WEDNESDAY 16 DECEMBER 1998

MR ROBERT FOSTER, MR PETER BUNN and DR ALISTAIR KEDDIE

  820.  It would be very useful if you could give us some indication of how much your Unit, not TECs or Business Links, your Unit, does breaking it down between the three sectors.
  (Dr Keddie) You mean here and now or subsequently?

  821.  No, subsequently. Please write to us on that.
  (Dr Keddie) Okay.

  822.  Can I just move on—
  (Mr Foster) Can I add one thing I should have mentioned which the Secretary of State will have said in his statement today. He will have referred to the new Enterprise Fund which is specifically geared towards helping small companies. I should mention that as a specific, it is the £150 million to help entrepreneurs and grow small businesses.

   Chairman: Thank you very much indeed. Mrs Lait?

  823.  Can I move on to the subject of venture capital? Venture capital is obviously very important in start up and small- and medium-sized companies. It is noticeable that pension funds can be very cautious in terms of investing in them. There is a technical reason for that and it is perhaps not appropriate to ask you what your views are on that particular point, but how do you think that situation could be changed and would it be helpful if it was?
  (Dr Keddie) I am not sure, Mrs Lait, what technical point it is that you are referring to.

  824.  The technical point is they have to maximise their returns to their pensioners and they fear that they would lose money and those trusts have that written into them.
  (Dr Keddie) I do not want to comment on that precise point at the present time but I think if you are asking how can we encourage more funds to go into genuine venturing in the United Kingdom, certainly there are two things that will help to shift that balance. One is if we can demonstrate that the actual returns on investing in smaller growth high technology businesses are as good as or better than some of the more traditional investments. I understand, although I am not an expert in this, that there is now evidence becoming available that is beginning to demonstrate that. Really what I am saying is if financial institutions can see as good or better returns by investing in that part of the economy one assumes they will begin to do so. Traditionally, that has not been the case but recently the evidence is that it is. The other point is that investors invest not only in the technology and ideas but the business acumen and management skill and marketing skill to deliver the products at the end of the day and in the United Kingdom I guess it is fair to say that there has been, traditionally, a weakness there as well in some parts of the emerging company sector so the more we can do through other channels that we are working with, the Department of Education and Employment and others, to improve the skills of people who are starting up businesses, the more attractive investments will become for the investing community.
  (Mr Foster) There are two things I would like to add on the venture capital side. Obviously the problem is not just about money. The venture capital business is operating more in the way US companies do. We have had a lot of discussions with them in recent months and what is becoming clear is the extent to which the US venture capital funds are successful because they are putting far greater effort into the recruitment of management and helping to organise the business than they are actually into the provision of finance. We have been quoted by one of the leading US venture capitalists a ratio of 4:1 so only a quarter of the effort of that company is going into the provision of finance, three quarters/80 per cent is making sure they have got the relevant management skills and engineers and so forth. There is a huge change needed in the venture capital market in the United Kingdom. That is the first point. The second point concerns the development of the "business angels" market which is developing in Britain where people will put in, say, £100,000. Quite often the problem there is brokerage. There are quite a lot of people emerging wanting to invest, but what we have not got is the networking and signposting. It is beginning to happen in the UK. That is an area, too, where the Secretary of State is very anxious that the Department should put a lot of effort in.

  825.  Is there then a case, do you think, for putting public money into venture capital? For instance, one of the barriers used to be that the cost of investigating any project was the same whatever the size of the investment required. Would that be an area for public money to go into?
  (Dr Keddie) The French have rather gone down that type of route. I think the perception is that it is less the need for straight cash and more the need for the venture capital markets to work effectively.

  826.  In relation to pension fund activities, have you had any discussion with the DSS in relation to their proposals for stakeholder pensions? If those get off the ground perhaps more money will be going into those kind of pension schemes. Will it not make pension funds even more risk averse?
  (Dr Keddie) The straight answer to your question of have we had direct discussions with the DSS is no. Certainly as a Unit we have not.

