The potential impact of the Patient Capital initiatives, announced by the Chancellor in the Autumn Budget, would be of considerable importance at any time, but is especially timely as we head towards a more independent post-Brexit environment.

With small and medium-size enterprises (SMEs) representing 99.9% of private-sector companies and 60% of private sector jobs, the U.K.’s international competitiveness could be boosted significantly by continuing to build on its ability to create and grow world-class innovative businesses.

At L.E.K. Consulting, we are proud to have supported Sir Damon Buffini and the Industry Panel of Experts in developing their response and recommendations to the Patient Capital Review, and the contribution it made to the initiatives announced.

From strength to not quite so much strength: the U.K.’s scale-up problem

The U.K. is already a successful environment for early stage businesses to set up and develop through the start-up phase. The number of venture deals and the amount invested has grown very strongly since c.2006 (see Figure 1), partly in consequence of the government’s EIS and SEIS initiatives which have widely been credited with significant impact on the issue of attracting start-up investment.

However, when it comes to growth beyond the start-up phase, the U.K.’s performance tails off, due to a relative scarcity of “next phase” investment of the type which has created world-class success stories in the U.S., for example (see Figure 2).

Vicious cycle to virtuous cycle: What the initiatives aim to achieve

So why does this gap exist? The Patient Capital Review concluded that a vicious cycle of poor risk-adjusted returns on scale-up investments, a lack of capital available to be invested in these businesses, and the subsequent lack of attractiveness to top investment and entrepreneurial talent, is responsible.

What the Chancellor suggested in the Autumn budget is the development of a suite of initiatives to address these problems:

  1. The establishment of new investment funds focused on ‘patient’ investment: these funds, specifically a £2.5 billion fund incubated by the British Business Bank, and a series of investments into private sector funds of funds seeded by British Business Bank capital, are intended to act as aggregators and providers of capital for investment in U.K. scale-up businesses and capital-intensive R&D-based businesses. Collectively, these initiatives aim to address the relative lack of capital to invest.
  2. The continued support of emerging fund managers through Enterprise Capital Funds: this programme enables the British Business Bank to improve returns on equity for managers up to a certain size investing in start-ups, scale-ups and capital-intensive R&D-based businesses. This is achieved by “gearing” the return structure through co-investing British Business Bank capital alongside private capital, improving returns for investors.
  3. The extension of EIS limits for knowledge-intensive companies (KICs): these measures directly improve the attractiveness of investments in those companies whose size is immediately above the currently permissible range, addressing the relative lack of capital to invest.
  4. The Chancellor also announced a review of the barriers that may exist to pension funds choosing to invest ‘patiently’ in innovative firms. The potential removal or lowering of any such barriers could further add to the supply of capital available.

If successful, these initiatives would instead result in a virtuous circle of mutually self-reinforcing benefits (see Figure 3).

Taken together, this circle could transform the fortunes of innovative businesses aiming to reach scale, and make a significant contribution to the U.K. economy’s competitiveness.

Radical yet practical: Why these initiatives could have substantial impact

Collectively, the measures suggested today are undoubtedly far-reaching and radical. Yet they are also practical in the sense that they (i) build on the current strengths of the U.K.’s early stage investment environment; and / or (ii) are supported by directly relevant, demonstrably successful precedent in similar economies:

  1. The new investment funds build on and support the current venture capital investment environment, rather than seeking to replace it;
  2. The Enterprise Capital Funds programme is building on schemes already deployed;
  3. The extension of the EIS programme builds directly on the very successful initiative which has had such a transformational impact on the U.K.’s start-up environment.

In our opinion, these initiatives have an excellent chance of success and we eagerly anticipate their implementation by the British Business Bank.
 

Further Reading

Autumn Budget 2017: Financing growth in innovative firms

Patient Capital Review: Industry Panel Response

Financing growth in innovative firms: consultation responses