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5. Funding Phases 1 & 2 - Seed Capital

A scheme will require a level of ‘seed capital’ to fund the preliminary feasibility study and make an application for resource consent (phases 1 and 2 above). This funding is considered seed capital as it is essentially funding the research and development stage of the project with a high chance that the funds will not be recoverable.

Feasibility

This is high-risk research expenditure with no certainty of recovering costs incurred if the scheme is in fact not feasible for the area.

Resource Consent

Funding an application for resource consent to take and use water is also a high-risk investment. There is little certainty that consent will be granted until the process has been completed. If the application is declined all costs incurred to that point are irrecoverable.

5.1 Providers of seed capital

5.1.1 Private Sector (excluding water users)

Based on discussions with private sector investors (both debt and equity providers) the absolute risk of financial loss is simply too high for them to consider and therefore there is simply no interest in providing seed capital to these schemes. There are many examples of proposed schemes which have incurred significant expenditure but subsequently have not proceeded for any number of reasons e.g. the scheme is too expensive, lack of farmer commitment, can’t raise required funds, issues with resource consent, returns are too low etc.

5.1.2 Water Users

Water users stand to benefit most from the introduction of a water enhancement development and therefore should be a source of at least a portion of this funding. In addition, a financial commitment from water users at this point is an important signal to the funding market that the users are committed to making the scheme a success.

5.1.3 Government (Local and Central)

Where there is insufficient funding available from the private sector, financial support must come from Government if the preliminary investigations are to proceed. In reality Government is only likely to fund a portion of the seed capital requiring a contribution from land owners given that land owner commitment to the scheme, even at this early stage, is a key indicator of the future success of the development.

Providing seed funding to a proposed irrigation scheme is a high-risk investment, and Government must be prepared to provide funds on this basis. However, there is no need for Government to provide funds without an expectation of a repayment and return if the scheme does proceed, particularly given the risk of the investment. It is therefore important for Government to structure the provision of seed funding with repayment and return in mind.

There are two options available for Government when contributing seed capital:

• Provide the funding by way of debt – Returns are fixed and funds repaid under agreed terms if the scheme proceeds.

• Provide the funding by way of equity – Government owns shares in the scheme that have some value on a tradable market if the scheme proceeds.

Debt

If the scheme proceeds there are several advantages for Government in providing seed funding by way of debt:

• Debt carries a lower risk for Government than equity given that the return on the funds is fixed regardless of the performance of the scheme;
• Debt gives Government a clear exit from the scheme i.e. Debt is to be repaid from proceeds raised from the construction phase. (These were the repayment terms used by the Waimakariri District Council when seed funding was provided to their scheme).

Converting seed funding to debt may have some disadvantages for the scheme.

• It may restrict the schemes ability to borrow funds from the private sector for later development (i.e. debt/equity ratios will be impacted),
• The scheme may have to service the debt during the start-up phase when cash flow is limited.

Equity

Where seed funding is converted to equity Government will carry more risk than it would converting the seed funding to debt, given that returns are dependant upon the success of the scheme and the amount that the market is prepared to pay for shares.

The potential capital gains (and therefore risk) from equity trading are dependent on the class of shares accepted by Government. Historically, shares with water rights attached have sold for significant capital gains (Opuha and Waimakariri schemes), however, these shares attract take or pay commitments that may be difficult for Government to recover if it is not the ultimate water user through the holding period.

Equity will give Government the ability to share in the success of a scheme and potentially generate super normal profits from the sale of this equity.

Government holding equity will not impact on the scheme’s ability to raise funds from the private sector, and depending on the terms of the arrangement, allows the scheme flexibility to pay returns when cash flow permits.

Government Support

The arguments for and against Government support are addressed in study 3 and 4. For the schemes currently under investigation, both Central and local government have provided either all or a portion of this seed funding for feasibility studies with no requirement for repayment or conversion to debt or equity.

Contact for Enquiries

MAF Information Services
Pastoral House
25 The Terrace
PO Box 2526
Wellington, NEW ZEALAND

Fax: +64 4 894 0721
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