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The need to address the issue of long-term, “patient” capital is not new to the UK. It has been addressed in several reviews from the Cruickshank report in 2000, the 2009 Rowlands review, the 2012 Breedon review and the 2014 Scaleup Report.

Many of the “market/structural failures” identified in these reports have been addressed. The major banks have set up the Business Growth Fund (BGF) with its network of regional offices. The British Business Bank has been established. The UK angel investment market has flourished. The Small Business Act has been passed. The fintech revolution has been supported by the Bank of England and the broader UK regulatory environment. All of these have been positive measures which have created a stronger, more plural and diverse finance market in the UK than has ever been seen before.

Yet important work still remains to be done in order to unlock UK institutional funding to create a depth of UK-based, long-term capital that is ready to invest in ten-year-plus cycles and which is capable of multiple follow-on rounds. Scaling businesses consistently cite challenges in finding patient, ten-year-plus investors for Series B rounds and beyond – which is why they often turn to overseas markets for such capital.

So we welcome the Government’s focus on scaleups in its consultation on Financing Growth in Innovative Firms. The key is to turn this consultation into targeted, appropriate and measured action which achieves the outcome we are all looking for: to make the UK not only the best place in the world to start a business, but also to scale one.

With the dynamics of Brexit and an emerging sentiment among our fastest-growing firms that the UK is going to become a harder environment in which to scale, it’s never been more important to ensure that the UK is “match fit” for scaling up. This means building out our available finance options in tandem with access to skills, leadership capacity and markets.

Supply is not the only issue to address; demand still plays a role, as evidenced by the recent SME Finance Monitor: The Scaleup Perspective. Demand levers should be encouraged by sustained education to business on the options, benefits and accessibility of growth finance. This should include aligning the multitude of resources in Government to a relationship management culture – as exemplified in the Scottish Enterprise model, which works to great effect in joining up public and private sector initiatives to its fastest growing companies.

There is no one silver bullet that will address the needs of scaling firms or, in the words of the consultation paper, “encourage the development of young innovative firms…to foster their ambition…and ensure they grow to maturity in the UK [and] fulfill their full economic potential.” In our response, we recommend a series of actions that can be taken in the immediate and short-term. These are not either/or actions – they must all be undertaken in a concurrent manner.

Our five key recommendations are:

Within the coming months, to:

1. Allocate new funding to the British Business Bank (BBB) in order to develop the necessary flexible and scalable substitutes for a UK EIB/EIF that will work with private sector players across debt and equity instruments.

2. Continue targeted tax relief under EIS/SEIS. Lift current time and capital limits on Venture Capital Trusts (VCTs) to allow VCTs to provide appropriate follow-on funding for fast-growing firms in their portfolios. Assess the removal of stamp duty from closed-end funds and VCTs.

Across next 12 months, to: 

3. Create a National Investment Fund / Patient Capital Investment Vehicle to “crowd in” institutional and retail investors, with the vehicle capable of listing and operating alongside a substitute EIB/EIF structure.

4. Stimulate demand and improve knowledge of finance among high-growth firms as part of the development of comprehensive local ecosystems.

Generally, to:

5. Take on board the private sector recommendations under the Scaleup Taskforce on data, markets and leadership to ensure they are taken forward in an appropriate manner. 

Let’s take a deeper dive into each of these recommendations.

1. Allocate new funding to the British Business Bank (BBB) in order to develop the necessary flexible and scalable substitutes for a UK EIB/EIF that will work with private sector players across debt and equity instruments.

This funding should be allocated within the upcoming Budget to give confidence and certainty to investors and businesses alike; it is important that the scale of the funding is sufficient to reassure markets. This funding should be flexible and scalable so it can address evolving market trends and dynamics, not just “here and now” requirements.

The EIB and the EIF have played significant roles in the UK financial ecosystem. They have acted as a cornerstone in the evolution of various growth capital instruments – across debt and equity – in the UK. Their contribution in 2016 alone is estimated to be approximately £750m, spread across venture capital (£300m), private equity (£200m) and debt funds (£155m).

It is now essential that the UK has the funding capacity to step up, and take on what has previously been an EU capital resource to many foreign investors and UK growth companies.

