UK venture awaits EIF replacement

At the beginning of August, the UK government announced it is to launch a new national investment fund to address a £4bn funding shortfall it has identified in the UK growth capital space. The announcement is the result of the treasury's patient capital review, which is being overseen by a panel chaired by Permira's former chairperson and managing partner Damon Buffini.

At the time of announcing the new fund, the government also launched a consultation process, the results of which will inform the specific structure and remit this new fund will take. Subsequently, chancellor Philip Hammond is expected to reveal further details when he delivers the Autumn Statement to parliament in November.

One of the aims of the process is to address specific gaps in the UK equity funding landscape. In particular, the document cites a lack of follow-on funding and slower scale-up rates among younger British firms compared to their US counterparts. Additionally, the research finds that fewer than one in 10 UK businesses that receive seed funding go on to receive fourth-round investment, compared to almost 25% in the US.

Numerous UK-based VCs have publicly made it known that EIF has walked away from their most recent fundraising processes until the future relationship between the EU and Britain is ironed out

This shortage in funding has been exacerbated further, as one industry insider told unquote", by changes to VCT and EIS structures introduced by the British government in 2015 in order to comply with European state aid rules. Among other factors, the changes mean VCT and EIS are limited to investing a maximum of £12m per asset – £20m where the business is judged to be "knowledge-intensive" – and can only invest in companies under a certain age.

"Around 80% of British SMEs are more than 10 years old," the source said. "That means that when the changes to VCT funding came into place, 80% of these businesses lost potential access to VCT funding overnight and that has created an issue when it comes to equity financing for scaling up." Indeed, unquote" data statistics also reveal a significant drop in recent years in UK expansion rounds valued at below £10m – the deal space in which VCTs typically operate. Having reached a peak of 160 such deals in H1 2014, only 64 were recorded in the same period in 2016, and 73 in H1 2017.

The solution mooted by the source is for the new vehicle to be set up as a public-private partnership to enable it to make investments that have become out of bounds to VCT fund managers. This is one of the options being considered by the panel, alongside the possibility of placing the vehicle fully on the government's balance sheet to be sold off once it has established a sufficient track record.

Another key factor the review is intending to address is that backing from the European Investment Fund (EIF) might dry up for UK-focused vehicles post-Brexit. In recent months, numerous UK-based VCs have publicly made it known that EIF has walked away from their most recent fundraising processes until the future relationship between the EU and Britain is ironed out. Indeed, since the Brexit vote, only four British VCs have received commitments from EIF, according to unquote" data, and three of these – Medicxi Ventures, Felix Capital and Keen Venture Partners – have international investment remits. By contrast, in the 12 months prior to the referendum, EIF made commitments to eight UK-based venture capital firms.

Filling the void
The government is proposing to fill the void left by loss of access to EIF with a domestic equivalent, should it be required. This could potentially include what it calls "a Green Investment Bank-type institution" being set up as a new subsidiary of the British Business Bank, or a series of funds-of-funds, or a public-private evergreen vehicle. To this end, the treasury last year announced it would invest £400m in venture capital funds via the British Business Bank, though the consultation document says there is a "strong case that government should seek to crowd in new investment significantly beyond this commitment".

Whatever shape the national investment fund takes, it undoubtedly has a critical role to play in the future of UK venture capital. Should the government get it wrong, and EIF commitments continue to dry up, the country's follow-on funding gap would only be likely to grow.

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