there is generally adequate investment capital and the venture capital market is functioning well, but there are difficulties for innovative projects/firms in raising capital at the early stage of development
there are too few financiers and deal making experts focused on start-ups and early stage innovations due to the relatively high risks and costs of assessment, investment and monitoring involved
small firms and innovators often overestimate value and underestimate risk, do not know how to present proposals, are unwilling to share control or provide information on their ideas in return for capital, and do not have a good understanding of when or how they should seek or access capital
a number of business incubator projects are emerging in New Zealand
the Government should focus on building on existing expertise in providing any incubation support.

3. As a result, in November 1999, Cabinet agreed (CAB (99) M 27/8 refers) to implement Invest New Zealand national incubator initiatives comprising:

training services for small and medium enterprises (SMEs) and innovators focused on investment readiness upskilling
brokering and deal-making services for innovative start-ups to provide assistance to get them to the stage where others will invest.

4. Cabinet also agreed that the components would be delivered via a service contract approach, whereby interested existing organisations would tender for partial funding to both design and deliver the assistance, within defined parameters, throughout New Zealand (CAB (99) M 27/8 refers).

5. It is recommended that officials proceed with implementing the Invest New Zealand incubator initiatives as planned, but include an additional component which will provide support for institutional incubators on a contestable basis.

6. The incubator initiatives will be managed by Industry New Zealand but in the interim will be implemented by the Ministry of Commerce. This work will need to be coordinated with the work to develop the broader Economic Development and Industry and Regional Development policies. However, the initiatives are a useful catalyst for the new approach to industry development, being based on integrated assistance, economic and regional development, and partnerships between Government, education and research sectors, and the private sector.

7. The paper notes that $1.125 million in 1999/2000 and $2.250 million in 2000/2001 and outyears (all GST inclusive) has been allocated for the incubator initiatives in Vote: Commerce, Departmental Output Class D1 - Policy Advice: Business and Competition. The paper recommends that $0.113 million for implementation in 1999/2000 and $2.250 million for administration and delivery in 2000/2001 and outyears (all GST inclusive) of this funding be transferred to Vote: Business Development (in the interim), as the Invest New Zealand incubator initiatives better align with the objectives of the Industry and Regional Development portfolio than Vote: Commerce.

Background

8. In July 1999, Cabinet agreed in principle to a new proposal for "incubator initiatives" aimed at providing capable individuals and small businesses with skill-based assistance to develop their ideas to the point where others could invest in them. Cabinet directed officials from the Ministry of Commerce, the Treasury, the Ministry of Research, Science and Technology and Te Puni Kokiri, in consultation with interested parties, to undertake a review to determine the design and delivery of the incubator initiatives (CAB (99) M 19/2B refers).

9. Consultation was undertaken with experts representing 22 organisations in the field of venture capital and business incubation. This included venture capital providers, university-based incubators, Chambers of Commerce, and enterprise development agencies. The aim of the consultation was to determine:

the specific gaps and the underlying problems in the area of investment in start-ups and innovations and why they exist
whether any government initiative was required in this area and what form it should take
feedback on possible models for assistance and how a programme could work in practice.

10. The main concept emerging from the consultation was that any initiatives should build on the incubator initiatives already underway in New Zealand and focus on providing upskilling and facilitation services. In particular, the objective of any government support in this area should be to accelerate the development of private sector activity and not crowd out or discourage its development.

11. Officials recommended and Ministers agreed in November 1999 (CAB (99) M 27/8 refers) that the incubator initiatives include:

training services for SMEs and innovators focused on investment readiness upskilling
brokering and deal-making services for innovative start-ups to provide assistance to get them to the stage where others will invest.

12. Ministers agreed that these components would be delivered by involving interested organisations tendering from partial funding to both design and deliver the assistance, within defined parameters, throughout New Zealand.

Reasoning behind the Incubator Initiatives

13. From a review of existing incubation and investment facilitation initiatives and information gathered from the consultation in 1999, the following were identified as major barriers restraining the development of innovative ideas into commercial propositions.

Supply of Capital

14. Consultation indicated that there is generally adequate investment capital and the venture capital market is functioning well. However, the venture capital market in New Zealand is relatively immature compared to some overseas markets.

15. A common theme raised in the consultation process is the relative difficulty of raising capital for innovative projects/firms at the early stage of development. This is sometimes called seed or start-up capital. While there are a small number of firms that provide (or broker) such funding, it is recognised that overall there is substantially less funding available than for later stage or expansion capital.

16. Examples of such early stage development include:

further developing existing research with a view to developing potential commercial applications
establishing a firm (rather than expanding it)
expanding a firm which is very small or has a limited track record.

