Blog Entry | Wed 1 Jul 2009

Is new £150m innovation fund another false dawn?

Ian Wallis

It's hard to pick an empty promise from a sound and worthy initiative these days. Such is the desire, on the government's part, to boost its own flagging ratings, the business community is left wondering whether it is being duped by the latest marketing spin on an initiative that falls short of the mark.

On the face of it the £150m fund for innovation, announced on Monday by prime minister Gordon Brown and laid out in more detail by business secretary Lord Mandelson, sounded like the much-needed shot in the arm high-tech firms – such as those in life sciences, green tech and digital technology – needed to drive them through and out of the recession.

And so it may prove, particularly if it transpires that £1bn of private investment is injected into the innovation community as a result of the UK Innovation Investment Fund. Less a promise, more a hope as far as the government is concerned. There's a nice ring to the sound of the word 'billion' though isn't there. The caveat, if you can call it that, is that the 'anticipated' £1bn additional investment will be spread over the next decade.

So £100m a year for the next 10. Is this actually a great deal more than must have been invested privately in the past decade or a case of smoke and mirrors? You could argue that the £750m Strategic Investment Fund announced in April and created to support low carbon and technology initiatives among others bulks up the total new injection, but that's not necessarily the case as some of the new fund will apparently come from the previous allocation. Plus, it's still not what had been called for late last year.

Is it another false dawn?

When the word went around the business and investment community on Monday morning that the prime minister was set to make an announcement with significant implications for companies seeking finance and investors in general, there appeared to be a sense of bated anticipation, which perhaps wasn't sated by the speech.

In December I attended the launch of a report entitled 'Attacking the Recession' by NESTA (the National Endowment for Science, Technology and the Arts). I sat as Lord Drayson, minister of state for science and innovation welcomed the recommendations in the report. The headline grabber that day was that NESTA was calling for "the establishment of a £1bn venture capital fund to support early stage innovative firms that are already suffering from the retreat of private venture capital from the sector".

On Monday, in response to the news, NESTA called for match-funding of £150m to be put up by the venture capital community now, creating a total £300m fund instantly, with the government bearing the cost of 'first losses' and accepting to "subordinate its investment position" by putting a cap on its returns for the benefit of private funds.

Clearly there's only so much 'left' in government coffers and each sector has to make its own case for new funds, but surely the £150m will only go so far in saving the remaining early stage innovation companies that are being slowly but surely strangled by the recession. For many it will be too little, too late. Jonathan Kestenbaum, NESTA's chief executive said: "We welcome today's announcement to support the next generation of high-tech growth businesses. These companies are on the verge of collapse owing to an absence of capital. This initiative needs to get capital urgently into the system and must not get snarled up in bureaucracy."

NESTA reported that up to 30% of the UK's high-tech start-ups were facing liquidity problems in early 2009. And the Bioindustry Association (BIA), which represents the interests of small drug developers, said in March a third of its members had less than six months' worth of cash remaining. Those businesses will need almost instant gratification. And any that get it will no doubt need follow-up rounds, which given the lack of appetite recently may still be hard to come by. The reality is that companies may be left waiting until the end of the year before investments are made.

Nevertheless, Mandelson had this to say about the potential for more private investment on the back of the fund: "It is also a challenge to UK venture capitalists to follow the government's lead in backing British entrepreneurs in building exciting new companies, investing in new technologies and creating jobs."

The CEO of the British Venture Capital Association (BVCA) Simon Walker appeared ready to rise to the challenge on the behalf of the funds he represents. He was "immensely encouraged" by the initiative and said that more than 1,000 young venture-backed companies could benefit.

Seeing as there are 1,093 venture capital-backed technology companies already, this begs a question about whether this mean the £150m fund will only support those with a round of finance already in place? Such clarification would be useful to know for all the early stage companies just trying to get out of the starting blocks.

Certainly NESTA has recommended that if its desired £300m fund was created a third would go to existing venture capital-backed businesses with £200m going on new ventures over a four-year period, with £100 in the first year. We'll have to hope some transparency emerges from the various agendas and wish-lists of the players involved. Equally, we'll have to wait and see who will get the money - those in the 'equity gap' seeking less than £500,000 or larger businesses. NESTA at least would prefer the former.

So how will it work?

The initial £150m fund, made up of £100m from the Department of Business, Innovation and Skills and £50m from the Department for Health and the Department of Energy and Climate Change, will operate as a Fund of Funds. This means it will not be directly invested into companies. Instead a handful of specialist technology funds with investment expertise and a sound track record, will allocate the finance.

You can see the logic of harnessing VCs' knowledge here and it is more likely to provide the necessary incentive for institutional backers to commit more cash to the funds given it offers the portfolio approach which spreads risk across a number of fund manager teams.

If it delivers its goals - and the government has been down this road before with the UK High Technology Fund in 1998 - then it could have an impact on the economy. Certainly venture capital-backed businesses have more potential for high growth and global reach. In 1998, the government provided a £20m fund which leveraged £105m from the European Investment Fund, UK pension funds and a French bank. While the high-tech boom of 1998-2001 proved a bubble for e-commerce players unable to provide the returns VCs had anticipated, the biotech, clean tech, nanotechnology and low carbon industries emerged from the ashes. We'll just have to wait and see whether those same companies and new players will rise again.