Photo by Ben Mater on Unsplash
(Up)Start
In May 2022 the government appointed a startup council of industry leaders led by Phil McCaw and Suse Reynolds. They were asked for recommendations “to create a coordinated and whole of government approach to maximising the success for New Zealand startups”.
They were on a hiding to nothing.
Their final report was published this week. It’s titled UpStart Nation.
A few people have suggested I write a response. But, honestly, I worry I’m too jaded. I’ve read it and have tried to find more generous words to describe it, but the best I can come up with is: a hot mess.
The headline proposal, as the name suggests, is a new “challenger brand” for the startup ecosystem:
It’s time for us to own our destiny; to learn from the experience of other leading ecosystems but to embrace what is unique about us - our strengths, our culture and the opportunity for our nation.
And:
It defines our unique position in the world and our willingness to challenge boundaries, to lead globally and do things differently.
Not that different though. The same name was proposed in the 2018 book No. 8 Recharged written by David Downs and Michelle Dickinson (see the summary in a series of articles published on Idealog).
They are not credited in the report, so maybe just a coincidence? Please tell me somebody other than me Googled that term before it was used as the title of this report.
Either way, this very awkward re-branding made it a slow report to read. Every time UpStart was mentioned in place of “startup” I wanted to UpThrow a little.
In addition to the report itself, all of the minutes from their meetings have been published online. Some of the details are redacted. But those in the group might wish more had been.1
They show that the members consulted widely with all of the same old turkeys in the ecosystem, who were unsurprisingly unanimous that Christmas should be permanently banned.
Let’s consider some of their specific recommendations at the end of that process. The full report includes 25 in total, but we can summarise most of them under four headings:
Tax Cuts
Derivatives
Investment Funds
Imports
Tax Cuts
The #1 recommendation in the report is removing tax on unrealised gains from employee share schemes.
No doubt, this is a real issue. I’ve probably spent as much time as anybody trying to unpick this over the years on behalf of investors and employees. But I fear the proposed solution in this report completely misses the wood for the trees.
The current tax system we have in New Zealand means the tax paid by employees and investors in any successful business sale is calculated very differently. This is because investors pay cash to buy their shares in advance, so any gains on that investment are capital gains which are not currently taxed. Meanwhile employees earn their shares by working, which means they are a form of income, and that income is taxed (either immediately or eventually).
The report focuses on the straw man scenario where tax needs to be paid by employees immediately when shares are issued. This is true in theory, but in my experience very rare. Much more commonly these days, employees in high-growth startups are issued long-dated options rather than shares. This means the tax is deferred until an exit occurs. But tax is then due on the full value of those shares at exit, which can be very large amounts.
For example, that’s exactly what happened when Vend was acquired in 2021. I know a number of those employees who received life changing amounts suffered from some initial sticker shock at the amount of tax they had to pay as a result.
It’s difficult to argue that is fair - investors pay 0% capital gains tax on their gains while employees pay 39% income tax on their gains.2
Of course, there are two ways to close that percentage gap - by reducing the income tax rate that employees pay (as the report suggests) or by increasing the capital gains rate that investors pay (curiously, this isn’t mentioned at all). The smartest solution would be a mixture of those two things.
I’ve written about this previously.
See: Compensate
Even more boldly than a tax cut for startup employees, the report also suggests introducing tax incentives for early-stage investors.
This is a piss take, right? I fear it may have been a serious suggestion.
To quote myself:
We already have one of the most generous environments for early-stage investors in the world, including a 0% capital gains tax. We should push back on anybody who says they need even more incentive to invest.
For example, imagine a generous system where we incentivise startup investors by waiving all tax on capital gains. Unlike subsidies currently paid in advance, this would mean that taxpayers don't take on any of the up-front risk. Plus the benefits flow mostly to the investors who generate the outcomes we say we want by successfully turning startups into high-growth companies.
This would be trivial to implement. The capital gains tax on startup investments in New Zealand is already 0%. We just need to turn off the subsidies!
Source: Rocket Fuel
The report references similar incentive schemes in Australia and the UK, which do allow angel investors to deduct investments in some cases. But they overlook the capital gains tax treatments that apply in both of those countries. Elsewhere in the report they talk about the distortions caused by different tax treatments for US investors who have migrated to NZ. But they don’t seem to have considered the equivalent distortions that their own proposal would introduce.
I’m tired of proposed tax changes that can be broadly summarised as “we’d like to pay less, kthxbai”. Especially when the “we” are already wealthy people. Anybody suggesting tax cuts for their own sector should list the sectors they think should pay more tax to compensate.
Politicians like to talk about how startups are the key to lifting our collective prosperity. But the key to that is the tax we collect on the outputs from successful startups, to be reinvested in the things we say we want like better hospitals and skilled people to work in them, schools to educate the next generation of startup founders and (more importantly) qualified people to work with them. And roads without potholes, of course.
