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UK government creates £150m fund to help VCs back startups. Good for you? Or just the VCs?

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Back in December last year the UK government announced it would back the creation of a “£1bn venture fund” to invest in startups. At the time it sounded rather far-fetched. However, yesterday it was confirmed that this would indeed be going ahead, along the lines proposed by the NESTA, the National Endowment for Society, Technology and the arts.

The fund is broadly aimed at startups, but it’s likely to concentrate around science and technology, since its specifically aiming at “innovative, fast-growth companies” – and these don’t tend to be companies created to sell socks online. Thus, the fund is expected to focus on clean technology, bioscience, digital technology and advanced manufacturing. According to government figures there are 1,093 venture capital backed tech companies in the UK employing more than 40,000 highly skilled workers. That’s relatively small, however venture capital backed companies significantly out perform other companies and and 69% of these venture backed companies introduced entirely new products or services into the market.

The UK Innovation Investment Fund, as it’s called – announced by by Lord Mandelson, First Secretary of State at the London Stock Exchange yesterday – will invest £150m, to be matched by private sector backers. Prime Minister Gordon Brown has suggested that the fund could be higher, up to £1bn, if enough private investment is forthcoming – I think we can safely say that’s very much up for debate in this current climate. This notional £1 billion figure comes from a 10 year window for the fund.

Lord Drayson said £100 million of the £150 million will come from the Department of Business, Innovation and Skills, with the remainder being put up by the Department of Health and the Department of Energy and Climate Change. The fund will invest on an equal basis in a process known as known as “pari-passu”. The fund will be regulated by the Financial Services Authority (FSA).

A government-appointed manager will run this “fund of funds” and – according to the statement – hopes to make its first investment by the end of the year – so they had better get cracking.

Part of this initial £150 million will come from £750 million strategic investment fund the government announced in April to provide financial support to high-tech companies. That announcement sparked a wave of debate on TechCrunch Europe, with an open letter from Angel investor Robin Klein and two further responses.

Accordingly, this latest move was broadly welcomed by the private equity and venture capital industry which, largely in the form of the British Private Equity and Venture Capital Association, has been lobbying the government over this issue for the last two years, along with the European Investment Fund and others.

The government says say this “Fund of Funds” structure turned out to be most attractive to institutional investors because it creates a portfolio approach that spreads the investment risk across a number of different technology fund management teams and enables the Government to back private sector innovation without distorting or competing with existing fund managers. It’s also designed to complement existing public sector interventions such as Enterprise Capital Funds, RDA European Development VC Funds as well as tax measures (though I don’t see much new initiatives on the latter of these).

However, this initiative really isn’t all that new.

It looks very much like the previous UK High Technology Fund structure that was announced in 1998. This was a £125 million “fund of funds” which invested in a number of specialised technology VC funds such as Advent, Amadeus, MTI and Scottish Equity Partners. Back then the Government provided a cornerstone investment of £20 million which the funds were able to leverage with an additional £105 million from the European Investment Fund, UK pension funds and a French bank.

So overall, the questions are this.

Is this the best way to fund good start-ups? We still haven’t seen any movement on the UK government on capital gains tax, an area which tended to provide a great pool of seed funding before it was destroyed a couple of years ago. The issue I hear from startups time and time again is that it’s pretty cheap to build a beta, but getting seed funding to do this is tough.

And why has the government not used the tax system to stimulate innovation? In France, a recent new law brought in by President Sarkozy to allow private individuals to invest in startups has proved a rip-roaring success. It even allows them to spend 25% of their allocation in other EU countries. Talking to entrepreneurs and startups in Berlin recently, the chatter even suggested that the Germans may copy this French law. Where would that leave the UK? Right now it leaves startups stumbling back into the much higher barrier to entry VC eco-system.

And which VCs will get access to this fund of funds? Will they be the “good” ones that have consistently picked big global / European plays like Skype, SeatWave, Wonga and the like?

What happens if this fund is distributed to VCs that are actually using it to prop up a failing business model? The ones which, left to market forces and the changing role of VC, would have withered and died?

Let’s take a look at who did the bulk of the lobbying. The BVCA’s committee to lobby the government on this issue consisted of the following:

Richard Anton
Alan Bristow
Mark Caroe
Rob Carroll
Andrew Carruthers
Mike Chalfen
Stuart Chapman
Simon Clark
Anthony Clarke
Russ Cummings
Stephen Edwards
Nigel Grierson
Tim Haines
Barrie Hensby
David Hunter
Graham O’Keefe
Gary Le Suer
Bruce Macfarlane
Mary Monfries
Philip Newborough
Patrick Reeve
Ernie Richardson
Simon Walker
Rob Young

Unfortunately it’s not disclosed which venture firms these people were with – though perhaps readers can help me to identify their companies. Update: He’s what we have so far:

Andrew Carruthers – Spark
Anthony Clarke – BBAA/LBS
Russ Cummings – Imperial Innovations
David Hunter – NESTA
Patrick Reeve – Albion Ventures
Ernie Richardson – MTI
Simon Walker – BVCA

So, there we have it. No tax loosening from the government, but instead a system to prop up the VC industry. Hopefully it will work and feed through into innovation and entrepreneurs. Fingers crossed.

