OPINION
investing in innovation Inventors need risk capital not just tax deductions
Above: The success of California’s Silicon Valley is difficult to emulate. Image courtesy Alamy
Trevor Whittington – CEO WAFarmers
We can afford to put a few billion of risk capital on the table to kickstart our innovation sector.
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f you remember the ABC TV show The Inventors, which ran from 1970 to 1982, it may surprise you to know that at one stage it was Australia’s highest rating TV show of the era and a disproportionate number of the winning ideas were farm inventions. Unfortunately, many of the great innovations showcased ran into the brick wall of a lack of risk capital to take their ideas from the farm workshop to the commercial world. Since the 1990s, it seems as though every prime minister wants to be remembered as the architect of the innovation revolution that turns Australia from being the lucky country to the smart country. Only problem is, for all the programs announced – from tax deductions, university funding and research hubs to industry levy schemes and tech parks, Australia has failed to develop a Silicon Valley or turn itself into another Israel. So what happened? Why have Paul Keating’s 150 per cent tax deductions, Kevin Rudd’s education revolution and Malcolm Turnbull’s innovation ideas boom failed to turn us into a creative nation and why will the current government’s latest changes also fail to hit the mark? The statistics tell us that Australia has consistently fallen below the Organisation for Economic Co-operation and Development’s (OEDC’s) average when it comes to our spend on R&D. Recently, the former chair of Innovation and Science Australia Bill Ferris pointed out that R&D investment in Australia had fallen to its lowest levels since the Global Financial Crisis, “to just below 1 per cent of GDP [gross domestic product] while top nations, including the US, Israel, Korea, Sweden, Japan, Germany and Singapore, had increased theirs to 2 to 3 per cent, and Israel to more than 4 per cent”. Substantive changes to the rules (of the R&D tax incentive) have occurred every five out of the past 20 years. By contrast, the US has had essentially the same R&D tax rules since 1990. Added to the fact that there have been 10 public inquiries and reviews that have assessed the R&D tax incentive since 2003, all of which failed to understand why tax deductions are just part of the equation. Industry needs more than an effective 150 per cent deduction on its R&D spend to go for broke and really invest big time. Under the current rules for companies with an aggregated annual turnover of less than $20 million, the refundable tax offset has been set at 18.5 percentage points above the 26 per cent company tax rate. So a company that spends $20,000 on R&D instead of getting the 26 per cent deduction for business expenses receives a 44.5 per cent deduction. But with the falling company tax rates the incentives need to increase to encourage businesses to invest in R&D, hence a 1:1 ratio of 26 per cent is probably needed.
Over the years, this deduction formula has been hailed as one of the things making Australia attractive to startups and larger tech companies alike, as well as offering an incentive for startups to stay, and grow, in their home country. Problem is, it is only half the equation. If you want to create an innovative ecosystem you have to look around globally at what works and the go-to place for policy settings that helps turn ideas into businesses is Israel. The program to look at is called Yozma (which means ‘initiative’ in Hebrew), described by a 2010 OECD report as “the most successful and original programme in Israel’s relatively long history of innovation policy”. Established in 1993, Yozma invested around $80 million for a 40 per cent stake in 10 new venture capital funds. To further attract foreign investors, the program offered them insurance covering 80 per cent of the downside risk. Yozma became the catalyst for the Israel’s venture capital industry. It provided much-needed early-stage funding for Israeli companies to bring their products to market. In the 1990s, the venture capital investments jumped 60-fold from $58 million to $3.3 billion, with portfolio companies increasing from 100 to 800. By 1999, Israel was only second to the US in private equity capital as a share of GDP and 70 per cent of its growth came from high-tech ventures. All the while we stuck with a tax deduction formula. Another crucial initiative is the Technological Incubators Program by the Israel Innovation Authority, which targets disruptive, early-stage ideas that are deemed too risky for private investors. Startups are incubated for two years with funding of $500,000 to $800,000. The government takes no equity and provides 85 per cent of the budget as a grant, which will only be paid back when the startup generates revenues (as 3–5 per cent of revenues). The incubator operator invests only 15 per cent of the budget and keeps up to half the equity. By funding the riskiest part of the innovation process, the program helps startups survive their most vulnerable phase and scale up to receive private sector capital. Of over 1,500 companies that graduated from the incubators, 60 per cent have attracted private investments of $3.5 billion and 40 per cent are still in operations. So what do Australia’s inventors and innovators need? They need access to both a high tax deduction rate, probably closer to 200 per cent to attract the initial investment, and then they need a viable pathway to commercialisation via access to risk capital. If we can afford to run up a debt of $1.8 trillion over the next decade, we can afford to put a few billion of risk capital on the table to kickstart our innovation sector.
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22/10/2020 2:01:58 PM
