Sam Morgan gives Callaghan the bash, outlines preferred alternative

Sam Morgan has been on one of his periodic social media crusades against Callaghan Innovation's moneybags R&D Growth Grant programme over the past couple of days — with Steven Joyce weighing in at times to defend the Crown agency (see tweets below).

Callaghan is in the midst of a four-year programme to award $566 million in matching funding over four years. Friday, it announced its last allocations with an estimated $32 million on the way to 22 companies 

I've also been quite critical of aspects of the Callaghan setup, including the mystery surrounding why some firms get money, and what they spend it on, and the fact that some companies have received $10 million-plus from the taxpayer, only for the wealth of intellectual property created by that money go to offshore owners as the firms are sold (Endace in the hot areas of internet and network security, and LanzaTech in clean energy are two glaring examples, but TIN100 CEO Greg Shanahan says 32 of the companies in his NZTE and Callaghan-backed list of our top 200 high tech exporters have been sold offshore since 2010. Some, like Endace, have kept jobs in NZ. Others, like LanzaTech, have decamped).

But I can say that. NBR's publisher has never accepted money from Callagan.*

In 2011, Xero got a $4 million grant from one of Callaghan's precursors (FoRST; the government consolidated several R&D-promoting agencies to create Callaghan in February 2013).

Sam Morgan was a Xero board member then, and he's a board member now.

If he's so philosophically opposed to government grants, why not propose to Xero's board that it pay the money back? (Certainly, it doesn't need it. At the time of its 2011 Callaghan grant, Xero had $16 million in the bank, today it's got around $180 million cash — and if it lists on the Nasdaq later this year as it's hinted, its coffers will swell again. Although he's best known for Trade Me, half of Morgan's wealth now comes from Xero).

I picked up that point in an exchange with Morgan this morning (keep reading).

Morgan could also be called a poster boy for Callaghan (and NZVIF's) assertion that although entrepreneurs sometimes sell their companies offshore, they typically reinvest profits here. Morgan's NZ investments include Sonar6 — also a grant recipient, and also sold off-shore (Trade Me, of course, has repatriated to a fashion, with Australian buyer Fairfax floating it on the ASX and NZX).

Callaghan never comments on individual grants, but if it did, I'm sure CEO Mary Quinn would say the Crown cash awarded to Xero paid off handsomely. The accounting software company has doubled staff then doubled again. It now employs just on 1000, most in its Auckland and Wellington offices.

But Morgan isn't having a bar of it. He tweeted:

Anyway, enough background. He's my Q&A with Sam this morning:

Chris Keall: Xero got $4m from the Crown, from Callaghan's precursor. What's your take on that, as a Xero director? Should Xero pay it back?

Sam Morgan: My views are my own and, hopefully, pretty clear through my Twitter comments.  I don’t wish to comment on Xero specifically.

Needless to say, if the government suddenly decided to ask for repayment of all historical grants it might create a few liquidation events.

CK: I didn't mean to suggest the government should ask for repayment of all historic grants. Just whether you personally thought Xero should pay back its $4m given you're philosophically opposed. 

SM: Any director who recommended such a thing should be sacked by shareholders.

CK: So if the government's dumb enough to dish out millions, a company would be stupid not to take it (even if it think's the grant scheme is ill-judged)?

SM: Worse than stupid.  It would be irresponsible not to try to get some. 

CK: Labour proposed taking an ax to Callaghan (or at least halving its growth grant budget) and introducing a 12.5% R&D tax break and accelerated depreciation.

Would you like to see a policy move in that direction., from pick-a-winner to a universal leg up. Or should the Crown just butt out altogether?

SM: The main thing I’d like to see is the government halting their picking of winners based on how software companies (somewhat arbitrarily) classify their development efforts (expense, capitalise, R&D).   Any policy in this area should apply fairly to all companies doing similar stuff.  Anything else is simply unfair and it does not work.

In my view, software developers (and testers, designers, etc) should be able to be expensed or there should be a fixed component that you can’t expense (say 30%) that you must capitalise and write down over three years for certain roles (also dumb, but less so).

It is ridiculous that when I have a great idea and spend a year building it in software I must capitalise it.  If my maybe profitable (probably not) idea is best expressed in a spreadsheet or a Word document or a sonnet, then I can expense it.

Presently managers go through gymnastics to decide whether a developer is working on stuff that can be expensed (bugs and fixes), must be capitalised (new projects) or should apply to the R&D policy (because it is speculative).

In a hypothetical small company situation, I have $1m of revenue and spend $1m on my developers per year.  If I can expense their salaries, I pay no tax and I break-even.  If I must capitalise half the salaries then I have a $500k paper profit and must pay $150k tax, meaning my cash-flow for the year is down $150k.  So I raise money or go broke.  Is that the intent ?

I suspect the underlying premise that there is no R&D in NZ companies is partly due to classification.  Without clear tax policy requiring R&D to be classified in tax returns (and there being incentives to do the classification), you simply don’t get visibility.  I’m unsure what the source of the R&D percentages is.

Most younger software companies I know (where lots of R&D happens) are not really aware of these tax gymnastics and therefore just expense all their developers.  The incentives are also such that this keeps them afloat longer. 

See some of Morgan's Twitter attack below, which includes dings at new recipients Serko and GeoOp (Darrin Grafton, who jumps in, is Serko's CEO).

Morgan also asserts a whole new species of consulant has emerged: people who used to be part of the grant allocation process who now help companies nab grants.

Steven Joyce weighs in at various points with his familiar arguments that Callaghan grants (which are paid retrospectively, and require the recipient to spend more on R&D itself) are effectively a 20% rebate for R&D (you could add: for those lucky enough to get a grant).

Joyce also reiterates that the Callaghan grants are designed to increase R&D activity in NZ, so he's happy to see a foreign company's subsidiary (like NEC NZ in the latest round get a grant, or an NZ company continue to receive Callaghan money after it's sold to an offshore owner — as long as Callaghan-funded R&D stays local.

The minister has always staunchly defended Callaghan in the debate over taxpayer-funded IP going to overseas shareholders when an tech is sold offshore. But behind the scenes, the government has quietly tweaked the rules. The latest Callaghan recipients will have to pay back.

Morgan has previously argued it's better for the Crown to have "skin in the game" by directly investing in a company. Joyce has said the government has a separate vehicle for that the (I would argue thinly funded) NZ Venture Investment Fund, NZVIF, which buys private equity shares in early-stage companies.

Early in the piece, he disclosed three of his companies have received government grants (Sonar6, Outsmart and Xero).

ckeall@nbr.co.nz


Latest tweets first; see all of his feed here.


* NBR does run articles from BusinessDesk, (a news service it pays for) who has one staff member part-funded by Callaghan.

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