17. The venture capital firms consulted all stressed that much of the reason for the relative lack of capital flow to start-up firms and inventors lies in the high relative risks, and the costs of assessment and monitoring of finance required - and it is important to recognise that these are real economic costs. In addition, some saw quite highly specialised skills (over and above those of normal venture capitalists) as being necessary to allow them to identify projects with merit and to manage the risks around their development.

18. This situation is not unique to New Zealand. Early stage funding is inherently riskier than later stage, essentially because the technology, markets, products and/or management have not been tested. As a result, early stage capital is harder to raise and is more costly. Most countries have a `thinner' seed capital market than an expansion or development capital market.

Skills of Innovators/SMEs

19. The venture capital community suggests that there is a lack of "investment-ready" SME and start-up investment opportunities in the market.

20. People that develop ideas do not necessarily have the skills or background to know how to progress them. Innovators tend to lack understanding of the implications of different forms of funding, do not know how to present proposals, and are unwilling or reluctant to share control or provide information on their ideas/companies in return for capital.

21. Similarly, it seems likely that in some cases managers avoid upskilling in investment readiness because they do not recognise the potential value to the firm of these skills.

22. The BIZ programme provides some generic management capability assistance in this area. However, individuals with innovative ideas seeking investment require a far more focused combination of investment readiness, facilitation, risk management and business planning expertise than the BIZ programme provides.

Supply of Incubation/Brokering Expertise

23. Facilitators and intermediaries are important - these deal-makers or brokers enhance the search process. They can identify and assess the investment proposals and provide legitimacy. Brokers understand the investment decision criteria used by investors and can assist their clients to adopt the practices necessary to be attractive to investors.

24. Although there is growing activity in "incubation" services in New Zealand, there appears to be a lack of well-connected deal-making experts in the seed investment area who know the problems faced in getting an idea developed, who can effectively link in with needed expertise, reputable business people, financiers etc and present the package. Accountants and other professionals may offer these services but specialist advisors are more difficult to find. The necessary skills are not easily acquired.

The Proposed Incubator Initiatives

25. Officials recommended and Ministers agreed in November 1999 (CAB (99) M 27/8 refers) that the incubator initiatives include:

Investment Readiness Services

26. A programme is needed that provides information and training about the requirements and implications of obtaining capital. There is existing private sector expertise that could deliver this and potential for the Government to contract training programmes via a contestable process.

27. Training and information could be provided on the following issues:

the circumstances in which equity should be considered
the different types of equity providers in the market place and their specific focus
who the intermediaries are and how to access these
equity investors' evaluation processes and decision-making criteria
how to present a proposal
what to expect in relation to equity partners and legal safeguards for the future, including management of intellectual property
risk and return aspects of equity investment and determination of value.

Ideas Brokers and Deal Making Services

28. The second proposed element of the incubator initiative would involve the Government contracting out services to "ideas brokers" that would act as a focal point for new ideas and "make deals". These brokers would provide hands-on, in-depth assessment of the potential of ideas, deal-making expertise and assistance and would co-ordinate and link in with other agencies/expertise (i.e. venture capitalists/angels, technical expertise, stock brokers, New Capital Market etc) as appropriate.

29. There appears to be private sector expertise in this area that could be used rather than creating any new service. There is at least one organisation involved in negotiating and packaging deals for innovative small and medium enterprises (SMEs), and feedback indicates that larger investment firms, which deal mainly with development and expansion deals, would also be interested in moving to this level if the transaction costs and risks of failure could be reduced. The Government should offer partial funding for the provision of early stage brokering services with such existing providers, thereby acting to share the transaction costs of providing these services.

30. Rather than be a first-round filter and assess hundreds of ideas, these contracted brokers (deliverers) would need to focus on good ideas provided through existing ideas filters such as universities, Crown Research Institutes (CRIs), Techlink Consultants, Economic Development Agencies, BIZ providers, business advisors etc.

31. Deliverers would be required to provide services in all of the main centres of New Zealand. If practicable, this will be achieved through having brokers in each of these centres. However, given the limited number of people in New Zealand that have the required skills and the need to provide services nationwide, it is also likely to be necessary to provide services through remote mechanisms such as toll-free phone numbers and regular visits.

32. Contracted providers would therefore need to demonstrate an intention and an ability to co-ordinate their activity and form close working relationships with the New Zealand Stock Exchange (NZSE), tertiary education and other research organisations, incubators, business development assistance providers and other experts across New Zealand.

33. I recommend that the incubator initiatives be implemented as planned, but also include an additional component:

Support for Institutional Incubators

34. A number of incubator projects have emerged over the last 12 months or are under development in New Zealand. Examples include ICAN (Innovation Canterbury - Canterbury Development Corporation), VictoriaLink's Innovation Greenhouse (Victoria University), UNITEC's Centre for Innovation and Entrepreneurship, Massey University's Albany campus incubator, and the Otago Centre for Innovation.

