A recently released NSW Innovation Blueprint presents the NSW government’s strategic vision for the state’s innovation ecosystem. The Blueprint includes a proposal to investigate the development of a government venture capital (VC) fund, the ‘NSW Government Strategic Investment Fund’.
The stated purpose of the proposed fund would be to catalyse private sector investment in target areas such as advanced manufacturing and deep tech.
Government VC can be an effective strategic policy tool to support innovation-driven companies. These government VC programs have been used successfully to stimulate the development of private VC markets.
The Israeli Yozma Fund that ran between 1993 and 1998 is a good example. Its success led to a Yozma Fund 2.0, which is now underway.
Where private VC markets already exist, government VC can be valuable for startup firms in certain types of innovative industries that may otherwise struggle to obtain funding.
Such firms typically offer potentially significant social and economic returns but face higher technological, regulatory and market demand risks which can deter private investors.
As an example, the development of technologies such as new materials for carbon sequestration, or e-fuels have higher product development costs and are unable to generate revenue before the full product development is complete.
Startup firms in these areas often require more patient capital that can be invested for longer terms than the typical life cycle of a private VC fund.
To catalyse private sector investment, government VC should be used not only to fill funding gaps, but also to transform the market, building expertise and eliminating barriers to private investment thereby reducing the need for future interventions.
This requires a fund structure, incentives and management that allows the government VC to take on higher risks from capital intensive projects, to have longer investment horizons and build expertise in VC fund investors (limited partners) and VC managers.
The NSW Innovation Blueprint suggests that the Strategic Investment Fund could operate as a Fund of Funds. Under this structure, the government VC does not invest directly into any particular startup firm but invests in multiple VC funds. A structure like this is generally aimed at increasing the supply of VC financing and is used to encourage the development of younger VC markets.
A fund of fund model has been used in New Zealand (Elevate NZ) and the UK (UK Innovation Investment Fund) and by the Queensland government to attract private VC funds to invest in Queensland companies (Queensland Venture Capital Development Fund).
However, a fund of fund model provides the government with limited scope to specifically address underlying issues that drive funding gaps in targeted industries.
It limits the government’s opportunities for input into the design and investment mandates of the VC funds that make direct investments in startups.
A more direct model could provide the government with sufficient influence and oversight of investment mandates and fund design to achieve policy objectives.
This type of model allows for capacity building in other limited partners that invest in the fund, the government VC fund manager and the private VCs that co-invest with the government VC fund in targeted industries.
Various design features relating to fund management, structure, mandates and risk and return sharing have been used to address specific issues relating to higher risk, capital intensive nature and longer time horizons of certain targeted industries.
These design features depart from conventional VC models and concessionary returns and other incentives may be required to attract a fund manager and limited partners to invest in the fund.
The establishment of panels with expertise in specific technologies to assist fund managers could reduce the costs of technical due diligence and build pools of VC expertise in targeted industries.
Investment from a government VC fund may serve as a market signal of the technical and commercial feasibility of a venture for private VCs who may not have the capability to conduct due diligence.
Private VC funds who co-invest alongside the government VC will obtain more exposure to assessing the commercial and technical viability of targeted ventures which will facilitate skills development and help build confidence in the sector.
A government VC when appropriately designed, can be effective in catalysing private investment to accelerate the development of innovation in advanced manufacturing, deep tech and other areas, growing sustainable industries and job opportunities for NSW.
The role of a government VC fund and its costs and benefits needs to be considered in the context of the broader innovation ecosystem. A government VC fund will have greater impact if supported by a range of complementary policies.
These measures such as targeted non matched grant programs, can address barriers at different stages of the startup lifecycle to help develop a pipeline of ventures through to market.
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