Investors say New Zealand has ‘all the right ingredients' to be a startup nation

This is part of a survey of investors focused on Australia and New Zealand. The following responses are from the New Zealand investors. You can find the Australian responses here and the full writeup here.

We spoke with:

Angus Blair, partner, Outset Ventures
Jo Wickham, partner, Icehouse Ventures
Vignesh Kumar, co-managing partner, GD1

The responses have been edited for length and clarity.

Angus Blair, partner, Outset Ventures

Inflation is slowing. Does the possibility of fewer interest rate hikes in the future change your venture capital investing and fundraising strategies in the coming quarters?

Domestic interest rates play a significant role in domestic appetite for fund investing since such a high portion of capital is tied up in the property market. Though there will be less or no rate hikes in the coming six months, we don’t expect significant rate cuts or for interest rates to materially affect our fundraising in this fund life cycle.

As a pre-seed and seed investor, interest rates have a limited effect on our investing. At the margins we err toward higher level of capitalization, seeking 24 months plus, rather than 18 months of runway given our perspective. We have seen limited impact on seed stage valuations and expect them to remain flat over the next 12 months.

Both the number and value of venture deals decreased in Q3. Are you expecting the same trend to continue in Q4 2023 and into 2024?

For pre-seed and seed deep tech deals, we expect the number of deals and valuations to remain flat into Q4 and 2024.

How does declining late-stage venture round velocity in Australia and New Zealand impact your investing strategy? For those who mainly invest in seed and Series A, does this make early stage more crowded?

For New Zealand, we are experiencing increased interest from off-shore funds (Australia, U.S. and EU) we predict will net out to flat or increasing velocity at Series B+ for New Zealand firms.

Competition for early-stage deals continues to increase, but this is largely from new fund entrants rather than multistage funds concentrating earlier.

Climate tech has been a huge driver of private investment in both Australia and New Zealand. Are any of these players poised to become global leaders? What kinds of incentives, laws, or policies would be helpful?

The obvious candidate for a global leader in climate tech is OpenStar. The Wellington-based nuclear fusion company that is building levitated dipole reactors with first spark scheduled for December this year is already attracting global attention (and talent) from the physics and magnetics communities.

I think the world learned not to rely on carbon economics to build sustainable ventures after the clean tech boom of the mid 2000s — VCs look for the businesses to be both sustainable and economic on their own merits. Having said that, ventures based in the U.S. or Europe often have significantly greater grant programs if they are working on critical technology of national significance. We make up for that with a lot of other benefits, including more clear slate regulatory frameworks, but to keep these companies here we’ll eventually have to match some of those financial incentives as well.

Blackbird opened a New Zealand fund, and many New Zealand investors look to Australia for new investments. What is the relationship between the two countries when it comes to funding each other? Does your firm prefer to fund locally?

All founders are excited to have more Australian firms investing locally and the same is true for most VCs. For now it’s largely one directional but that will change as relationships within the sector build.

There’s structural reasons why we don’t see more investing, though; all of the large VC funds in New Zealand have New Zealand Capital Growth partners (a NZ government backed fund) as an LP, which restricts where capital can be deployed, particularly for first investments. Similarly, the Australian ESVCLP structure (typically used by firms with $250 million or less under management) means that to retain their capital gains tax–free status, they are limited to how much investing they can do offshore. As and when this limit changes, we’ll see more Australian firms investing into NZ-based startups, which will be great for the market.

Funding in AI startups increased this year. What are the challenges that AI startups in Australia and New Zealand face, particularly as they tee up against giants abroad?

The same challenges that face VC-backed startups around the world and make AI such a challenging category for VC.

No advantage on data and distribution means a majority of value will accrue to incumbents.

Truly differentiated base models are too capital intensive for venture funding, without incumbent capture.

Less fragmented stack structurally means more value will be captured by incumbents (see: GPTs from OpenAI this week eating thousands of startups).

