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The way to seed startups

Robin Klein’s open letter to the UK government about how to stimulate startups got a lot of response from TechCrunch Europe readers. We’ve decided to run two responses to his letter, making their own case for how government intervention should take place. The below is by Simon Cast, (@Simoncast) a freelance Product Strategy/Product Management analyst. The other response is here.

TechCrunch Europe posted an open letter by Robin Klein of The Accelerator Group to the Chancellor of the Exchequer Alistair Darling and Lord Dryson Minster for Science and Innovation about what to do with purported stimulus funds. BVCA wants the money to go to large VC funds whereas Robin Klein wants to see the money channelled to supporting very early stage companies (amounts less than £100k).

Robin’s logic and reasoning is sound and I agree with them. But it is not a good use of the money for two reasons.

Tech (web) Focused
The idea is far too technology (read web) focused. There are lots of opportunities throughout the UK for entrepreneurs to create businesses; many, indeed most, outside the world of the web. Why shouldn’t someone starting a lawn-mowing business have access to early stage funding as a technology developer? Both create value. We in the technology sector tend to be myopic about start-ups, small businesses and entrepreneurs. Richard Branson can hardly be accused of creating a technology business and yet he is by most measures the UK’s most successful entrepreneur.

Yes, technology creates long term value and wealth, but the vast majority of wealth is created by companies outside of the technology sector using technology and not developing it. It is created by a lawn-moving business using twitter to alert their customers that their lawn is done and having a website where clients can go and book a visit using something like BookingBug to provide the functionality. The lawn-mowing business is creating value through better customer service and consequently generates wealth. Would a business angle or early seed stage fund invest in such a company? What about if it is located in the hinterlands of Wales?

Relying on Judgement
The mechanism for distributing funding relies on someone making a judgement call as to what is potentially a good opportunity. The act of making a judgement takes time and as many commentators pointed out in response to the open letter, time is very precious at the early stages of a business. Waiting more than a month for a response is a massive drag on very early stage businesses. Small business need responses fast.

More problematic is that a person can only make the judgement based on their experience and expertise. Many great opportunities will be bypassed as the judges’ focus on what they know. Now however is a time to fund companies that are moving into new areas and new ways. It is a time to let 1000 flowers bloom. In the end the only real judgement that matters is that of the market. It would be better to create a situation where those companies can be judged by the market rather than a limited individual. The market is crowd-sourced investment decisions.

In place of co-investing or creating lots of seed funds, I propose that the UK government create a scheme of income-contingent loans. Under the scheme an entrepreneur can take out a loan that covers his previous salary up to a maximum of £50k to £60k. The loan is paid monthly like salary and is re-paid by the individual (not the company) through the tax system (similar to student loans). Other characteristics of the scheme are:

* The scheme would provide loans for up to 3 people per business in the first year, followed by another 2 new employees in the second year
* The loans are tied to the individual and are re-paid by the individual based on the individuals income
* An individual can only take out a loan under this scheme once every 5 years

An income-contingent loan scheme provides funding irrespective of industry or goods and services. It addresses the funding gap that is a barrier to entry for all entrepreneurs and has a lower administrative burden. The loan scheme can be administrated through the existing Government banks and through an online loan application system which are widely geographically diverse, scalable and most importantly can return a fast decision.

One big objection is the potential for fraud. Nothing involving money is without the potential for fraud and venture funding is not immune (witness Tiger Telematics). By putting the liability to re-pay the loan onto the individual reduces the avenues for fraud using this scheme. The other limitations are also designed to reduce the attractiveness of fraudulent behaviour.

Granted, the loan scheme is unlikely to produce the next Google but I would rather see the loan scheme generate 100,000 businesses all employing an average of 10 people. That would be far more valuable to the UK economy as a whole than 1 Google.

Ideally, you would run both an income-contingent loan scheme and co-invest in early stage investments. However, given the realities the loan scheme is more valuable. The co-investment scheme should follow. By the time the co-investment scheme is up and running many of the first lot of companies that have benefitted from the loan scheme will be ready for their first round of funding.