The substitute arrangements should be housed within the British Business Bank. It has built a successful track record with some core strengths. Recent Pitchbook data on VC funds shows the BBB to be the UK’s largest LP and the third-largest in Europe (based on VC commitments between 2010 to 2017). Their TVPI and IRR returns compare favourably to EIF and the private market.

Vital pools of capital and research collaboration for life science businesses and other innovative sectors have been provided under the Horizon 2020 and COSME programmes. As the UK’s relationship with the EU is clarified, access to these schemes should be maintained for UK innovative businesses – or be replicated as part of the UK’s replacement to EIB/EIF arrangements.

In taking on this enhanced role, the BBB’s UK and sectoral reach will be essential to address regional disparities and sector needs. This may lead to specific sector funds (e.g life sciences, fintech, creative) as well as local solutions relevant to local gaps. Such solutions would have the further benefit of providing further support to the Government’s Industrial Strategy. The key will be to ensure that the remit of the BBB allows such flexibility, and that their mandate ensures working with private sector players with strong regional dynamics.

2. Continue targeted tax relief under EIS/SEIS. Lift current time and capital limits on Venture Capital Trusts (VCTs) to allow VCTs to provide appropriate follow-on funding for fast-growing firms in their portfolios. Assess the removal of stamp duty from closed-end funds and VCTs.

The Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) have unlocked significant capital for early-stage growth firms and are particularly important for angel investment. They must be maintained and certainty provided over the structure of their risk capital tax reliefs – otherwise investor confidence will be damaged.

VCTs are a proven route for the provision of growth finance and investment into the real economy. According to the VCT Association, companies backed by VCTs have created 27,000 jobs and in 2015 alone its members invested £220m.

Yet current rules limit VCTs’ ability to provide follow-on funding for scaleup firms who are on a continuing high-growth trajectory.

It is disruptive for a fast-growth business to be forced to find alternative/additional investors – distracting the management team at a vital stage of its growth – due to regulatory barriers. The current time and capital limits on VCTs should be lifted to allow such follow-on funding.

We understand the Government may have some residual concerns on “capital preservation.” If this is so, then this could be addressed on a principles-based approach – developed in conjunction with the VC industry – to ensure that the lifting of time and capital limits is aligned with Government objectives. Actions could be undertaken to removed the grandfathering of excluded trades, excluding new qualifying investments from contributing to the purchase of freehold properties, and continuing to exclude sectors that do not meet the Government’s aims for innovation.

3. Create a National Investment Fund (or Patient Capital Investment Vehicle) to “crowd in” institutional and retail investors, with the vehicle capable of listing and operating alongside a substitute EIB/EIF structure.

Releasing institutional money to provide long-term patient capital must be the key outcome of this consultation. Life insurers hold assets of £1.81trn and UK corporates hold £500n of cash on balance sheets. This could be invested as patient capital. Only 16 per cent of UK pension funds are currently invested in UK equities.

Arguably, the UK has always needed some form of long-term, fully-fledged National Investment Fund (NIF). Concerted effort, working with private sector players, is now needed to create this.

Institutional investors require economies of scale, a portfolio approach with inherent liquidity and a favourable regulatory regime to enable and optimise investment flows.  Institutional investors are likely to prefer a scale vehicle which can deploy to UK growth capital investment firms, who have the skill sets to invest in fast-growth firms.

It is likely that several billions will be required. This is evidenced by the Business Growth Fund (BGF), which was established at £2.5bn and will require follow-on funding itself in the coming years. The BGF was backed solely by the banking industry and demonstrates that it is possible to “crowd in” significant investors. It is a model and vehicle that could be further bolstered through institutional funders to deliver even further scale to growing businesses. In creating a suitable NIF vehicle, lessons must be drawn from the creation of the BGF; it demanded the most senior industry, regulatory and Government engagement to reach agreement on the investment commitment and structure.

The NIF vehicle must work with the private sector. It must be established in a way that does not lead to the unintended consequence of stifling an innovative and diverse finance market.