Investors are becoming more demanding in the current environment about deal terms to de-risk their investments. Have you found this to be the case? How do you walk the line of de-risking yourself without overdiluting a young company and stifling growth?

I think this is less prevalent at pre-seed and seed stage, particularly for deep tech, where valuations didn’t reach the levels of inflation seen in other stages, geographies and sectors. Just as before, early-stage VCs and incubators that seek to own too much too early will introduce too much capital formation risk, leading to wind downs or recaps. As the market gets more sophisticated, this is decreasing but I don’t see that, for this market, as being related to the overall investment climate.

There has been a decline in mega deals, venture deals worth over $100 million in Australia and New Zealand. Do you think we’ll see an increase in mature startup acquisitions? Shutdowns? A resurgence of substantial funding to sustain growth?

I think we’ll see more bridging style rounds and slowly make our way back to a similar capital market over the next couple of years.

Are you seeing value in seeing international investors on the cap table? How much time do you spend seeking foreign co-investors?

It’s super critical to have a deep network of co-investors when you’re funding companies in New Zealand since we simply don’t have the capital depth to go the distance for a majority of our companies. Furthermore, the markets are all overseas, so offshore capital is a critical part of building those in-market networks. On any given international trip, 30% to 50% of the time is spent engaging with co-investors so that I’m well positioned to support my portfolio, accessing the right offshore capital when the time calls for it.

What advice are you giving your portcos right now when it comes to raising money? Are you suggesting they sell convertible notes? Or perhaps raise as usual?

Fundraising is business as usual, just harder. The only way to get to fair market terms in any climate is to run a process — you can have an opinion about what you want and what sort of terms you think are best but ultimately you’ll only find that out by getting as many investors to the table as possible. It’s never a good idea to rely solely on your insiders — run a process. Same as always.

In New Zealand in particular, there’s been a lot of comparison between the current venture environment and that of the 2008 GFC-era investing climate. Of course, it’s not as bad now, but the hope is that a new breed of companies along the lines of Xero, Rocket Lab, LanzaTech will emerge in this more challenging funding environment. Are you seeing any early-stage startups in the region that could meet that mantle?

They’re not even slightly comparable eras. None of those companies were funded by local venture capitalists — LanzaTech and Rocket Lab both raised from Khosla Ventures and Xero was funded first by an IPO (strange, I know). These days there are seven funds over $50 million, all with capital and all deploying. Great companies can emerge at any time; LanzaTech actually raised during a peak in climate tech funding (its first round anyway), so even though it was remarkable to happen here, it was relatively good timing for that type of technology.

There are absolutely companies starting today that can pick up that mantle; OpenStar is easily the most ambitious company started in New Zealand.

It’s been a while since we saw a New Zealand unicorn. Why do you think that is?

Depends when and how you measure; LanzaTech only listed this year as a unicorn. Rocket Lab two years ago — of course, they had private market valuations in excess of $1 billion much earlier than that. I think Crimson Education passed at least a $1 billion NZD valuation in private markets last year, so does that count? My bet on the next one would be Mint Innovation, which I expect is only one pre-IPO round away from a $1 billion+ listing.

Jo Wickham, partner, Icehouse Ventures

Inflation is slowing. Does the possibility of fewer interest rate hikes in the future change your venture capital investing and fundraising strategies in the coming quarters?

Our strategies remain unchanged, although hopefully it’s easier to raise funds and therefore have more capital to deploy.

Both the number and value of venture deals decreased in Q3. Are you expecting the same trend to continue in Q4 2023 and into 2024?

Q4 is traditionally when we do the greatest number of investments, as a lot of companies are trying to close their rounds before the Christmas/summer break so we expect Q4 to be busier than Q3. That said, we are experiencing fewer Series A-D rounds and a slower pace at seed stage as compared with other years.