  • http://uk.techcrunch.com/2009/04/29/the-way-to-seed-startups/ The way to seed startups

    […] Robin Klein’s letter open letter to the UK government about how to stimulate startups got a lot of response from TechCrunch Europe readers. We’ve decided to run two responses to his letter, making their own case for how government intervention should take place. The below is by Jens Lapinski (@jenslapinski), the CEO and Co-Founder of aiHit, a London-based business information company with VC backing. He was previously VP Analysis & Consulting at Library House, where he advised organizations on innovation programs and investment policy. The other response is here. […]

  • Tom K

    Nice report and ill have to say I agree with you in principle. I myself am a post graduate student who has nearly finished their degree and I am hoping to start a company this summer. In What way would I be entitled to this fund, or is it only intended for more established professionals?

    • http://simoncast.blogspot.com Simon Cast

      I’ve gone back and forth on this and with some caveats would support recent graduates.

      I think it wouldn’t hurt to support anyone with tertiary education but no work experience using the scheme. However, the amount would be capped at some nominal rate, say slightly below average graduate salary so it doesn’t become more attractive than a job.

      • Jen

        What’s wrong with it becoming more attractive than a job? The risk/debt/insecurity element is still going to put off freeloaders.

      • http://simoncast.blogspot.com Simon Cast

        From the inside the risk/debt/insecurity is large but for outsiders the perception will be different.

        Attractive is probably a poor choice of words. The idea is to create a psychological barrier that is a hurdle to filter applications.

        If the loan is at average graduate salary from the outside it will look nicer (own work hours, no boss etc.) than getting a salaried job (work hours set by coy, boss etc.). By reducing below the average graduate salary the loan scheme forces graduates to evaluate whether the reduction in salary is worth it.

        The point is to filter those who’s heart really isn’t in it.

  • http://trailbeater.blogspot.com/ Ben Colclough

    That is a fantastic idea. By linking it to previous salary, the government hedges its risk against the likelihood of the individual being able to pay back the loan of it all goes wrong and they have to go back and earn a decent wage again. Definitely think the future for v early stahe funding is in backing the individual rather than the concept – as the sums involved simply make judging the concept properly uneconomic. I’ll sign the petition

  • http://www.sweeble.com Sue Greenwood

    Loved this idea! I’ve spent the last two years working virtually for nothing, launching first one (parked) start-up and my current (moving) one.

    Every penny I earn gets re-invested in development, so being able to have access to a small loan fund I don’t have to jump through hoops for (read: spend weeks custom-writing business plans) would be a lifeline. I’m more than happy to pay the cash back, I just want be able to get on with the job of building and launching instead of constantly pitching.

    One other suggestion I’d make, I’d like the loan fund linked to a website where anyone getting a loan can post up info on their newly-launched products themselves, categorized so users can decide for what they want to look at.

    • http://simoncast.blogspot.com Simon Cast

      Yes the idea is to allow someone in that all important first year focus on getting things off the ground. While I don’t think you’ll ever get away from pitching it does ease the burden and support focusing on the business.

      Business listing is a good idea. If would be interesting to see if that would encourage people to support these new companies.

  • Michael D

    What about the government intervening less not more? I’d much rather slash the tax and regulatory burden that entrepreneurs face rather than just create another complicated, bureaucratic “scheme”. Entrepreneurs are naturally innovative, creative people and the government needs to focus on stopping hindering them rather than constantly messing with them.

    • http://simoncast.blogspot.com Simon Cast

      I don’t see this scheme being a red tape burden. At the very early stage, red tape is generally not the biggest issue in fact it comes way down the bottom. Cash is king and the aim is to address this problem.

      General red tape is a problem faced by all business and citizens. It is a broad problem that should addressed in the light of reducing the cost of government on society.

  • samd

    Interesting concept with social merit but risks on the loan would be huge as would the default rates, ok if all fails they could go back to work but no guarantee on what the individual will earn (just likleyhood it will be near what they were earning before) and if they do go back over what period do they have to pay off the loan, they would still need to live. Not knocking it just stating some issues …..also….thought of student loans instantly after I finished reading the article.

    • http://simoncast.blogspot.com Simon Cast

      Income-contingent loans are not new and as you pointed out it is the same concept as student loans in the UK and HELP loans in Australia.

      Yes the risk is there but then at very early stage there is huge amount of risk. On balance the potential to create a boom in small business is worth the risk of loan losses. The use of the tax system to retrieve the loan I think will reduce the capital losses to an acceptable level.

      Bear in mind that the idea is to give small business a fighting chance. The pay-off from salaries and taxes will outweigh losses (even with high defaults) over time.

