INTRODUCTION

  The British Venture Capital Association (BVCA) represents virtually every major venture capital firm in the UK, which each year accounts for over 95 per cent of annual venture capital investment in the UK. The BVCA is dedicated to promoting the UK venture capital industry for the benefit of entrepreneurs, investors, venture capital practitioners and the economy as a whole. Through its members, the BVCA has an in depth knowledge of the issues affecting the wide range of high growth smaller and medium sized unquoted companies in which they invest.

SUMMARY OF RECOMMENDATIONS

—  Encourage the development of all seed capital funds, for example by subsidising a proportion of their due diligence, monitoring and employment costs or underwriting part of the financing risks (see 1.4).

—  Encourage "career leapers"—experienced corporate managers—to move to young companies through tax incentives (see 1.5, 4.3 4.7).

—  Bridge the gap with funding between technology discovery and "proof of utility"—potential commercialisation, reducing the obstacles to commercial investment (see 2.1).

—  Improve university and business inter-communications (see 1.5, 2.2, 5.1).

—  Investigate how intellectual copyrights and patent positions can be assessed as commercially viable (see 3.1).

—  Encourage serial entrepreneurs possibly by way of tax incentives (4.3).

—  Produce a scheme that encourages business angels, or simplify the Enterprise Investment Scheme, so that venture capital firms can more easily invest alongside business angels (see 4.4).

—  Improve the small firms Loan Guarantee Scheme (see 4.5).

—  Reduce the Capital Gains Tax regime for business angels (see 4.6).

—  Improve share options for smaller unquoted companies (see 4.6).

—  Create an equity guarantee scheme or soft loan scheme (see 4.6).

—  Learn from the German and Israeli approach to technology companies.

—  Encourage technical and corporate innovators from outside the UK to locate in the UK (4.10).

—  Encourage UK technology companies to be globally competitive (see 4.11).

—  Persuade the Engineering and Physical Sciences Research Council to allocate a part of its budget to the assessment of the commercial potential of technologies (see 6.1).

TERMS OF REFERENCE

  To enquire into the manner in which companies in the fields of engineering and physical sciences decide on developing new products and processes and the factors influencing their decisions, with particular reference to:

1.  The industrial application of government funded research and the respective roles of government laboratories and independent research and technology organisations

  1.1  The traditional view has been that industry and academia do not communicate with each other very effectively. This now appears to be changing, in part because of universities' increasing needs to find alternative sources of finance to government funding and because of the increasing number of role models of successful companies started by academics or based on university research.

  1.2  As the universities have begun to be more commercially orientated, it has become easier for the venture capital industry to start to fund science based companies coming out of these institutions, creating the start of a virtuous circle. Examples of new specialist firms and funds that have started up over the last year or so focusing on this sector include; Amadeus in Cambridge, UK Medical Ventures (a specialist fund created by The Medical Research Council to help exploit its technology, which has been heavily backed by 3i, a BVCA member) and Merlin Ventures (all except UK Medical Ventures are BVCA members).

  1.3  Large companies have for some while been working alongside certain universities with some effect. The "gap" in exploitation would seem to be with the smaller more entrepreneurial UK companies. These companies have found it relatively hard to access the universities, lacking as they do the resources of the larger groups.

  1.4  The amount of seed capital funding available via the venture capital industry has increased in recent years but it is still its least common type of funding. The difficulties arise largely in the level of management (and therefore cost) required for quite small amounts of initial investment. Venture capital firms are used to working with cost ratios of around 2 per cent of assets of the management, whereas with seed funds this ratio can often be of the order of 10 per cent. We would, however, like to see the encouragement of the development of all seed capital funds (perhaps by subsidising some of their due diligence, monitoring and employment costs or underwriting some of the financial risk).

  1.5  Equally we would like to find ways of encouraging seasoned corporate managers to move to young companies ("career leapers"), perhaps through tax incentives such as the ability to write off capital invested against past or future income tax liabilities. We would like to find ways of better communication between educational establishments and the world of commerce. We believe that a closer dialogue between the educational system and the business community would improve the prospects of academic research being exploited commercially.