As noted above, we are investing in fewer Series A-D rounds and are experiencing less competition from offshore VC at that later stage. However, we haven’t experienced more crowding at the seed stage — a lot of funds tend to be focused on either the seed stage (pre-seed, seed, pre-Series A) or growth stage (Series A and on). So, I would say, it doesn’t impact our investing strategy.

NZ companies and funds have huge potential. Three kiwi companies were listed in the International Climate Tech 50 to Watch list — Neocrete, Tectonus and Bspkl.

We need to help these startups traverse the valley of death and bring tech from prototype to commercial scale within the next decade to have any hope of limiting global warming to 1.5 degrees above pre-industrial levels.

Some examples of ways we can speed up innovation include:

Promising future customer demand to give innovators the incentive to scale up unproven technology, raise money and find ways to cut costs in the process — the First Movers Coalition is 50 of the world’s largest companies making commitments to purchase emerging clean tech.
Supportive government policies and regulation (National’s proposed biotech policy is a good example, topping up the NZ government Elevate Fund would help, also).
More investment in clean technology with patient capital (e.g., NZ GIF and BlackRock $2 billion climate infrastructure fund to make NZ 100% renewable energy by 2030). Ideally we’d see investment that’s more proportional to the sectors contributing the most to GHG [greenhouse gas] emissions and focusing on technology that reduces carbon today rather than in the future (e.g., more funding into carbon capture technology).
R&D/tax incentives to fund research and development of novel IP — but also more funding for capex and access to facilities.
Sensible policies for immigration to get talent into the country to work in these startups.
World-class education, particularly in STEM.
Making it easy to commercialize IP out of crown research institutes and universities.
Get more funding/incentives to get KiwiSaver (NZ’s superannuation) funds to invest in venture funds.

Icehouse Ventures’ mandate is to invest in Kiwi-founded companies. There are a number of AU funds investing in NZ startups, less NZ funds investing in AU startups. The entry of Blackbird, AirTree and other AU funds to the NZ market has been positive for bringing more capital into the country, leveling up local VCs (a rising tide lifts all boats), helping with access and connections to the Australian market, which is often the next market our startups expand to outside of NZ. We often co-invest alongside AU funds like Blackbird — particularly in relation to deep tech companies that need a lot of capital to get where they are going. That said, to the extent there are NZ unicorns and success stories, it would be great to have at least some of those returns going back to NZ investors to capture value for the country and recycle that back into the innovation ecosystem.

Fintech has historically been a big sector in Australia/New Zealand, but we’re seeing a dip in funding invested into the sector this year. Why has investor appetite declined?

We aren’t seeing a lot of startups with a unique valuation proposition in the fintech space currently. I’m not entirely sure why that is but, in part, it may be because NZ’s regulatory environment for early-stage fintech is still evolving (e.g., we don’t yet have open banking), which can make it difficult for fintech companies to plan for the future and attract investment. A lot of fintechs may need to find cheap debt capital, too, which is difficult in a market with high interest rates.

Funding in AI startups increased this year. What are the challenges that AI startups in Australia/New Zealand face, particularly as they tee up against giants abroad?

So far we’ve seen AI present more as a feature to be promoted as part of a startup’s offering — so an application layer rather than a truly unique innovation (like OpenAI/ChatGPT). Using AI innovation to increase the productivity of your offering is really table stakes in terms of what a good founder needs to be doing these days. We are yet to see and invest in truly unique applications of AI that are differentiated and have a strong competitive moat, but hopefully they’re coming!

Yes, a lot of the deals we’ve seen are more structured than in the past. We remain very founder focused and try to offer balanced market standard terms with usual downside protections but continue to focus on value creation and the upside — Icehouse only wins if we all win, so making sure founders remain incentivized and that they’re not overly diluted is critical to our investment strategy.