  • http://www.smaltitech.com Martin Owen

    Interesting but…..
    I am at the fringes of Wales and I do understand the problem as expressed (although there are investment schemes here).

    I am, however, in the tech business and my start-up, pre-revenue requirements are different from starting a lawn mowing business. My development, scale-up and launch needs are significantly different. I do not think it is an either/or comparison between the two proposals. Many who have started small business with the aid of the Prince’s Trust will go a long with the suggestions above, but they would not work for someone trying to create a disrupt or nothing concept.

    Public money for investment grants and loans have one function. First and foremost they are awarded to stimulate the economy and create jobs and wealth for the country/region. Currently they are not awarded to make the entrepreneur rich – that is a potential side effect. They do enable the entrepreneur to have access to funds they might not otherwise have.

    There is a good reason why such grants should be targeted where the aim of the support is most needed.

    The grant/loan suggested above is awarded in a way that is contingent on the entrepreneur becoming rich – and if they are “easy to get” – that may be based on self-delusion. Writing a custom business plan; scrutiny by someone whose wealth/job depends on picking winners; and competition for the finance has to be healthy part of the process.

    However it is clear that a quick loan scheme which is underwritten by my future performance is needed. Getting a loan from a bank to cover cash flow, even when underwritten by a mortgage free house, has been like looking for hen’s teeth.

    • http://simoncast.blogspot.com Simon Cast

      To an extent the scrutiny by a professional is valid. However, the hit rate of professionals is patchy as best. A good discussion on this is on-going on Fred Wilson’s blog on his two recent posts about the math of venture investing.

      Investment professionals don’t scale as someone over on Fred Wilson’s blog pointed out and unfortunately, there aren’t large numbers of good investment professionals around. That makes scaling the use of investment professionals difficult.

      The point of the loan scheme is to address the very, very early stage needs of business. Essentially the first year (potential first 2 years). It isn’t about replacing angel, seed or venture funding. The aim is to get small business to the point of being able to take on private funding should that be suitable (as in the case of your coy) or be at a point that revenue can support the coy (as in the case of the lawn mowing coy).

      The co-investment proposal comes in but I think at a later stage. It isn’t an either/or but the loan scheme will be faster to roll out and benefits a larger range of businesses.

  • http://www.WORKSsitebuilder.com Angus Phillipson

    I agree that looking at tech (web) is myopic. I also agree that job creation is important, but I am not sure if seed investment is to be made available that lawn-mowing is the answer to our wider economic development. Is our future not reliant on the continued development of a knowledge-based service economy, not just technology?

    With the decline in importance of the city and the finance sector within the economy, previously representing 11% of GDP in 2007, should we not be looking to invest in our knowledge economy and the creation of the requisite skills to drive that?

    In my sector (back to the web myopic!) it surprises me that the (software) engineering skills required are still so narrowly taught in the UK, given we are aspiring to be Digital Britain. Surely it is a more attractive proposition for under-graduates if business is burgeoning in that sector on the strength of global demand, and ongoing investment in that sector?

    Is this not our future in this increasingly connected world, and their economies?

    I like your income-contingent loans idea. Although will it become my responsibility as an employer to administer repayments, like student loans? Government red tape will get us in the end…!


    • http://simoncast.blogspot.com Simon Cast

      The knowledge economy is important but don’t let that blinker you to the value to the wider importance of a robust economy.

      If anything the financial crisis has shown that relying on any one particular industry as a significant portion of the economy leaves a country heavily exposed to a down turn in that area.

      We are shifting into what Umair Haque likes to refer to as an edge economy. That changes the dynamics in which smaller, interconnected business of all varieties are important. The concept of one particular area being dominate is unsustainable. Arguably, businesses such as plumbing, carpentry etc are as much knowledge-based service as Google. It is simple a different type of knowledge.

      The idea of the scheme isn’t necessarily a seed investment but a seed loan with forgiving terms that isn’t tied to the success of the enterprise but the income of the individual. The loan is to be paid back through the tax system and imposes a burden on business but no more than student loans and would dovetail into the same system. In essence it wouldn’t be different from employing someone with a student loan.

  • Angus Phillipson

    Hi Simon,

    Appreciate what you say, but feels a bit tail wagging dog to me…

    Is this not loosely the difference between the tertiary and quaternary sectors?