2.  The operation of government schemes designed to promote collaboration in and industrial application of research

  2.1  The government has long run successful schemes such as SMART and SPUR awards and we have anecdotal evidence of various research exploitation groups within universities regarding these as being of very significant importance. Government schemes, however, have typically focused on the creation/proof/concept of technology itself. It is our view that there is a lot of very interesting technology within UK academic institutions. The difficulty is now in the linkage between that environment and the commercial world. In particular, investors typically seek to back companies that have a clear commercialisation strategy and have capable management. Many of the interesting technologies evolved with government funding are left somewhat stranded before reaching these next two milestones. It would be particularly valuable to have some form of government scheme which bridged this gap and allowed people help, advice and funding to create outline commercialisation plans for interesting technologies. The objective of this would be to make the "hand over" of funding from commercial investment organisations easier. This is particularly relevant for small firms, whereas large firms may be able to afford the overhead of doing much of this work themselves. The "University Challenge" venture capital fund, appears to be an important contribution to this sector.

  2.2  Many of the issues surrounding collaboration and the industrial application of research are cultural and educational. We should beware of quick fixes to long standing cultural problems but it would certainly be welcome to see a greater targeting of the creation of effective dialogue between academic institutions and the business community at all levels.

3.  Intellectual copyrights and patenting

  3.1  The key issue for investors here is the cost of due diligence to assess the status and effectiveness of intellectual copyrights and patent position of the companies they are considering investing in. In particular it is often very hard to place this information within a sensibly broad commercial context. In the UK there are only a few experienced "lead" venture capital investors in technology and we would be keen to find ways that we could encourage a greater depth of experience to be created. The funding required to employ more experienced investment executives is a serious problem for those firms with the small funds that typify much of the early stage technology funds in the UK.

4.  The provision of finance to support enterprises involved in the application of research and innovation

  4.1  Does the government have a cost benefit equation for job creation? It would be useful to know the answer to this if we are to work effectively towards a common solution.

  4.2  The overall situation that we find is encouraging. The amount of venture capital invested in technology businesses has increased by 10 times from 1983 to 1996. It is also worth noting that over 70 per cent of UK biotechnology companies listed on the London Stock Exchange have benefited from venture capital funding.

  4.3  Whilst the returns from technology investments in general can often be attractive to investors, there are a number of specific difficulties:

(i)  The relatively low returns that can generally be achieved at the early stage or seed investment end of the market.

(ii)  The difficulties faced by some venture capital firms that specialise in early stage technology investments in raising funds of a size that would enable them to afford to employ more experienced investment executives.

(iii)  The lack of a sufficient number of experienced investors in the sector.

(iv)  The poor quality of management in many potential investment opportunities.

  4.3  The whole debate about providing finance to support technology has tended to miss one crucial point; it is that people are supported by the "investment community" rather than "technology" per se. In our view we do not see any specific shortage of "technology" in the UK but rather we see a shortage of seasoned managers who have the capability of building successful businesses. We do see a greater number of such "corporate innovators" in the UK than a decade ago. In our view this pool of people is as much a resource which the UK should foster, as is "technical innovation". Within this pool of people, the most important, and those who we would like to see encouraged further, are "the serial entrepreneurs"—people who have a track record of successfully starting companies. Persuading these people to focus their talent on young technology businesses, by whatever means, would be a very effective way of helping create successful businesses that people wish to fund with the depth of resource required for success. We believe that there could be room for tax incentives to encourage these individuals further.

  4.4  We believe that there are also arguments for a simplified system of tax incentives for private investors in technology businesses. The Enterprise Investment Scheme may in part be aimed at this but, in our experience, its rules are complex and it tends to be difficult to accommodate alongside more conventional institutional capital.

  4.5  Schemes, such as the small firms Loan Guarantee Scheme (LGS), have been very helpful in encouraging new businesses development. A survey conducted by 3i in 1994 showed that 38 per cent of the young companies it has backed had received an LGS loan. However, the DTI restricts the maximum loan for companies which have been trading for less than two years to only £100,000 compared to £250,000 for established businesses and its guarantee to 70 per cent rather than 80 per cent for established businesses from clearing banks. These loans, anecdotally, also seems to be less readily forthcoming for technology based businesses. We would encourage the DTI to consider whether it might be possible to allow younger companies to benefit from the full £250,000 limit; to find some way of targeting technology companies; and to consider whether a larger overall cap on the LGS loan than £250,000 would be an appropriate mechanism for helping smaller companies.

  4.6  Overall it is the motivation of the people that is key and not the motivation of investors. In our view, the most effective investors tend to follow capable people and we would not wish to see a scenario whereby tax incentives for investors encouraged them to back people whose skills were only marginal, rather than focus resources on the most able. Getting the motivation right for individuals is in part about increasing the upside for them. This is about:

(i)  Capital Gains Tax. Following the Budget, this situation has changed significantly in the entrepreneurs' and management teams' favour, however, the benefits for business angels need to be fully assessed. The financial rewards to individuals who invest in technology businesses usually come in the form of capital gains. Regardless of specific incentives, the rate of CGT is therefore likely to be very influential in determining an individual's appetite to invest.