35. These are examples of institutional incubators, which aim to assist entrepreneurs with enterprise start-ups and development. Such institutional incubators typically seek to provide workspace, often on preferential and flexible terms, for a specific industry or type of firm. In addition to workspace, the services provided by incubators can include various forms of business planning and managerial advice, office facilities, finance and accounting expertise, access to business networks, and legal services.

36. Providing support, either in the set-up phase or on an ongoing basis, of these incubators or the training programmes within them would also be an effective way of encouraging both investment readiness upskilling and brokering and deal-making services for SMEs.

37. A proportion of the funding currently allocated for the incubator initiatives, say $0.563 million (GST inclusive), could be earmarked for providing support on a contestable basis, such as sponsorship, for institutional incubators. It is important, however, that Government not become involved in the property investment side of incubators. Investment in infrastructure is a static investment, while an investment in capability development can enable and catalyse communities to develop their own solutions. An approach that seeks to encourage partnerships between the private sector, universities and research institutions, and central government is optimal. This means that any support should be on the basis of a clear partnership with commitment from all participants.

Delivery

38. Both the investment readiness training and ideas brokering/deal making components would operate along similar lines to BIZ. This would involve an open contestable tender for existing specialists and organisations (deliverers) to design and deliver the investment readiness and ideas brokering/deal-making services. The deliverers would receive partial funding to both design and deliver assistance within defined broad parameters. This contract approach would provide the flexibility to tailor assistance that would allow deliverers to develop assistance specifically for identified needs.

39. The third component of the incubator initiatives would also involve an open and contestable tender for support, such as sponsorship, for existing or emerging institutional incubators.

40. The incubator initiatives will be managed by a small core unit within Industry New Zealand. It will need the expertise to work with the NZSE, CRIs, universities, researchers, venture capitalists etc.

41. The Ministry of Commerce will have responsibility in the interim for implementing the three components of the incubator initiatives. Criteria for selecting the organisations will be developed by the Ministry of Commerce, in consultation with the Treasury, the Ministry of Research, Science and Technology, and Te Puni Kokiri, and subject to joint agreement by the Minister of Industry and Regional Development and the Minister of Finance. The Ministry of Commerce will work closely with these departments on the implementation of the incubator initiatives.

42. Originally the incubator initiatives were to be in operation by April this year. However, they were put on-hold until new Ministers had a chance to decide whether the proposed scheme should proceed. The initiatives could now be operational within four months - by July 2000:

a contestable tender process would begin on 24 March with expressions of interest called for, for all three components
a request for proposal would be sent out to interested parties on 7 April
proposals would be received by 19 May
proposals would be evaluated and preferred providers chosen by 9 June
contracts would be finalised and implementation begin by 3 July.

43. A key to the success of the incubator initiatives will the degree to which they integrate and interact with existing government initiatives such as BIZ, Trade NZ and Tech NZ. This work will also need to be coordinated with the work to develop the broader Economic Development and Industry and Regional Development policies, and Maori Business Development initiatives. However, I consider it is a useful catalyst for the new approach to industry development, being based on integrated assistance, economic and regional development, and partnerships between Government, education and research sectors, and the private sector.

Fiscal Implications

44. $1.125 million in 1999/2000 and $2.250 million in 2000/2001 and outyears (all GST inclusive) has been allocated for the incubator initiatives in Vote: Commerce, Departmental Output Class D1 - Policy Advice: Business and Competition.

45. It is proposed that around $0.338 million (15% of the total funding) would be directed for funding the investment readiness upskilling services on a national basis, $1.125 million (50% of the total funding) would be directed for funding contracted broker/deal-making services, and $0.563 million (25% of the total funding) allocated to support institutional incubators in outyears (all GST inclusive). Based on costs associated with delivering BIZ, annual administration costs would be kept to around 10% of the overall funding.

46. Given that the incubator initiatives will not be implemented until the beginning of July, only $0.113 million will be required from the remainder of the appropriation in 1999/2000 to meet administration costs. This leaves $1.012 million of the 1999/2000 appropriation for other Industry and Regional Development policies in this financial year.

47. I seek your agreement to a new non-departmental appropriation in Vote: Business Development and associated transfers of funding to this appropriation item in 1999/2000 and the outyears in accordance with the proposal in this paper to progress the Invest New Zealand incubator initiatives.

48. The costs of these initiatives can be met from the current funding in Vote: Commerce, Departmental Output Class D1 - Policy Advice: Business and Competition. The transfer to Vote: Business Development, in the interim until Votes are established for Industry and Regional Development, and Economic Development, better aligns with the objectives of the Industry and Regional Development portfolio than Vote: Commerce.