There has been somewhat of a retreat from offshore VC in later stage NZ deals. That means NZ startups need to raise more capital from NZ investors to get to more meaningful milestones to attract bigger checks and offshore investment. We have seen a number of our portfolio companies that might have raised at the peak in 2021 start to run out of runway without having hit their milestones and are looking at down rounds or are struggling to raise at all. Startups need to change their mindset and use revenue to fund growth rather than equity.

Are you seeing value in seeing international investors on the cap table? How much time do you spend seeking foreign co-investors?

Yes, we do see value — we are investing in NZ companies with global ambitions, as the NZ market isn’t typically big enough to sustain venture-sized returns, so the capital and connections and distribution expertise they offer can be extremely valuable to our startups. We will make introductions to offshore VCs for our growth-stage startups.

What advice are you giving your portcos right now when it comes to raising money? Are you suggesting they sell convertible notes? Or perhaps raise as usual?

Make sure you raise enough to have a good shot and enough runway to hit your milestones. Also, you have to hit your milestones, or you may not be able to raise. We are seeing more notes with bridging rounds to get to those milestones, but ideally you won’t need to. Focus on capital efficiency — you need to have an exceptional vision and a disciplined approach to spending and operations to be best positioned to succeed. Get to product-market fit, a clear path to profit and default alive as soon as possible.

NZ’s venture ecosystem is starting to mature. There has never been more evidence that NZ can produce world leading technology companies. Macro conditions are favorable to venture investing — valuations have decreased on the back of the economic downturn and while the number of deals have dropped, venture firms like Icehouse still have dry powder. VC vintages post downturns systematically outperform other investment periods and have resulted in above-average returns in the U.S. market in particular over the last two recessions.

NZ has all the right ingredients to be a leading innovation economy. We are a high-income, developed nation with an emerging venture ecosystem, light regulation and government support, valuations are attractive as compared with other markets, cultural differences in a global sense give Kiwi founders niche perspectives to leverage and through a lack of available capital Kiwi founders are capital efficient by default. Talent is starting to recycle in the ecosystem as founders and operators are emerging from previous success stories like those you mention.

Vignesh Kumar, co-managing partner, GD1

Inflation is slowing. Does the possibility of fewer interest rate hikes in the future change your venture capital investing and fundraising strategies in the coming quarters?

I think the inflation rate changes definitely have a more noticeable impact on our fundraising efforts, as in higher rate periods we have to compete with more liquid yield-based investment products and fundraising is therefore harder.

As an industry, we’re likely operating in a “default conservative” mode, whereby those with investable funds are a lot more prudent with deployment of capital and extremely attuned to helping existing portfolio companies. This is certainly the case from the GD1 side, where we’ve also been focused on a concentrated portfolio of companies in each fund, with roughly 22 companies in Fund 3. We have had the benefit of deploying this fund slowly over the past three years, meaning we’ve been well placed to participate in trough markets like this. We don’t see this changing for the next several quarters.

Both the number and value of venture deals decreased in Q3. Are you expecting the same trend to continue in Q4 2023 and into 2024?

To some degree, yes. From the GD1 side, while we’ve seen the absolute number of deals reduce, along with the corresponding valuations, we’ve also witnessed average round sizes increasing (i.e., raising more capital at lower valuations). Companies are raising larger rounds, undertaking more extreme austerity measures and stretching the capital as far as they can.

Valuations are regressing to the mean, and in most cases we’ve witnessed sharp price and value corrections. There are always exceptions to the rule, and ultimately great companies will always be well funded, and most likely fought over by VCs. We have certainly observed this across many of our portfolio companies that have defied odds to raise some meaningful amounts of capital at what I would call fully priced levels. This is largely because a lot of money has flowed into venture capital in New Zealand in the preceding 36 months and ultimately needs to be deployed. That latent pressure to deploy capital will persist and mean that great companies will somewhat defy gravity for the next little while.

GD1 has always looked to invest with a barbell strategy, centered on seed and Series A. Having this consistent strategy has meant that we aren’t overexposed to waning opportunities at the growth stage like other much larger growth funds, and similarly has meant that we’ve always been active in the early part of the ecosystem at seed, so we have a very strong handle on the opportunities coming through.