These tax cut ideas should never have made it to print. Let alone at the top of the list.
We should stop asking what the government can do for startups and start describing what startups can do for the government (i.e. all of us). We should be demonstrating how startups will contribute more tax over time not less. Then maybe we could justify the up front investment required.
Derivatives
Support for startups in New Zealand is seldom centred on individual founders and their teams.
It's much more likely to be what I have for many years called derivatives:
Innovation hubs and clusters; shared working spaces all around the country; accelerator programs of different flavours; networks of angel investors pooling their resources and investing in a portfolio of ventures; public and private organisations that provide advisory services to startups and mentor founders; countless competitions or networking events hoping to flush out promising new business ideas; numerous business awards celebrating entrepreneurship, growth or innovation; various initiatives to commercialise research done at universities; and, last but not least, millions of dollars of local and central government funding including direct grants to companies, subsidised professional services and advice, tax credits and co-investment.
We fund all of these things, and then just hope that they help actual startups. It's like pouring gasoline onto the roof of a car and hoping some of it ends up in the tank.3
Many people have put significant time, effort and money into creating all these things. A large and growing industry has sprouted, all ultimately trying to increase the number of startups. Startups, and especially early-stage startups, are suffocated with support. And still we continue to invest in more.
This report doubles down on these initiatives in a big way.
They say the existing derivatives are not working as well as they should be. I agree. However, their proposed solution is an additional derivative - a super-agency they call “Accelerate Aotearoa” which will sit above Callaghan Innovation and New Zealand Trade & Enterprise (NZTE) and Ministry of Business, Innovation and Employment (MBIE) and NZ Growth Capital Partners (the new name for the old Venture Investment Fund) and all of the other national and regional organisations we already have and try to help by working to … checks notes … “reduce fragmentation and co-ordinate the implementation of this strategy”, “implement a coordinated programme of founder meetups and quality mentor connections”, and “establish a regular programme of storytelling to raise the profile of the sector and promote the opportunity it represents”. (🤦)
I have no more words on this.
It’s a royally dumb idea, and if that isn’t immediately obvious to you then you can read some of the 30,000 words I’ve already written that explain why.
Start here: Callaghan, Revisited
Then here: Building an Ecosystem
Then here: Derivatives
Then here: Startup Theatre
Investment Funds
Perhaps the most enduring misconception related to startups in New Zealand is this:
It's difficult for startups to raise investment in New Zealand, because there is a shortage of venture capital.
It's remarkable how widely this is believed. It has been repeated so many times by so many people for so long now that it has become an accepted fact, even when all the recent evidence points in the exact opposite direction.
The "difficult" part is true. But the "because there’s a shortage" part is easily disproved.
All around the world there is a massive and growing amount of venture capital looking for a return. The venture capital market is global. The best funds invest everywhere. It's literally their job to find the best ventures, wherever they are, and invest in them.
Most, if not all, of our local startup success stories have been funded in part by international investors. That capital from overseas usually comes bundled with expertise and networks that are invaluable. This is a measure of the maturity of our ecosystem and should be celebrated rather than discouraged.
Over the years, I've often challenged anybody claiming that there is a shortage of capital in New Zealand to list the most impressive local companies they know who have tried but failed to raise capital. Inevitably the examples they give, if any, are not actually that impressive.
We need to stop wishing it were easier and start working to be better.
Perhaps that explains why, despite years and years of subsidies and co-investment and underwriting, most of our local venture funds have struggled to generate notable returns for their investors.
Again, depressingly, I’ve written extensively about this previously.
Start here: Rocket Fuel
Then here: Trading Up
The specific proposal in the report is to double down (again) on the government venture investment fund, with another $500 million.
It’s embarrassing we still think capital is our constraint and it’s embarrassing that we don’t have any better suggestion than: let’s try again and hope the results are different next time.
By the way, it’s often said that doing the same thing and expecting different results is the definition of insanity. It’s not - it is perseveration (i.e. compulsively and persistently repeating a sentence or action). Not to be confused with perseverance (i.e. continuing to pursue goals in spite of road blocks or others assuming it’s impossible etc).
Politicians from all sides have over the years loved the investment funds they have set up. They get to put out excited press releases whenever new money is committed to them, without ever having to ask if those investments produced any reasonable return.
And again this week. Economic Development Minister Barbara Edmonds said in response to the release of this latest report:
Establishing the council was just one way we are supporting startups. We have invested $300m into the Elevate NZ Venture Fund, including $40.5m in Budget 2023. As a result, we’ve seen a significant increase in capital and transactions in the market since the Fund launched in 2020.
I don’t dispute the increase. I strongly dispute the “as a result”.
