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Investment – bring it on

17 August 2007

Here’s one very simple reason why the idea of packing up and moving across the Tasman has become so attractive to so many New Zealanders.

In 2006 New Zealand’s GDP was the equivalent of US$24,944 for each man, woman and child in the country. In Australia it was US$32,202. When it comes to GDP size does matter and not only is Australia’s GDP per capita bigger than ours, but it is also growing faster than ours.

With its higher GDP per head the Australian economy can afford to pay people more. For the best and brightest New Zealand workers, especially the young, this is a magnet. But for the New Zealand economy this is an unsustainable and challenging drain.

So how do we address it? How do we grow our own per capita GDP so as to keep our brightest in well-paid, challenging work here at home?

The start point is building up investment in industry by helping businesses large and small find investors to back growth.

This is not an easy task.

There has been some good news on this score. The 2007 Forbes Capital Hospitality Report ranks New Zealand fifth as an investment destination compared with Australia’s eleventh, and the 2006 World Bank Ease of Doing Business Ranking gives New Zealand a ranking of second to Australia’s eighth.

But those rankings alone aren’t enough.

New Zealand is still geographically isolated and small which means we have to work hard to get noticed by international investors. The best way to do that is to ensure our regulatory, tax and legal framework is world-class and attractive.

Which is where the recently introduced Limited Partnerships Bill comes in.

The Bill is the product of five years of consultation and drafting between the Government, the New Zealand Private Equity & Venture Capital Association and industry.

Worldwide, limited partnerships are the most common vehicle for international investment, particularly for private equity and venture capital funds. By using different structures New Zealand was potentially putting off prospective investors.

Certainly it was the view of NZVCA that as long as New Zealand maintained its own particular system investors would have to work hard to understand all its quirks. But by adopting an internationally recognised model investors and managers can focus on the investments and not the framework that underpins them. Investors will feel more comfortable investing in vehicles they are familiar with and understand. Since we want their investment, it’s in our own interests to keep it simple and in sync with other countries with whom we compete.

The regime proposed in the Bill will be familiar to international investors.

In a limited partnership, the limited partners contribute capital and generally stay clear of the management of the business, and the general partner runs the partnership, makes the investment decisions and has unlimited liability for the debts of the partnership. Losses and profits flow straight through to the partners often bringing tax benefits to investors if the partnership makes losses early in the investment cycle – as often happens in biotech and other heavy R&D industries.

The version of limited partnership being proposed is a hybrid of a partnership and a company. Those working on the Bill have compared equivalent models in the US, UK, Channel Islands and Australia, picked out the best elements of each regime and avoided some of the pitfalls.

Limited partnerships generally ensure that so long as investors do not participate in management of the limited partnership, their liability is limited to their investment – just as a shareholder’s liability is limited to the amount they pay for their shares.

The New Zealand regime will allow unlimited partner numbers and duration, in contrast with the existing special partnership regime, and will also allow unlimited investment unlike Australia which effectively caps a limited partnership’s assets.

Most importantly for many New Zealand businesses, limited partnerships will be transparent vehicles for tax purposes so that losses and gains are attributed to investors directly – this is particularly effective if losses are expected in the early stages of investment or if a non-taxable capital gain is to be passed to investors.

Limited partnerships can be used for any type of business, except banking and insurance, although they will be most useful for venture capital, private equity and general investment vehicles.

Without a doubt this vehicle will be much easier to establish and administer than complex existing fund structures and will give fund managers the right to keep the identity and contributions of their investors confidential.

As with any new legislation the Bill now heads to a select committee. It isn’t perfect as it stands. In particular some more thought needs to be given to the following issues:

  • the extent of the "safe harbours" or activities a limited partner can be involved in without contravening the "no management" rule. These are to be contained in regulations which need to be developed well in advance of the enactment of the legislation
  • the trigger point for when someone becomes a limited partner and can avail themselves of the protection of limited partner status. The draft Bill places the obligation on the general partner to get it right
  • the extent of the power in an insolvency to claw back distributions made to limited partners. The current test applies if the limited partner knew that the limited partnership would not satisfy the solvency test after the distribution and applies for three years
  • written partnership agreements are compulsory for limited partnerships but there is no test as to the quality of those agreements
  • continued confidentiality of names and investments of limited partners, including where that information is contained in annual returns
  • the pass through of all losses to investors – at the moment this would be limited to the capital contributed by the relevant investor.

Those issues aside, the regime should attract domestic and foreign investment and introduce an internationally competitive framework for venture capital and other investments.

For those looking for investors – this has to be good news.

This article appeared in the New Zealand Herald on 17 August 2007.

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