  • Wille

    Good for the VC’s that qualify, as it effectively constitutes a subsidy to the chosen VC’s.

    I do not believe in the “efficient markets” theorem one bit, but neither do I believe that the government is magically better at investing than any other market actor, especially considering it’s not their money on the line.
    Why would bureaucrats with no skin in the game know what VC’s will be the best investors better than anyone else?

    If they want to stimulate entrepreneurial activity and investment, incentivice it through the tax system and regulation (or lack thereof).

    We’re on a slippery slope if we start believing that all money has to be ferried through the exchequer for it to be invested wisely..

  • http://philippmoehring.de Philipp

    There is a very similar structure in Germany – the KFW Bank can co-Invest with private investors in the ERP Startfonds, essentially getting the exact same rights and provisions as the private investors. It works quite well for early stage firms, but the high-flyer deals are usually financed completely private (even if syndicated). For earlier stages, this is of course very interesting, since Business Angels and smaller firms can stretch their funds with this method. Especially in a down economy where follow-up rounds are much harder, this gives a little leeway to investors. All in all, there can be problems of adverse selection, so the structure and set up are really important.

  • http://jackson-delaney.co.uk @_nige

    One of the first things I noticed was that there was only one one woman’s name on that BVCA list.

  • John Barrett

    I would take what this government says with a very big pinch of salt if I were you. Gordon Brown promises a lot of things that never seem to come to fruition, especially lately, he’s saying and promising anything in a vain attempt at re-election. Usual labour thing, great ideas, but where’s the money going to come from. especially as they have now nearly bankrupt the country. They seem to think were all stupid or something. Personally, I’ll believe it when I see it.

  • http://www.g2i.org g2i

    Andrew Carruthers – Spark
    Anthony Clarke – BBAA/LBS
    Russ Cummings – Imperial Innovations
    David Hunter – NESTA
    Patrick Reeve – Albion Ventures
    Ernie Richardson – MTI
    Simon Walker – BVCA

  • http://www.estatecreate.com Henry Yates

    Richard Anton – Amadeus Capital Partners
    Alan Bristow – ICON Corporate Finance
    Mark Caroe – Eden Ventures
    Rob Caroll – Catapult Venture Managers
    Mike Chalfen – Advent Venture Partners
    Stuart Chapman – Esprit Capital Partners
    Stephen Edwards – Core Capital
    Nigel Grierson – Doughty Hanson Technology Ventures
    Barrie Hensby – NEL Fund Managers Limited
    Bruce Macfarlane – MMC Ventures
    Philip Newborough – Bridges Community Ventures
    Rob Young – Accelerator Group

  • anon

    Russ Cummings – ex SEP now Imperial Innovations
    Gary le Sueur – Scottish Equity Partners

  • http://www.avc.com Fred Wilson

    The top venture firms don’t want, don’t need, and are never going to take government money. The same is true of the top entrepreneurs.

    The worst firms, on the other hand, will gladly accept government money. And that is what is going to happen with all of these government efforts to pour more money into the “innovation sector”. That money will go to bad investors and weak entrepreneurs and management teams for the most part. It’s a problem of adverse selection.

    http://www.avc.com/a_vc/2009/02/a-stimulus-plan-for-venture-capital-no-thanks.html

  • http://www.icomplete.com Stuart Hibbert

    This would have been great a few years back when VC’s were investing in startup businesses – since which the bar has been moved up and now they are ‘generally’ won’t look at businesses with say less than a million a year revenues – so if this fund is aimed truely at innovation then this won’t necessarily help those companies who are at the cutting edge of innovation who need it most.

    So to answer your question, I would say this is aimed at the VC’s not the innovative companies that it is aimed at.

  • http://www.broadstuff.com alan p

    There have been these sort of funds for a few years, the aim was to “bribe” VC’s into investing in the riskier early stage company by sharing the risk.

    But in general they haven’t worked that well in the past, not clear why – I suspect Fred Wilson above may have hit the nail here.

  • Julian Dicks

    I have to disagree with these comments, and certainly with the assertion that Fred Wilson has ‘hit the nail on the head.’ If only it were that simple. There are plenty of successful UK VCs that have backed some of the best technology to emerge from the UK (and Europe) this past decade – it is these managers with a proven track-record that can help stimulate innovation. I don’t think anyone is suggesting this fund should pour money into less successful firms. The central problem is that venture in the UK doesn’t have the levels of institutional support that exist in the US and money tends to be thinly spread. This problem increased markedly post the dotcom crash and many investors who got burnt then won’t give venture another look now. I happen to believe the UK has an excellent stable of exciting, high-growth young companies that with this cash may now be able to get to the next stage of their development and deliver outstanding returns (and hopefully coax investors back to venture).

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