading microstructure (reduced hours, increased tick-size, anonymous call-auction) the NZAX Market is designed to draw liquidity to newly-listed NZAX securities. With increased quantity and quality of information available on NZAX listed securities, hosted by the NZAX website, investors and advisors will benefit from increased knowledge, enhancing confidence and liquidity in NZAX securities. NZX will also be committing significant in-house resources to assist companies to remain compliant, eg guidance notes.'