The question, Minister, is what is the return on that investment? The important thing isn’t how much you spent, it’s what you bought with that money. You might be surprised to learn that by far and away the biggest winner to date from these funds has been Valar Ventures, backed by Peter Thiel - literally a billionaire. I’m sure he appreciated our contribution.
Our constraint isn’t (and wasn’t ever) a lack of capital to invest. The thing we’re lacking is great companies for that capital to be invested in.
Successful local venture capital funds are a consequence of a successful startup ecosystem.
Imports
Whenever I read that New Zealand needs to incentivise successful entrepreneurs from overseas to relocate, I like to imagine we are the owners of a second-division French Rugby club, who continue to believe that the key to success is signing another soon-to-retire All Black or Springbok.
We've fallen deep into the trap of promoting ourselves as a comfortable place to retire for people who are at the end of a successful career, rather than a place that attracts people who are still hungry to build new businesses. Somebody who has been successful overseas needs to invest just NZ$15 million to effectively buy a visa. There is no requirement that these investments go specifically into growth businesses. If they do choose to invest in growth businesses then we discount the amount required to only $5m. That price is at least an order of magnitude too small, in my opinion. But rather than suggest we put the price up, the report claims that the problem is these new arrivals are paying too much tax.
Another tried and tested idea that is revived by the report is the Global Impact Visa scheme, previously outsourced by the government to a private organisation called Edmund Hilary Foundation (EHF).
Unfortunately the results from that previous test were mostly negative, but once again … maybe next time is different?
On top of that the report suggests two new types of visas be added to this scheme:
Startup Visas (missing an obvious opportunity to leverage the new brand and call them UpStart Visas). These would target people who want to start a business based here, with the extra incentive of an accelerated path to citizenship and the ability to purchase property. Those who qualify would apparently be selected by “ecosystem actors”. Did we learn anything from previous failed attempts that used these same incentives and selectors?
Global Talent Visas. These would target people who want to live here but continue to work remotely for international employers. The quid-pro-quo is we would insist they attend at least two ecosystem events per year. Honestly! Are these events so awful that we need to mandate attendance. I wonder if we will eventually consider ankle bracelets to enforce this policy?
It’s true that talented people are the biggest constraint we have to achieving the goals that this report starts with, so I do applaud the attempt. But the solutions to those issues are complex and varied. We should start with an honest assessment of what hasn’t worked with previous iterations so we can avoid repeating those same mistakes. And we should ask why we continue to be so excited about importing solutions from overseas rather than investing in the people we already have here.
Again I’ve written about this previously: People, People, People
Dissent
You might reasonably ask, as I link to all of these things I’ve previously published on these topics, why I didn’t share them in advance with the panel of experts.
The awkward (for me) reality is: I did. That means either they didn’t bother to read them, which would be disappointing. Or, worse, they did read them, but chose to ignore or disagree with nearly every conclusion, which would be remarkable.
And so, once again, I’m a hater.4
This is nothing new. Way back in 2014 future Arch Angel Dave Moskovitz5 posted this on the NZ Tech Startup Eco-system Facebook group, after I criticised the unearned posturing I saw on social media from some of the founders in the Lightning Lab accelerator program, ahead of their demo day that year:
It's easy for Rowan Simpson to take pot-shots from the sidelines. He has no idea how many people slogged their guts out, both out front and behind the scenes, how many people have backed this effort over a number of years, just to help everyone lift their game and improve the general environment for startups in Wellington and NZ. I'll pay more attention to what he says when I see more evidence of unselfish behaviour on his part.
That was nearly 10 years ago.
Meanwhile, I’ve continued put all of my selfish energy into working with a small and carefully selected group of founders and helping them to grow their businesses.
The results are in. I know this works.
We could talk about financial returns, and those are an easy way to keep score, but much more interesting to me are the hundreds of people who have worked in these companies we started who now have their own capital and (more importantly) relevant skills and experience to contribute to the next wave of companies. That’s how an ecosystem grows, not from the top down, but from the bottom up. And that’s exactly what’s happening. That’s what makes me optimistic for the future.
The report proudly lists some great companies that have been started in New Zealand as an example of what’s possible: Trade Me, Xero, Rocket Lab, Allbirds, PushPay, Seequent, Vend, etc. It’s a long list. But how many of them have emerged from government funded incubator or accelerator programs? None. How many of them got investment in the beginning from government subsidised venture funded? None. Surely that should give us pause before suggesting we double down again on all of these programs?
To be clear, there is a massive gap between "we shouldn't do anything - let the market decide" and "those who claim to help should be able to demonstrate that what they are doing actually does help" (which is the drum I've been banging this whole time). This is especially true where those people who claim to help expect to be paid/subsidised/underwritten by the government (i.e. all of us). The really depressing thing is how few of the things we continue to invest in and promote as solutions pass that simple test.