At a wider ecosystem level, we’ve certainly observed others shifting tact and coming in earlier, which has definitely made seed rounds a more competitive experience. We feel that this will be a temporary experience as fund managers settle into new strategies. Again from the GD1 side, not too fussed, given we have a single fund strategy rather than a multi-fund strategy; those with multiple funds will need to be attuned to the shifting goal posts.

It’s an interesting question, but one subject to a number of nuanced responses.

Larger VC funds, whether Australian or New Zealand, are typically bound by allocation and nexus limits embedded into their LPA. This is true of the ESVCLP structure in Australia that necessitates 80% of an Australian VC fund’s committed capital be allocated to Australian startups, and similarly for NZ funds such as ours anchored by NZGCP and NZ Super, we have limits that focus our attention and ability to invest mostly to “NZ Connected entities,” with similar 80% rules as in Australia.

So, tl;dr: While we may have lots of Aussie VCs visiting NZ, not many can invest here, and not many, if any, can meaningfully invest long-term here. As a NZ homegrown firm, GD1 focuses exclusively on backing ambitious NZ founders and teams going global from New Zealand. We may look to expand this remit in the future, but our genesis is in NZ and we will remain focused here for the foreseeable future.

Funding in AI startups increased this year. What are the challenges that AI startups in Australia/New Zealand face, particularly as they tee up against giants abroad?

Speaking more broadly about AI, I tend to largely agree with May Habib’s comment about the state of AI startups in that folks are still scratching the surface on AI-enabled technology, mostly building GPT derivative stuff. A lot of these tools are increasingly commoditized and so building any AI startup likely needs to be either:

(A) Focused on honing in on real impactful use cases that require much more know-how and deep understanding in order to drive efficiency and gains in some workflow, or (B) chaining together more valuable disparate aspects from the workflow of a certain industry or job workstream, sort of like a turnkey solution like Writer with its own proprietary non-customer trained datasets, and capturing high-quality customers this way.

New Zealand AI startups have always typically built such types of companies, and in my opinion aren’t at any unique disadvantage relative to other geographies, except to say that our SaaS or AI-enabled solutions tend to start out life as service/bespoke consulting-type arrangements, before morphing into a more scalable productized solution after achieving some level of service revenue.

In order for our AI startups to compete meaningfully on the world stage, they are going to have to overcome this design hurdle upfront and build a more product-centric approach from Day 1, get to a meaningful level of global traction with a diversified customer base, and do so somewhat expeditiously before others cut their lunch.

The other big elephant in the room for NZ AI startups is also talent density, and not having access to the right level of skills and experience to build a more globally compelling and competitive product from the outset.

I think it’s clear to see that investors worldwide are increasingly returning to more fundamentalist views of what VC is ultimately about, which is cultivating great businesses with great capital efficiency, rather than fanning the hype cycles and heavily subsidizing top-line growth with investor dollars. With that in mind, from the New Zealand and GD1 side we’ve consistently stuck to our standard terms without introducing any weird and antiquated measures to de-risk our investments. Valuation is obviously one lever to pull to de-risk, but we tend to protect our risk concerns around other dimensions such as stratified discounts on convertible instruments based on how long it takes to raise the new equity round, or being more strategic around the purchase of secondaries from existing investors. We would much prefer to keep founders incentivized with equity and focused on growing their companies than worrying about getting a raw deal during a downturn. Both eyes should be focused on the long-term.

While deal volumes have generally slowed, great companies will continue to attract capital, and we have witnessed several rounds pushing company valuations north of $100 million. What has changed is how public or showy these companies want to be with their valuations. It seems folks would rather keep building in private rather than get swept up in the celebratory fervor of highlighting company valuations that tended to happen from 2021 through 2022. I don’t think we’ll see a resurgence of substantial funding to sustain growth, but certainly a convergence to the better performing companies and ultimately a razing of the playing field where weaker companies either consolidate positions with stronger players or shut down.

