The iconic image most people have of entrepreneurialism is of a founder working away in her garage, office or laboratory coming up with an innovative idea to help make the world a better place and then becoming rich off building the company.
The question for governments and investors is whether the founding idea is worth much versus building the company to a big enough size in terms of revenues, profits and/or employees to impact the world.
States around the world are looking at helping both ends by encouraging people to develop their ideas and start up a company and then providing them with the money and resources to scale up but without reducing the entrepreneurial spirits or crowding out private capital through unnecessary or misguided interventions.
It is a difficult balance to strike. But reading between the lines of the UK government’s consultation of patient capital – money invested long-term in businesses to help them scale up to be large companies employing at least 250 people – and it seems that the emphasis inside government and among its advisers is that more value and focus should be on the investors scaling up the business rather than those coming up with the idea and helping the entrepreneur set up a business.
That seems to be the big question underlying the UK Treasury’s review of patient capital, Financing Growth in Innovative Firms, and whether “a material number of firms in the UK lack the long-term finance that they need to scale up successfully?”
It also goes across a similar review being carried out on university startups and spinouts by the UK’s Department for Business Energy & Industrial Strategy (BEIS, expected to report in about four months,) and the broader industrial strategy set out in a green paper last year.
Following on from Global Corporate Venturing’s editorial last week, Finding a venture investment edge, one insider to the UK’s spate of reviews, papers and consultations summed up the thinking as: “The value of a patent is less because the pace of change is higher. The bigger risk is in commercialization.”
Equally, the adviser said avoiding entropy and improving the innovation toolkit for these larger companies if they became public was also important. “It is a changing world of money. [Western] public companies are mediocre, lacking vision and uninvestible.”
By contrast, the leading venture investors are increasingly Asia-based corporations active in China and the US and which combine pace and size of investment with business unit speed of execution and follow-through on opportunities.
It reflects the changed world of venture that the past week typifies in about half a dozen rounds of more than $100m in size:
- Meituan-Dianping, the Chinese local listing and services portal formed in late 2015 by the merger of unicorns Meituan and Dianping, is reportedly in talks with investors to raise between $3bn and $5bn in a round that will feature a $1bn investment by existing backer Tencent
- SoftBank’s Vision Fund is reportedly in talks to invest $1.5bn to $2bn in Flipkart, which was valued at $11.6bn as of its last round earlier this year, in a deal that would enable it to join an investor base that already includes eBay, Tencent, Intel Capital and Bennett Coleman & Co.
- App developer DotC has raised $350m in a series B round led by Avazu’s parent company Zeus that involved the ownership of Avazu being transferred to DotC in a deal that will give Zeus a stake of just over 30.6% in the company.
- Online fresh produce retailer Yiguo has secured $300m in funding from Alibaba subsidiary Tmall as part of a partnership agreement that will involve Tmall integrating Yiguo’s product into its existing offering.
- US-based online business lending platform Kabbage has received $250m in funding from existing investor SoftBank, roughly doubling its overall funding in the process.
- Peer-to-peer lending platform Dianrong has secured $220m in a round led by Singapore’s sovereign wealth fund, GIC, and followed a $207m series C round two years ago that included Standard Chartered Bank and industrial leasing firm Bohai.
- E-commerce software and services provider ShopEx has secured $104m in a series D round led by venture firm Joy Capital and its past investors include Alibaba, Bertelsmann Asia Investments, Legend Capital and Legend Holdings.
And it would be less than a surprise to see strategic investors in other deals last week, such as BlueteamGlobal, a US-based provider of cyber threat and security services co-founded by ex-Morgan Stanley COO Jim Rosenthal, which raised more than $125m, or healthcare companies such as Medtronic interested in Auris, a health care company developing less invasive medical interventions and that has just raised $280m in its series D round.
Bear in mind this is the past week’s larger deals. Excluding Meituan and Flipkart as just potential deals, that is about half the total annual venture capital funding in the whole of Europe in 2012 or 2013 (of just more than €3bn in those calendar years). And with none of these larger rounds above based in Europe it is also hard to see many European investors in them either, let alone leading.
As the Treasury’s consultation* said: “UK corporates make a small but important contribution to investment in patient capital, most typically in venture capital… [and] the UK was the second most attractive destination for corporate venture investment (100 investments in 2016).”