It’s exhausting being a dissenting voice. Mercifully, the authors of the report have a solution to that too, buried deep in the report. If they have their way we will all be encouraged to pledge our allegiance to the ecosystem and all of the derivatives that operate in it. I can’t wait.
What a nonsense. If we’re going to orient our ecosystem around a “North Star” can I humbly suggest that we instead choose something that is actually visible from the Southern Hemisphere?
So, that’s my review of this report, for those who have asked. I feel like I’ve been pretty consistent in this advice for a long time now: try to ignore the noise that is generated by the “ecosystem”; focus on one company and try to make it as great as you can - that’s by far the best contribution you can individually make to growing an ecosystem; if you’re working on the ecosystem rather than in it then ask yourself how you can get closer to the source - we don’t need any more derivatives, we need more high-growth startups.
This approach has been so successful for me personally that I spend a growing proportion of my day working on how to sensibly invest and give away the piles of cash that are the exhaust of these high-growth companies when they go well. Meanwhile I either pay too much tax on a dollar basis or not enough tax on a percentage basis (depending on which flavour of politician you support). Both of those topics are much more interesting to me now than continuing to debate the ecosystem.
I hope to write more about both of them here in the coming months… stand by.
This is perhaps the worst example amongst many notable contenders:
It was noted that the lack of a capital gains tax in New Zealand is an incentive for founders to stay here, otherwise many would leave for Australia. However, a [capital gains tax] with carve-outs could also help shift capital allocation away from property.
There are many good reasons to consider moving to Australia, but leaving because you don’t want to pay a capital gains tax would be one of the worst to choose.
And a capital gains tax that “carves out” property isn’t going to move investment away from property. It would be more likely to do the opposite.
It’s hard to be wrong that much in a single sentence.
Strictly speaking only most of their gains - but effectively all, given that employees are likely already earning more than the top tax rate threshold.
Credit to Nat Torkington for this perfect metaphor.
Haters get all the headlines but in the process we’re completely overlooking the players, heart breakers and fakers.
In New Zealand there are multiple ranks within the angel investor fandom. Dave Moskovitz was named Arch Angel 2018 by the New Zealand Angel Association. I check most days but still have no wings or halo, so I’m obviously still doing something wrong.
It seems like the general trend over the last decade has been seemingly more and more people who are in the start-up "ecosystem" however are not actually starting or running businesses. It almost feels like there are more people on that side than founders now, and most of the "ecosystem" people have never actually founded, run or exited their own business. I live in Queenstown now, and there is currently a VC event happening here this week with over 100 attendees from various Australasian VC funds...and they invited 9 companies to pitch, a 10:1 ratio of ecosystem:founders!
I agree that none of these initiatives are likely to make a significant difference in the successful outcome of a start-up. If founders, investors and team members are worrying about tax obligations based on a successful exit in early or growth stage, their headspace is in completely the wrong place. There are far too many other priorities, like actually growing revenue whilst focused on margin, and establishing a team and culture that people want to be a part of for reasons other than just their rem package.
As a nation, we should be ashamed of how difficult we make it for amazing people from other countries to come to live and work here (unless you are super-rich). It needs to be sorted, but is not specific to this industry. Remote teams mitigate the visa issues anyway.
This report seems like the classic case of a solution desperately looking for problems to solve.
I get why everyone wants to be in the "ecosystem" without actually being a founder, starting and running business is hard. I describe it as playing "Whack-a-Mole" whilst sprinting on a treadmill. I am just going to keep running whilst I whack those moles, and as you said, focus on the people. Not everyone should be a founder, but if you want to be in the ecosystem, then approach this through the lens of asking how you can help, rather than deciding what problems need to be solved. There are people (like our investors) who do an amazing job in this area and should be a source of inspiration for the right approach.
A superbly constructed and well-elucidated piece - thank you for your insights Rowan. I find myself in full agreement with you. I enjoyed your ecosystem piece, too... and loved this - "The best way to grow an ecosystem is to create one great company."
I work in a biotech startup, and I'm tasked with raising funds, amongst other things. As I'm sure you're aware, Callaghan's latest push (via Arohia Grants) is to back innovation that provides benefits to the 'ecosystem', so I've been busy sketching out the ways our potential success will do just that. It's been interesting to tease out the details here, and discover benefits across almost all areas of our business model. (This is all well and good, but of course, the bulk of our costs are R&D related, which this grant doesn't cover.)
We seem to have an obsession across government funding agencies with targeting very specific outcomes for grants. It's "impact" here, "ecosystem benefits" there, "Treaty obligations" here, and something else - "world-leading research" perhaps, over here. The worst thing for me is that, despite ticking most of these boxes and demonstrating enormous potential for health, social, economic, and even ecosystem benefits - somehow we seem to slip through the cracks on all of them. Fortunately, there are some overseas agencies can see the value in what we have developed.
I hope the Upstart Nation report ends up in the bin where it belongs.