Are you seeing value in seeing international investors on the cap table? How much time do you spend seeking foreign co-investors?

Certainly a lot of the “tourists” have eroded from the margins in the NZ startup and venture ecosystem, and I would posit that this is a net-positive outcome given most of them were dead weight on the cap table. VC in NZ is still fairly oversupplied, but what is different now is the overly judicious way in which capital is being allocated out, where investors are that much more discerning. One of our big strengths at GD1 is our international network strength owing to the fact that every senior team member has either lived in or built or operated in iconic companies around the globe. One of our biggest goals is finding future capital partners for our portfolio companies who not only have true depth of capital to underwrite substantial capital risk for later rounds but also can open networks from a BD and customer perspective for our portfolio companies. Ultimately if it comes from local or international sources we aren’t too plussed about it. The main aspect is the utility of that capital and the folks representing that capital. Can we work these folks, are they human, and do they add utility?

What advice are you giving your portcos right now when it comes to raising money? Are you suggesting they sell convertible notes? Or perhaps raise as usual?

I think our advice is that the market will bear what the market can bear, and great companies generating free cash flow or that are on a path to such cash flows will clearly attract a premium and have the ability to negotiate hard with investors. We aren’t pushing companies any particular way toward a particular type of instrument, but we are having candid conversations around valuations and setting expectations appropriately before going out to market, because the wrong positioning can absolutely be fatal for future rounds. Ultimately investors may be favoring convertible notes and similar instruments for ease of complexity and kicking the valuation discussion down the road, but from the GD1 side we tend to try to focus on clean equity terms given that we find risk is more appropriately covered with equity-related terms.

In NZ in particular, there’s been a lot of comparison between the current venture environment and that of the 2008 GFC-era investing climate. Of course, it’s not as bad now, but the hope is that a new breed of companies along the lines of Xero, Rocket Lab, LanzaTech will emerge in this more challenging funding environment. Are you seeing any early-stage startups in the region that could meet that mantle?

Absolutely. Companies such as Foundry Lab, Basis, Zenno, Auror, Partly, Dawn, Hnry, and many, many more are all forging the path to potentially become the big outlier success stories in NZ, but like most things, these take time. The original litmus test for a lot of these companies, many of which we’re proud investors in, was originally getting to some sort of globally diversified revenue or marquee customer. When you stop and think about that for a second, it really does dawn on you that things have changed dramatically in the NZ startup and venture ecosystem in the past three years, where these sorts of impressive milestones are being met earlier and earlier in a NZ startup’s life cycle, and that ultimately we are getting to some sort of parity with global expectations around performance of a young company. A lot of those companies mentioned above are now easily doing north of $15 million in annual revenues, which is phenomenal.

It’s been a while since we saw a New Zealand unicorn. Why do you think that is?

I think the NZ venture ecosystem is getting there. We are certainly seeing outcomes of substantial scale like Vend’s acquisition by Lightspeed, Seequent’s acquisition by Bentley Systems, and those outcomes are either almost at $1 billion or above $1 billion in transaction value. Certainly M&A interest in NZ tech companies is growing, but in order for us to truly hit a “unicorn” private company in NZ, it does require true value generation and a certain level of domestic venture capability in terms of being able to underwrite large growth rounds for such fast-growing companies.

From the GD1 side, we’re aiming to play a small role in that transition, but this will also take time, and a mind-shift change, where investors need to perhaps reframe perceptions of growth valuations being too expensive despite them actually being somewhat cost neutral or below global parity when weighted by each dollar of global revenue generated. Matter of time, and a matter of more success stories. In the same way Rocket Lab’s success broke the dam for other aerospace opportunities, I think more wins on the board in NZ tech will help us finally organically hit loftier enterprise valuations that are truly deserved.