  827.  Has the DTI in general?
  (Dr Keddie) I am not certain about that. Does the Department talk to the DSS on these sorts of issues, yes, but on the specific question you have asked I could not tell you, Dr Jones, I do not have the answer.

  828.  You mentioned the new Enterprise Fund you mentioned earlier and Mrs Lait was suggesting that the Government could put money into venture capital. How will the new Enterprise Fund work where I understand you want to dish it out through Business Links to 10,000 new businesses?
  (Dr Keddie) I do not recognise it in quite the way you have described it.

  829.  That is the statement from the Secretary of State, my notes.
  (Dr Keddie) Some of the details of these are still being worked out at the present time, I am afraid. I do not think I can add to what it actually says in the White Paper itself, that it is under discussion with the leading banks at the present time and I am not personally involved in those discussions.

  830.  So there is £150 million but we do not know exactly how we are going to deploy it? Is that right?
  (Mr Bunn) In paragraph 2.24 of the White Paper it does explain that the Enterprise Fund will address four main planks. The first is the national venture capital fund supporting early stage high tech businesses. That is what is currently under discussion with the Secretary of State and the financial institutions. The second leg is the regional venture capital funds specialising in small-scale equity. The third element of it is using developments of the Small Firms Loan Guarantee Scheme. Then finally there is a fourth tranche relating to new and novel financing instruments which is being addressed too.

  831.  I was just about to say, Dr Keddie, I know my method of putting it is very simplistic, but if only we could persuade pension fund managers that failing every now and again is not a disaster. For example, if they were used to getting a five per cent return on anything invested and there were two start-up companies and they were hoping to get a 15 per cent return and from one they did get 15 per cent but the other one failed and gave them zero, they have still ended up with an average of seven and a half per cent. It is that sort of thing we cannot get them to accept because they take the 15 per cent for granted and the failure is total disaster to them, whereas if they mixed the failure with the success they could probably still do better than going down the safe route. Is there something in what I have just said?
  (Dr Keddie) There are two points there. One is we are constantly in discussions with pension funds and others to encourage them to look at things along the lines you have been describing. The Secretary of State is also wanting to encourage a much more failure tolerant economy which is part of that overall thrust.
  (Mr Foster) If I could add, in the discussions that have been taking place with some institutional investors and some leading companies in the United Kingdom, what has become apparent is that there is a need for a far greater understanding of risk assessment by the institutions. One of the major concerns is that there are significant numbers of companies that grow to the £20 million turnover level, the 200 employee sort of size, who are then not purchased by United Kingdom companies for the next stage of their expansion but by US companies who are better able to assess what the risk is particularly with high tech companies. One of the things the Department needs to do is to be working with the institutional investors to make sure they do fully understand and to try and find out what the blockages are to understanding the level of risk.
  (Dr Keddie) Just very quickly to follow up on that, indeed we are doing that. Just to give you an example. The Department and my own Unit is working with CISCO, which is the trade association for small listed companies, in looking at ways of improving the whole strategic relationship between small listed companies and financial institutions.
  (Mr Foster) Can I add to that, because I think this is an incredibly important point? On city analysts and that area, in informal discussions with companies there are quite a number who say they would prefer to raise money in New York than they would in London because of the knowledge of the city analysts.

  832.  Really? Jeremiahs?
  (Mr Foster) No, it is just professionalism. If you really want to understand the aerospace sector, the most knowledgeable city analysts are probably in New York.

  833.  This is in reference to your comments in paragraph 2.24. I note there that bullet point 2 refers to "new regional venture capital funds will specialise in providing small-scale equity to businesses with growth potential, drawing in local expertise." What is the magnitude of small-scale equity and what does the term "drawing in local expertise" mean?
  (Dr Keddie) In terms of what is the range of equity, you are probably talking anywhere between £25,000 to £250,000. That is what I would regard as the bottom end of equity. "Bringing in local expertise" can be anything from business angels, ie private investors, or other business people who have business contacts and experience to help develop that business, and also using other more well-established roots, such as Business Links and other organisations to identify where the local skills lie.

