Funding innovation

Overview
The Cutler Report considers the funding gap between idea and commercialisation – the idea that many small and medium-sized firms lack necessary capital to test new concepts, are unable to attract third party investors due to risk and lack the cash to take advantage of existing tax-based incentives. It asserts that government can play a role in bridging this gap – through direct funding, increasing the pool of available private sector capital and linking enterprises with available sources of funding – and proposes a limited number of complementary programs to do this.

Government funding
According to the Report, government can play a very direct role in bridging the funding gap, and the Report proposes a limited number of specific programs which range from direct support (eg, repayable grants) to indirect support (eg, funding costs of business advice / implementation or acquisition of information).

In terms of government grants, the Report proposes the establishment of a Competitive Innovation Grants program to assist firms with limited access to capital in proof-of-concept and development stages. The program would target projects falling within specific identified national innovation priorities. Businesses would be required to repay grants from earnings on commercial success.

The Report also noted that there is currently a lack of support in terms of building innovation performance and capability in firms, and for services firms. The Report recommends the expansion of the Enterprise Connect program (which allows firms to obtain a business review at no cost and matching funding in order to implement changes identified by the review) to these areas. In our view, one area that it would be interesting to explore further in these business reviews is the extent to which ESOPs could help to attract, retain and motivate talent within the firm. Such schemes are widely recognised to play an important part in innovation but are not yet in wide use in Australia, partly due to tax considerations (which may soon change) but more importantly due to Corporations Act disclosure requirements, which greatly limit a firm’s ability to incentivise employees through share or option schemes.

The Report also considered ways in which the government could encourage collaboration, which it viewed as critical for Australia, and considered in detail the recent Report on the Review of Cooperative Research Centres (Collaborating to a purpose), which concluded that government should assist firms to access knowledge generated by research providers. To this end, the Report proposes an innovation vouchers scheme, similar to schemes which have been successfully implemented in Europe. Each voucher would be worth a set amount of money, to be used to fund collaboration between small and medium-sized enterprises and a public sector research organisation.

Attracting private sector funding
The Report also considers ways in which it can assist small and medium-sized businesses to attract private sector funding. It considered this from two angles:

• “individualised” assistance, pursuant to which individual businesses get help to attract private capital, and
  
• more macro policies, which help increase the availability of venture financing generally.

In terms of the first type of assistance, the Report supported the extension of the COMET program, due to end in 2010-11, under which arms-length private sector business advisors assist companies ready to take an idea to market to identify the services they need to attract growth capital. This assistance has enabled firms to get funding from third party groups such as business angels.

On a more macro level, the Report also explored the state of the venture capital industry in Australia. It noted that the Australian venture capital market was growing, but was still small compared to other developing private equity markets, and venture capital investment is being directed away from the very early stage towards (less risky) early expansion stage.

As an aside, the Report highlighted the lack of information in relation to the venture industry in Australia. We wonder whether this lack of information was the driving force behind the dearth of comment on the success (or lack thereof) of the Venture Capital Limited Partnership program in attracting foreign investment in Australian venture capital – as this was arguably the most publicised effort by the Australian government to attract foreign venture capital ever and involved a major overhaul of Australian tax laws. (While the Report commented favourably on the aims of the Early Stage Venture Capital Limited Partnership program, we acknowledge it is too early in the life of that program to make any assessment as to its effectiveness – but data collection will be key to making this determination.) There are many well publicised criticisms of both of these programs, and it will be important to know the extent to which their shortcomings have impacted their effectiveness in growing the venture capital industry in Australia.

The Report’s recommendations in relation to the venture industry are aimed at narrowing the funding gap by increasing the pool of venture funds available for very early stage companies. The Report notes the success of the Innovation Investment Fund program (pursuant to which the government provides $20 million for funds managed by first time fund managers, provided they obtain matching funds and adhere to specified investment guidelines).

The Report also favourably recommends the continuation of the Pre-Seed Fund program (established to assist commercialisation out of public sector research organisations), but notes that the much-criticised $1 million cap on investments, which has left enterprises stranded squarely in the middle of the funding gap, should be replaced with a $1 million cap on first tranche investment.

The Report notes that angel investing is extremely important for early stage enterprises, and queries whether there is scope to expand tax incentives for other investor vehicles (like the Early Stage Venture Capital Limited Partnership program) to angel investors.

Finally, the Report comments favourably on the benefits of attracting overseas venture capital firms to Australia, both to increase the pool of funding for early stage ventures and to serve as a base for further developing local talent.

Recommendations
In summary, the Report recommends:

• establishing a grant program, which would aim to provide funding to firms in the high risk, proof-of-concept and development stages, focusing on specifically identified national innovation priorities, with grants to be repayable from later earnings;
• expanding the Enterprise Connect program and expanding and extending the COMET program;
• the establishment of a voucher system, to enable small and medium-sized firms to access public sector research better;
• attracting international venture capital funds to Australia (with a short-term goal of attracting a US venture capital firm to Australia), to increase the pool of funding available for venture capital and to further develop the skills base;
• improving data collection, in order to evaluate better the impact of government support;
• extending the Innovation Investment Fund program and the Pre-Seed Fund program (in the case of the latter, replacing the $1 million cap with a $1 million first tranche cap);
• further reviewing support to be provided to angel investors, including tax incentives and modest facilitating grants.