Deborah Sterescu speaks to Rory Earley, CEO of government-backed LP Capital for Enterprise, about what the UK venture capital industry needs to thrive

1. What are the various ways in which Capital for Enterprise invests its capital (directly/indirectly)? Are there limitations in which funds it can invest and where the respective private equity funds can invest (company criteria, etc)?

Capital for Enterprise is primarily a limited partner, investing in funds, and funds-of-funds from the government's balance sheet. We do, however, have a small co-investment capability which we can use to meet specific objectives. For example, the Aspire fund is a co-investment fund that invests alongside lead investors in women-led businesses, in order to demonstrate to female entrepreneurs that there are relevant sources of venture finance available. Our Capital for Enterprise fund-of-funds can also co-invest in qualifying growth capital investments which the 2 sub-managers in that vehicle do not have the capacity to take on.

Each investment programme we manage has some restrictions; our core Enterprise Capital Funds (ECF) programme can only invest in funds making investments of up to £2m in underlying companies. They can also follow their money, but the restriction exists because this is where government and the European Commission have accepted that a gap exists which is not adequately filled by private investors.

The UK Innovation Investment Fund invests through the Hermes and EIF funds-of-funds, has different objectives, and therefore fewer restrictions.

2. Some people in the venture capital industry remain sceptical about government-backed schemes such as the UK Innovation Investment Fund, as many believe that government support is not what the UK venture capital industry needs to thrive, but rather, the government needs to provide attractive tax incentives for investors. What is your opinion on this?

Yes, there is a range of views and it is right that the mainstream venture industry should not be dependent on the government. A thriving venture industry should be working with private investors, who want to invest for good economic reasons. However, recent events have shown a need for government support and the government has acted quickly to put that in place. Venture funds were not able to raise new capital because the institutions were not able to make new commitments. Fund managers therefore needed to reserve capital for their existing portfolios, which meant few new investments and little new syndication for later round investments. Not only was that not good for the industry, but for the government, it meant that its investment in the science base was not being fully exploited and benefits to the wider economy were being missed.

It is also worth noting that Josh Lerner at Harvard found that every VC market across the globe that he had looked at had benefitted from government support at some time in its development.

Tax breaks might have been an alternative to the UKIIF but would not have helped institutions who found themselves over-allocated to alternatives because of the fall in quoted equity values. Tax breaks can also be a very blunt incentive, can distort behaviours in ways that are difficult to predict and they can be removed as quickly as they are put in place, which may not be the best way of facilitating and encouraging long-term commitment to an asset class.

3. What difference has Capital for Enterprise made thus far in terms of capital deployed, etc?

Since we were established in April 2008, we have made commitments of over £300m to UK venture and growth capital funds. That makes us a significant investor in the industry. We were able to react quickly to the financial crisis and launch the Capital for Enterprise Fund to take advantage of the opportunity presented by the problems in the banking sector. We closed that fund-of-funds and made allocations to managers in less than 4 months. The managers have already put close to £35m of mezzanine and equity to work in over 20 companies and we are pleased with the performance. Not only have we taken advantage of a market opportunity but, for the government, we have made sure viable businesses could be supported who could no longer finance their growth through bank borrowing.

4. What can a private equity fund expect from Capital for Enterprise as a limited partner? Is Capital for Enterprise a passive or a more active LP?

We pride ourselves on being an active LP. We need to ensure the interests of all of our investors are protected. That does not mean, however, that we interfere or jeopardise our limited liability status. We work closely with our GPs and build relationships with them based on open and frequent communication, not just reporting. We also help them by bringing our experiences from other fund investments and encouraging and enabling the GPs to communicate with and learn from each other.

Our role, which is sometimes difficult to communicate, is to commercialise government policy objectives in private equity. We are at arm's length from the government, so we can take an objective and convert it into a properly commercial investment programme, which will also attract private investors. That way, we can generate good financial returns as well as meeting the government's objectives for wider economic benefits.

5. What other measures can be taken by the government to boost investment into SMEs?

We also manage the £1.8bn Enterprise Finance Guarantee programme, providing guarantees for bank lending to SMEs and that is important for businesses with more modest growth aspirations.

We are not a political organisation or part of the civil service however, so we are not privy to policy thinking. We do offer strategic advice in relation to investment and our independence means we can be quite flexible when it comes to delivery.

6. Do you think the UK Innovation Investment Fund will be successful in its goal to raise a total of £1bn from investors?

UKIIF's investment into the Hermes and EIF funds-of-funds has allowed them to reach first closings of £125m and £200m respectively. That is already an impressive total in current conditions, and they remain open for investment. When we consider, however, that these two funds will stimulate additional activity both by allowing underlying VC funds to hit their first closing and by cornerstoning new funds, the £1bn target looks easily achievable.