Simon Cook digs into the data to look at who really backs the companies of the future in the UK.
Yesterday, the UK government announced the creation of the new national investment fund and a Consultation on financing innovative growth companies. Patient capital, another way of saying long- term investment, has been identified as a strategic priority for the country. This is especially true in the face of Brexit, where the European Investment Fund is potentially set to withdraw funding from UK businesses.
Patient capital overtakes traditional VC models as the largest pool of investment
Every year in the summer months we analyse all tech VC investments closed in the UK and look behind the VC manager to identify their source of capital. We have categorised these sources into 6 groups:
· EU Limited Partnerships (LPs)
· Angel investors and crowdfunding
· Government initiatives (EIS/ VCT/ British Business Bank etc)
· Corporate venture capital
· US Limited Partnerships (LPs)
· Patient Capital (funding from evergreen listed and unlisted companies, city institutions, or other funds; these are not made up of fixed LP funds which last 5- 10 years).
The data shows that after rapid venture capital growth from 2013 to 2015, the growth in investment has slowed down. This slowdown could, in part, be triggered by the emergence of Brexit and the allocation of international investment to other European hubs, such as the rise in prominence of France. However, the market is still growing and will exceed £3 billion this year, if the second half matches the first in percentage terms.
The data supports the Consultation’s view that the UK tech industry is funded by a broad spectrum of investors with no dominant provider.
Key findings from the data:
1. The LP model continues to suffer in the UK and we estimate the total EU LP capital has shrunk to 10% this year.
2. US LPs have also pulled back a little as they look into Berlin and Paris and other start-up hubs post Brexit.
3. The Angel and Crowd capital remains relatively small but shows solid support.
4. Corporates are increasingly active in venture, rising to 18% as they all seek to understand disruption and which start-up might kill them tomorrow.
5. Long term investment funds (not LP based) that provide “patient capital” continue to be the largest group as a source of investment for UK startups representing over 30% of the capital injected into the UK. These funds usually do not have a 5- 10 year limited life. Such investors are therefore willing to forgo quick returns in the hope of securing larger profits at a far later date. They are usually permanent capital vehicles and include listed companies such as ourselves, Draper Esprit and IP Group, unlisted companies like Cambridge Innovation capital and Oxford Sciences, as well as leading city funds such as Baillie Gifford, Invesco and Woodford Investment Management. We note the Consultation wrongly describes these as retail funds; ours and others shareholders are 90% large institutions who prefer listed groups to LPS.
6. The Government, having stepped back in 2015, has once again stepped up to increase venture capital spending to over 20% by refocusing schemes such as VCTs and EIS on tech growth deals and by increasing the British Business Bank’s allocation to venture. Diving down into those various Government initiatives suggest a broad spread of uptake across all initiatives.
The good news is that the most important investment on any startup’s accounts are its employees. In the context of high growth technology businesses, it is therefore safe to assume that most of the capital governments invest is used to create and fund skilled technical jobs. The Government’s 20% investment is therefore likely recovered from 30%+ PAYE and other corporate taxes. It is arguably the case, then, that this is a wise investment from a Treasury perspective.
Identifying the Consultation’s £4Bn equity gap
As the data shows Europe is short of about 1000 start-ups rounds of $3–5m each, and about 1000 scale-ups of $20–30m each. As Silicon Valley captures 50% of the US market, perhaps the UK, as the leading European VC market could aim for 50%, but post- Brexit it may end up around the 33% we are running at currently. So that £4bn translates into about 300 more start-ups and 300 more scale-ups a year totalling about £4bn, or just over a doubling of the current UK VC market as identified in the Consultation.
We believe that with the right support, the UK VC market is entirely capable of that potential doubling, which requires 20% per annum growth over the next 5 years, to end up with a VC industry comparable to the USA benchmark. No mean feat.
So let’s get behind this insightful Consultation and debate how to address this issue over the coming months; we firmly believe that together we can help find the levers to generate that 20% per annum growth. As the Consultation states, it is likely that no one investor group should be the sole focus of any new policies to increase the supply of patient capital. In our view, the continued interest from corporates could generate another £1bn, and the continued refocusing of EIS and VCT on tech scale-ups (about 25% of these schemes reach tech: we can double that especially if the £5m limits are increased post-Brexit without State Aid rules to battle against) and add another £500m through a new BBB fund/EIF replacement. That leaves about £2bn a year to find.
The Consultation offers a very insightful target here: shifting attitudes to investment in patient capital by large institutions. We need collectively to ensure our largest investors are investing in the future of our economy, in manner consistent with their fiduciary duties for strong returns to their stakeholders. We note listed and unlisted company funds are a solution for these institutions too, and not just retail investors as per the Consultation, as well as LP funds.
As the returns from VC funds start to demonstrate success, and our unicorns turn into thoroughbreds, it would take a 1–2% shift from these £trillions of pension and insurance funds to put Britain’s entrepreneurs on equal capital footing with the best of the USA and plug that £2bn gap. It should become a badge of social honour, in their annual reports, just as ethical investing is, for these funds to state they have committed this 1–2% to the future of our country.