Softbank’s $93bn Vision Fund is based in the UK but outside of its $502m round for Improbable in May has struggled to find suitable large targets in Europe, instead focusing on the US and Asia as typified by last week’s deals. Other deals, such as last week’s $8.5m B round for UK-based Wonderbly is perhaps more indicative of how “fewer UK firms receive follow-on investment compared to the US, and those that do receive less,” according to the Treasury consultation, as the global series A and B round average size in the second quarter was $11.9m.
In this context, governments trying to focus on why the old continent has effectively missed out on much of the greatest wealth-creating opportunities of the past generation is worth reflecting on. None of the top 10 largest internet companies are based in Europe, although Germany has in the past few years seen the flotation of conglomerate Rocket Internet and some of its portfolio companies, such as Zalando and Delivery Hero.
But in the UK, there appears concern in the consultation paper about the relative lack of similar success stories in its country. The Treasury looked at one vintage, the 239,649 firms started up in 1998, and found that while 11% had survived their first 15 years only a few (“less than 100”), such as Asos, Double Negative, Financial Express, YouGov, Abcam, EcoTricity, Jack Wills and Sweaty Betty, had scaled up to a “large” size by employing more than 250 people and remained independent in this period.
As the consultation perhaps pointedly noted: “Some of these firms remain private firms and appear not to have received investment from external investors.”
This raises the question of whether existing tax breaks and investment programmes have worked. The consultation asks: “Which programmes (investment programmes, tax reliefs and tax-incentivized investment schemes) have most effectively supported the investment of patient capital to date [and] when is it more appropriate for government to support patient capital through investment rather than through a tax relief?”
The Treasury calculated the cost of its tax breaks per £1 of additional investment and using the upper and lower tax costs and multiplying against the annual investments made through the different schemes works out at between about £1.6bn to £3.6bn per year***.
Venture capital investment in UK-based private firms is about £4bn per year but if the country had the same level of investment as the US, total venture capital investment in British firms would be around £4bn per year greater, according to the Treasury consultation paper.
The secretariat of the industry panel supporting this review, led by leveraged buyout doyen Sir Damon Buffini, has separately modelled an overall range of between £3bn and £6bn per year between the current annual supply of capital and that in a fully functioning UK system.
Its analysis pinpointed UK universities spinouts** as a potential area for greater focus as it found the number of investments in spinouts rising from 45 in 2011 to an average of 85 per year from 2014 to 2016 but the total amount invested falling slightly from £370m (2011) to £340m per year (2014 to 2016).
As a result, the UK is considering setting up a National Innovation Fund under the British Business Bank in its Autumn Budget and after the consultation finishes on 22 September.
But unstated in the consultation, which has regulation as one of its focus areas, is the broader issue of how these entrepreneurs and investors can navigate the tricky issue of how, having effectively missed some of the latest deep tech and innovation trends of the past few decades, the UK can navigate the future given the oligopolistic nature of the economy.
As Mauro Guillen, professor of management at Wharton School, said in his blog about how in the age of big data companies from large markets would have an advantage: “Perhaps the single most important factor in the future development of technology will not be the process of innovation itself but how effectively companies align themselves with large transformations in the marketplace so that they can gain scale quickly.”
Life for entrepreneurs, whether at the early or later-stage, remains a hard journey it seems.
Notes:
* Disclosure: The UK Treasury included data provided by Global Corporate Venturing for its section on corporates’ role in patient capital
** Global University Venturing will be focusing in more detail next week on the implications for UK academic institutions on the patient capital review and how if starting ownership positions for universities from its research is less than 10% rather than nearer 50% how to develop follow-on funds as well as a proof-of-concept fund, infrastructure and talent.
***Tax breaks in the UK per year
Scheme Cost per £1 of additional investment Total invested Tax amount
SEIS £0.87-1.11 2014-15, 2,290 companies received £175m 152-194m
EIS £0.57-0.73 2014-15, 3,265 companies raised £1,816m £1035-1325m
VCT £0.90-1.22 about £400m/year since 2011-12 £360-480m
ECF £0.20-0.34 Since 2006, 23 funds worth just over £550m (end of January 2017) £110-187m/10 years
VC £0-0.40 “venture capital investment in private firms is currently around £4 billion per year” £0-1600m
Source: HM Treasury, analysis Global Government Venturing