  834.  The National Enterprise Fund I see is just supported by the Government, clearly the money is coming from the private sector and the Government is perhaps acting as a guarantor. Do you think that is a more effective way of fostering innovation than schemes like LINK? How do you evaluate LINK type schemes?
  (Mr Foster) Evaluation in this area is difficult, it is true. We have very comprehensive evaluation of specific schemes like the Teaching Company Scheme, the Small Firms Loans Guarantee Scheme. Each individual scheme is heavily analysed and the returns are good, otherwise we would not be backing it. The Teaching Company Scheme generates nearly 3.5 times as many jobs as the expenditure on one individual job. When it comes to the aggregate level, to try and work out what is the overall economic return from putting money into the Loan Guarantee Scheme compared to putting money into the Teaching Company Scheme, then we do start running into problems. We are trying to do that sort of analysis but I have to say there is still a long way to go on that. I have not got a substantive reply to tell you exactly what the emphasis should be. I do not know if anyone else can answer?

  835.  Have you put in place systems to compare the effectiveness and at what point do you expect to be able to say: "Yes, this is worth more than that one"? Five years' time?
  (Mr Foster) No. It is one of these fields where there is a great deal of work going on by economists in the Department on just that type of topic, the leading economists in SPRU and PREST are working just on that. It is the sort of field where I suspect if they were here, they would say they would probably have made good progress in a five year timescale.
  (Dr Keddie) The Department is putting increasing emphasis on how we actually measure outcomes in the economy, so the extent to which different measures, whether through the Loan Guarantee Scheme or through LINK, are contributing to, whether it is business growth, improvement in business performance, or whatever, actually depends a great deal on the nature of the business, the size of the business and the style of the business, and which of these particular instances is likely to be most relevant to them. But we should be measuring the actual outcome in the economy, that is the primary thing we should be going for and we are increasingly putting effort into that.

  836.  Mr Foster, earlier in answer to a question by the Chairman you were talking about encouraging innovation and recognised that tax breaks are a very important aspect of encouraging innovation. Are there in the White Paper any proposals regarding tax breaks to assist start-up high-tech companies?
  (Mr Foster) You may know that there was a reference in the Pre-Budget Report, which the Chancellor put out recently, that there would be further consultation on this topic and a technical document is currently being prepared which will be put into the public domain. This follows from an earlier consultation on a joint document which the Treasury and the DTI published on innovation and investment in research and development. The response to that was that although it was felt, for example by the CBI, that there would not be a major benefit from having R&D tax breaks for all sizes of companies, there could be benefits for the small firm sector, including those who are tax exempt as well as those who are paying corporation tax. One of the problems for smaller companies, particularly if you are in a sector like biotechnology, is that for the first five years or so you will not be paying tax and that is the very time you may need help. So, yes, there will be a further consultation in depth but whatever is done, if ministers do decide to go down this route, it is more likely to be on the basis of a volume based R&D tax break and more geared to small firms than, for example, the US incremental tax system which is quite hard to implement in the UK given our current tax regime, and so probably would not be directed to larger companies. But that is an issue we will address further following this consultation.

  837.  Can you tell us what is this US incremental tax system?
  (Mr Foster) There have been many efforts over the years in countries, for example the United States and Australia, to encourage expenditure on research through tax breaks. The ones which have seen to be effective are where there is not a huge amount of deadweight—where you just put in £1 of government expenditure to get £1 of research is not a very effective type of national investment—and the US has moved towards incremental tax breaks whereby any tax breaks relate to the increasing research of one year over the previous year. That is particularly problematic in the UK's taxation system because in the UK the Inland Revenue bases tax on individual companies rather than on groups and because of that there is a much greater liability to fraud if you go for an incremental tax system in the UK.

  838.  Can I check with you that the document you are talking about is the "Financing of High Technology Business" from the Treasury? Is that the document?
  (Mr Foster) I was referring to the Pre-Budget Report. I am sorry, I do not have a copy here.

  839.  I have had something from the Treasury Working Group which introduced the document.
  (Mr Foster) Yes, indeed. The original work was the work done by Keith McCullagh and Peter Williams.