    Constructive Capitalism, as Haque calls it, is knowledge, innovation and technology driven and falls largely within the quaternary sector. I think that investment and development of skills within the quaternary sector would see us optimise our remaining secondary sector services keeping them competitive and also providing expertise and services that are in demand globally; not forgetting that we export little these days.

    I agree that diversity is important, which is why I agree that it is myopic to focus on web technology. Innovation within manufacturing or engineering would be a good example, but even that is largely technology driven.

    As Haque says the future of value creation lies in better ways to compete (globally) and fostering innovation. For Haque this was based on technological change.

    My point really being that with globally competitive knowledge based economy comes robust, wider economy.

    Still don’t get why it is the employers responsibility to administer employee student loan repayments though….would much rather be administering innovation!


    • http://simoncast.blogspot.com Simon Cast

      I disagree with you. Constructive capitalism isn’t confined to one sector of the economy. It has to feed across the whole chain. There is no good in creating wonderful quaternary sector when people working in the primary, secondary and tertiary sectors only have access to soul destroying jobs.

      You can have all the knowledge creation you want but if it never is applied to real systems it doesn’t create economic value. The idea is to promote knowledge, innovation and development across the whole sector. Innovation happens at the edge, at the point of need. It rarely happens because someone in the quaternary sector has decided it is worthwhile.

      Technology development is not something confined to one layer. In fact you can argue that very little applied innovation happens in the quaternary sector rather it happens where there is a need.

      Value lies in creating great things, whether a good or a service. It has nothing to do with competing globally or locally. This may be technological or it could be shit hot customer service.

      A knowledge economy is not dependent on one sector or the efforts of one sector. It lies in the application of knowledge across the economy. Primary research and development feeds that but it firmly falls within the application of knowledge across the economy.

      Business already has to deduct student loan repayments from an employee’s salary. It is the same thing. It is a clerical procedure when paying the employee. It is a computer task and its not a burden. If it is a burden on the company to perform this clerical task as part of the process of paying a salary then that company has far more serious problems than clerical effort of making a deduction from a salary package.

  • Angus Phillipson

    Hi Simon,

    You are saying exactly the same thing, and you are correct that it is not confined to one sector of the economy.

    It is important to understand that the quaternary is not a sector of the economy per se, it is a notional construct that transcends all economic sectors.

    It is where innovation, largely technological and information driven, takes place. It is not confined to one particular sector of the economy, but it affects them all. It makes them more efficient, successful and in this case helps them compete globally.

    For example, Dyson make vacuum cleaners, primarily a manufacturing (secondary sector) activity. Research and development, product innovation, brand development, web strategy and innovation in customer service software systems (quaternary / knowledge activities) make the company more efficient and globally competitive, benefiting our economy as their continued (international) success trickles down through many different associated businesses and services, and ultimately making the life of the cleaner better.

    That is the salient point, and where I believe this funding should be directed.

    Its purpose is not front-line regional development, which is currently funded and managed separately.



    • http://simoncast.blogspot.com Simon Cast

      The point is you are trying to pick winners. The point of the scheme isn’t to pick winners but to allow as many entreprenuers to have a go.

      Bureaucrats are bad a picking winners and so are investment professionals. The scheme removes human judgement and lets lots of potential business start.

      Yes, many will fail and most that succeed will not go onto become Google or Dyson but that isn’t the point of the scheme. The point of the scheme is to allow as many as possible business to start to address a need that the entrepreneur feels is unmet whether this need is for a lawn mowing company in north Wales, a plumber in the Scottish Highlands or software company creating a new web service.

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  • http://www.becomeavonrepresentative.co.uk Claire Jarrett

    A lot of the time the money that is needed is much smaller amounts, just £500 to £5000 in order to get a business started. In my opinion we ought to making these smaller types of loans and grants available very easily at the moment. The type of person who needs to access the smaller funds generally also isn’t very good at the form filling so the less admin the better.

    • http://simoncast.blogspot.com Simon Cast

      That is a good point and micro-lending has been very effective in getting small businesses off the ground. There is value in bringing the Kiva model to the UK.

      Another method is for Zopa to set up a specific business loan stream so that users can specify details on the business.

      I still see this working in tandem with the loan scheme. It isn’t (or shouldn’t) be an either/or. For example, the loan scheme pays for living expenses etc. for an entrepreneur while the micro-loan pays for an asset that the entrepreneur will use in the business.

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