49. Initial funding for this initiative under Vote: Commerce was included in a departmental output class. While the changes for funding the direct costs of the initiative proposed do not meet Cabinet criteria for changes to baselines (Cabinet Office circular CO (98) 17 refers), based on the strategy proposed I consider that in accordance with appropriation type definitions, expenses for support and delivery of the initiative should be met from a non-departmental appropriation.

50. The changes in appropriation type proposed are technical in nature and the fiscal changes proposed in this paper will have no impact on the Crown's operating balance, as the changes sought at this time are fiscally neutral.

Consultation

51. The following government departments were consulted during the preparation of this paper: Ministry of Commerce, Treasury, Ministry of Research, Science and Technology, Department of Prime Minister and Cabinet, and Te Puni Kokiri.

Treasury Comment

52. Treasury considers the proposed Invest New Zealand incubator initiatives could contribute positively to industry development and supports the proposed changes in appropriations.

Recommendations

53. It is recommended that the Committee

note that consultation undertaken in 1999 with a range of organisations in the field of venture capital and business incubation provided the following key themes:

there is generally adequate investment capital and the venture capital market is functioning well, but there are difficulties for innovative projects/firms in raising capital at the early stage of development
there are too few financiers and deal making experts focused on start-ups and early stage innovations due to the relatively high risks and costs of assessment, investment and monitoring involved
small firms and innovators often do not have a good understanding of when or how they should seek or access capital
a number of incubator projects are already underway in New Zealand
there is agreement that the Government should focus on building on existing expertise in providing any incubation support

agree that the Invest New Zealand incubator initiatives include:

training services for SMEs and innovators focused on investment readiness upskilling
brokering and deal-making services for innovative start-ups to provide assistance to get them to the stage where others will invest
support for institutional incubators

agree that the components referred to in recommendation (b) above be delivered via a service contract approach, whereby interested existing organisations would tender for partial funding, within defined parameters
note that these components will be managed by Industry New Zealand, but in the interim will be implemented by the Ministry of Commerce
agree that the criteria for selecting the organisations be developed by the Ministry of Commerce, in consultation with the Treasury, Ministry of Research, Science and Technology and Te Puni Kokiri, and subject to joint agreement by the Minister of Industry and Regional Development and the Minister of Finance
note that an increase in appropriations of $1.125 million (GST inclusive) in 1999/2000 and $2.250 million (GST inclusive) in 2000/2001 and the outyears has been funded in Vote: Commerce departmental output class D1 Policy Advice - Business and Competition for the incubator initiatives and was approved by Cabinet in November 1999 (CAB (99) M 27/8 refers)
agree that the funding referred to in recommendation (f) above better aligns with the objectives of the Industry and Regional Development portfolio and, until Votes are established, in the interim these initiatives be funded from Vote: Business Development rather than Vote: Commerce
approve a reduction in appropriation of $0.113 million (GST inclusive) in 1999/2000 and $2.250 million (GST inclusive) in 2000/2001 and the outyears in Vote: Commerce departmental output class D1 Policy Advice - Business and Competition, and a corresponding reduction in revenue Crown of $0.100 million (GST exclusive) in 1999/2000 and $2.000 million (GST exclusive) in 2000/2001 and the outyears to meet the costs of the incubator initiative under the Industry and Regional Development portfolio
approve the establishment of "Invest New Zealand Incubator Initiatives" as a new non-departmental output class for 1999/2000 and the outyears in Vote: Business Development
approve an increase in appropriation in Vote: Business Development, non-departmental output class - Invest New Zealand Incubator Initiatives of $2.025 million (GST inclusive) in 2000/2001 and the outyears, for existing specialists and organisations to design and deliver the investment readiness and ideas brokering/deal-making services related to the incubator initiative, and to provide sponsorship/support for institutional incubators
approve an increase of $0.113 million in 1999/2000 and $0.225 million in 2000/2001 and the outyears (all GST inclusive) in Vote: Business Development Departmental Output Class D1 - Policy Advice: Business Development and a corresponding increase in revenue Crown of $0.100 million in 1999/2000 and $0.200 million in 2000/2001 and the outyears (all GST exclusive) for administering the incubator initiative
note that the changes in appropriation referred to in recommendation (j) and (k) leave $1.012 million (GST inclusive) of the 1999/2000 appropriation in Vote: Commerce departmental output class D1 Policy Advice - Business and Competition for other Industry and Regional Development initiatives
agree that the changes in appropriation referred to in recommendation (j) and (k) above for 1999/2000 be included in the 1999/2000 Supplementary Estimates and, in the interim, be met from Imprest Supply
note that the proposed changes in appropriation have no impact on the Government's operating provisions.

Jim Anderton
Minister for Industry and Regional Development

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Printed: 24/11/2009

Invest New Zealand Incubator Initiatives

Contents

Proposal

Executive Summary