Springboard to Funding #7 - No More Heroes?

Added Thursday, January 25 2018

Have you ever thought to stop and ask where Venture Capitalists get their money from? Well here’s an unlikely tale where the heroes are actually the government and a bank!

VCs take big sums of money from what are called Limited Partners. They invest this in a number of exciting companies with great growth potential while having some involvement in their management. Typically their aim is to invest for five years, weed out (close or sell at a loss) the non-performers, continue to invest in the rest and then sell them, ideally in the following five years. 

The theory is that a few stars or at least good performers will, balanced across all of the investments, provide a handsome reward to the Limited Partners. The LPs are so called because in this model they have limited (actually no) control over the investment process once their money has gone in.

Once upon a time this money came from pension funds and the like. But after the dot-com bubble burst, this became much harder. 
And another source of funding for VCs has hit trouble. The European Investment Bank has invested €2.3bn which is around one third of all UK VC funds. Funny enough, they’re not doing that at the moment – can’t think why…

Time for a hero then. But who’d have expected it to be a bank?

The British Business Bank was created out of the financial meltdown of 2008 by the government and is 100% owned by it. It does many things to encourage more funding into smaller and growing UK companies and it does them well. 

A case in point is the Enterprise Capital Funds. These put up to £50m into suitable UK funds, which can represent around 60% of each fund. There are some sensible restrictions which ensure the funds are doing the right sort of deals for UK target companies, but the system works well with 24 funds taking approximately half a billion Pounds from the Bank. This has provided finance for nearly 400 firms. What a hero!

And this banking superhero is rumoured to be taking on new superpowers as government considers mandating it to replace the European Investment Bank backing for UK VCs. We await this, along with all the other Brexit fallout, with great interest.

Now you may have seen some interesting news coverage of Invest NI’s approach to investing in NI VCs. Knowing that it was next to impossible to raise money for regional funds, they provided £30m across two NI funds in what is known as subvented capital. This is likely to mean that the private LPs get their money back including a good return before Invest NI get anything. And of course this has attracted criticism from those who do not understand how important and yet how difficult it is to make this type of capital available locally. They conveniently ignore the other £30m of private capital which INI has enabled.

That said, it’s interesting to compare this to the British Busines Bank approach. They get a 3% prioritised return while repayment of the original capital is both to the Bank and the other private LPs. And then the Bank only get a fixed share of the upside.

I’m not saying that Invest NI are wrong in their approach, only that the further out into the regions you go, the harder it is to raise this sort of capital and the more incentives you have to dangle to get it.

However the most interesting thing is that there are no funds in NI utilising the Enterprise Capital Funds. Until this happens we are going to need more subvented capital, or alternatively it may never happen while we provide subvented capital.

Perhaps we need some more heroes?

Alan Watts is the Director of Capital Match at Catalyst Inc (formerly the NI Science Park).

For more information about Capital Match or to contact Alan, go to capitalmatch.catalyst-inc.org