(ii)  Effective share option schemes should be available in a tax "friendly" way and we look forward to taking part in the discussions for smaller companies.

(iii)  Potential for an equity guarantee scheme or soft loan schemes (as this in reality gives the individuals a bigger slice of the equity available in the companies).

  4.7  Motivation is also about reducing the downside that individuals experience. We would be keen to encourage the more entrepreneurially minded middle and senior managers in large corporations to look at starting or being associated with smaller technology based companies. Key to this, we feel, is reducing the downside that they may experience. In our view many of these people could become involved in younger companies, would wish to, and would have a lot to contribute but are deterred by the risk involved. In particular we believe that they are influenced by the relatively high social stigma attached to corporate failure, which is greater in the UK than in the USA, as well as the financial risks involved. Working with large companies they are more capable of earning high salaries and have reasonable job security. They will usually have to forego both of these to start up a company and we would wish to see ways of lessening their perceived cost in doing so.

  4.8  We believe that the whole of this issue of the creation and fostering of technology companies needs to be looked at in a far more global context than has occurred to date. For example, the continual comparisons between the US and the UK are, in our view, unhelpful and misleading, particularly as the cultural differences between the two countries are so large. The USA venture capital market has benefited from considerable government intervention over the past 15 years, it is also supported by a strong stock market (NASDAQ) with good investor demand for early stage technology companies that is not seen in the UK. In spite of this, in early stage to expanding companies, although the USA economy is some seven times the size of the UK's, in 1996 the UK made just over half as many investments as the USA in these types of companies. Relative to GDP, the UK invested about the same amount as the USA in 1996.

  4.9  We would, however, like to see the debate moved towards what is happening in Germany and Israel, where start up technology companies receive a far greater level of financial support than in the UK. We are not advocating the large-scale government intervention that has been applied in Israel (successfully) but we do feel that these economies and cultures bear close comparison. In addition, as good ideas for start-up companies are pretty transportable and we have begun to notice one or two biotechnology start-up companies choosing Germany as a location over the UK, we believe that this comparison deserves more attention than it has been publicly receiving.

  4.10  We need to recognise that markets for technology companies are international now. The UK's outlook should be similarly international if our native resources to be fully exploited. We should be concerned to retain our creative talent in the UK, both "technological innovators" and "corporate innovators", and to make the UK an attractive place for talent from other countries to locate. We believe that it is important to develop what we see as a scarce resource and encourage this talent to be "recycled" in new ventures wherever possible.

  4.11  Because the competition for technology companies is increasingly global, we do not feel it is correct to focus simply on getting more businesses funded. They must be quality businesses that are globally competitive. If not, the long-term result will be to create a problem and disillusionment with technology in the UK.

  4.12  Technology markets also develop quickly and speed in product development and establishing distribution channels is becoming extremely important. The sale of advanced technology companies is often, mistakenly, seen as a bad thing for Britain. In fact it frequently represents the best way for technology to be fully exploited and returns capital to the UK which can be re-invested in other products.

  4.13  Interestingly, we believe that one of the benefits of the growth in funding management buy outs by the UK venture capital industry is that a greater number of managers who would have traditionally remained within large organisations are becoming entrepreneurs. In our view, many of these people could now be persuaded to spend time with younger growing businesses and would have a lot to contribute.

5.  The role of the foresight programme in fostering networks and identifying priorities

  5.1  We do not yet have any clear evidence of how this initiative has directly and specifically impacted on the flow of business proposals to the UK venture capital industry. One benefit, however, of the initiative has been that it appears to have encouraged greater dialogue between scientists and industrialists.

6.  The role of the engineering and physical sciences research council in fostering technology transfer

  6.1  We view the council as an extremely important source of funding for ideas that can ultimately be turned into viable commercial technologies. We feel that it is a shame that a small portion of the council's funding could not be spent on its most promising ideas to help these be investigated for their commercial potential. The objective of this would be to make the transition between council-funded projects and commercially funded projects a less difficult one and the gap between the two types of funding less of an obstacle. We believe that a small shift in the council's priority, away from, say the bottom 5 per cent of its priorities in academic fundings, towards the investigation of commercialisation, would produce a very large effect in the number and quality of start up technology companies based on its funding.

  7.  Progress made towards implementing those recommendations of the science and technology committee in the previous parliament in their report on "The routes through which the science base is translated into innovative and competitive technology" relevant to the field of engineering and physical sciences.

  7.1  No comment.

20 March 1998