The following principles should frame the structure of an NIF vehicle:

  • Flexible and large (initial seed capital of c. £3-5bn) to address challenges of tomorrow, not just current ones
  • Able to aggregate funding from institutional players (>£100m) and be able to deliver long-term later-stage funding to scaleups through a selected group of private sector partners
  • Able to address regional challenges in raising of capital, and provide the double bottom line in order to provide confidence in the current investment climate
  • Assess sourcing of cornerstone seed funding from UK Government or Bank of England to work alongside private sector institutions
  • Able to crowd in international funds, family office funds and corporate venture capital

It will also be necessary to:

  • assess and enable changes that need to be made to capital rules, including adjustment to risk weighting and the impact of Solvency II on institutional investment. Capital charges under the Solvency II regime act as a disincentive to invest in equities rather than bonds; on average, the capital charge for equity is double that of debt
  • reassess tax treatment of equity vs debt to recalibrate the fiscal and regulatory system to foster equity investment from a range of institutional players
  • review RWA treatment for ring fenced banks to review ability for UK commercial banks as a further source of investment
  • reassess whether an EIS for UK corporate investment would incentivise the unleashing of core corporate funding, and/or whether a formal agreement with UK pension and life funds to allocate one per cent of Assets Under Management (AUM) to UK funds investing in high-growth companies is beneficial

To take this forward, the Government should create an NIF Implementation Group. This would be chaired by HM Treasury and bring together the CEOs of institutional investors alongside the Bank of England, Prudential Regulatory Authority (PRA), the Financial Conduct Authority (FCA), the British Business Bank, London Stock Exchange plus the BGF and Woodford Investments who have existing experience and structures that currently support patient capital investment. The remit of this group should be to design the optimal structure for this vehicle and reach agreement on investment commitments which should then be implemented during 2018.

4. Stimulate demand and improve knowledge of finance among high-growth firms as part of the development of comprehensive local ecosystems. 

As evidenced by the ScaleUp Institute publication SME Finance Monitor: the ScaleUp Perspective (July 2017), recognition among scaleups of finance programmes could be improved. For example, only 24 per cent of scaleups are aware of the BGF; 16 per cent are aware of the British Business Bank; and five per cent of the Business Finance Guide.

It will be important to increase the consistency and quality of guidance and education on growth capital finance.

This should include a digital platform as part of a joined-up approach that leverages the available programmes and works alongside current business support infrastructure such as the LEPs, Growth Hubs and the British Business Bank.

As part of this process, the alignment of the resources in Government to an effective relationship management structure focused on scaling businesses should be implemented.

This is exemplified in the Scottish Enterprise model. Such a structure should go across local areas and product specialisations. At a local level, this could be built within LEPs/Growth Hubs, or the Growth Hub resources be realigned to a larger-scale British Business Bank responsible for a joined-up finance and business support framework operating with private sector partners. The ScaleUp Institute is happy to work with Government to develop this further and provide international comparators.

5. Take on board the private sector recommendations under the Scaleup Taskforce on data, markets and leadership to ensure they are taken forward in an appropriate manner.

We must pull all the available levers – at both local and national level, across public and private sectors – to support our diverse, cross-country, cross-sectoral scaling businesses. The good work already under way as part of the Scaleup Taskforce should be taken forward.

This includes the essential, more effective use of HMRC/ONS data to identify as early as possible our scaling businesses; the opening up of procurement opportunities; the better targeting of scaleup export services; the assessment of enhancing a fast-track visa system for scaleups based on the TechNation model; and the development of local scaleup programmes, including peer-to-peer networks, as part of Strategic Economic Plans.

Conclusion

There is no silver bullet to address the needs of scaling businesses, or to encourage the development of young innovative firms so that they grow to maturity in the UK and fulfil their economic potential.

The consultation on Financing Growth in Innovative Firms must deliver on several fronts; the replacement of the EIB/EIF through an enhanced British Business Bank; the continuation of targeted tax relief under EIS/SEIS and the lifting of limits on VCTs; the reassessment of the tax treatment of equity vs debt; the removal of Stamp Duty from closed-ended funds; the reassessment of capital charges under the Solvency II regime; and, crucially, the formation of a long-term National Investment Fund that does release greater UK institutional and retail investment into our scaling businesses.

 

 

 

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