These are exciting times for the venture capital industry but only if the regulatory authorities back the government and are bold and ambitious in backing growth business.
A changing VC landscape
A few years back, I wrote an article for Tech City News congratulating the government on various initiatives to stimulate an entrepreneurial culture but bemoaning the lack of funding for venture capital businesses.
And to the government’s credit they have done a great job redirecting capital to the right places. For instance, the EIS / VCT rule changes announced in 2015 and 2017 have hopefully stopped the old ‘tax led’ products for good and brought these schemes back to what they were designed for, which is backing early stage businesses.
Now the UK venture capital schemes (EIS and VCTs) are all about ‘investment led’ funds with tax benefits to help offset the risk.
But this is just the start…and the government understands the need for the larger chunks of capital into the venture capital sector to enable the successes to compete on the global stage.
The government is looking to take VC funding to the next stage
The latest budget might have seemed tame compared to last year’s patient capital review-based announcement for the UK Venture Capital Schemes, but there was intriguing news about pensions.
The Government is reviewing ways to enable investors to invest a portion of their pension pots into venture / patient capital.
This could result in the required later stage funding for growth businesses, working well in conjunction with the UK venture capital schemes which would take the earlier stage risk. And sitting alongside the £2.5bn Patient Capital Bank programme of investment announced by the government in the 2017 budget.
Even a small allocation from pension pots would make a huge difference to the ability of venture capital firms to support later stage companies, which might require £20-50m to go to the next stage, especially in those areas where the UK is a genuine world leader, such as Innovation and R&D.
A recent FT article by two Imperial Professors pointed out that if ‘we adjust for the size of our economies, the UK now exceeds the United States in numbers of spinouts formed, disclosures of discoveries, patents and licences.’
And in terms of commercial success, we would argue that the continuing professionalisation of the spinout process – from patent protection, investment structures and the recycling of successful academic and management teams – is delivering the investment returns which should allow the field to emerge as a stand-alone asset class.
Even with some specialised funders in this sector there still lacks the big-ticket funds required to produce a long stream of true global winners, which is where the pension funds could step in.
Role of pension funds
Undoubtedly pensions funds will be reluctant given historical variation of returns from the venture capital sector. But the UK VC sector is maturing with a number of funds generating attractive returns and track records.
This is coupled with a fantastic entrepreneurial tech ecosystem in the UK which has been transformed over the last 10 years and is fueling deal pipelines with quality investment opportunities.
Plus the pension proposal is focused on the later stage investments / companies, ie the successes that have broken through the earlier stage risk period, and any allocation to this sector would be capped. So arguably a lower risk subset of VC overall return profile.
On the other side, the returns from other alternative assets are flatlining, or even falling. For instance, there has been various articles regarding the high levels of Private Equity ‘dry powder’, and there seems to be a concern over the lack of quality deals.
In addition, there is still a lot pension cash invested in government and corporate bonds, with limited yields. So a patient capital solution for pensions potentially makes sense for all – investment into growth asset classes could provide the necessary growth kicker required in portfolios to meet the increasing long term financial needs of the retiree.
Role of regulatory bodies
As the policy document accompanying the announcement stated, the authorities are looking at ‘a range of measures to ensure the UK’s regulatory environment enables DC pension schemes to invest in patient capital as part of a prudentially diverse portfolio’. And reviewing the rules to allow further unit-linked investment into patient capital assets
The FCA consultation on this subject is currently open and due to close on 28th February 2019. It highlights that the proportion of illiquid assets (mainly commercial property) held in unit-linked funds was very low in proportion to overall assets (£27 billion compared with £914 billion in total).
Currently there is 10% limit on the proportion of fund assets that may be held in land or property, with a proposal of increasing this to an overall amalgamated percentage limit for all illiquid assets to 50%.
For unquoted investments the current rules allow unlimited investment in unlisted securities, but only when these securities are ’readily realisable in the short term’. Clearly most VC investments do not meet this criterion.
So the FCA propose allowing investment by firms in permitted unlisted securities which are not ’realisable in the short term’ provided that liquidity requirements at the level of the investment fund can be met.
Clearly lots of details to be accessed, reviewed, clarified etc but regardless it is fantastic that venture and patient capital is at the forefront of the UK strategy and let’s hope the asset class moves further to the mainstream to help realise UK Plc ambitions.