Practical problems

The UK government’s proposed venture initiative is a positive step, but may be unrealistic, writes Toby Mitchenall.

Far from being pilloried as a providing food for fat-cats, venture capital is happily seen by many as an important mechanism to jump-start the economy.

With this in mind, the UK government has now committed to seed a fund which it hopes will ultimately channel £1 billion (€1.2 billion; $1.7 billion) into UK venture. In order to encourage investment in high tech, early stage companies, the Department for Business, Innovation and Skills has committed £150 million to a fund of funds named the UK Innovation Investment Fund (UK IIF). Established fund of fund managers have been invited to put themselves forward to manage the vehicle and it is hoped that the selected manager will leverage the state money with third party capital to take the figure up to £1 billion.

Toby Mitchenall

There is no doubt the intention behind this initiative is laudable. Everyone in the industry would agree that Europe needs more capital to reward innovation and to commercialise the world-leading intellectual property borne of its universities.

There are, however, a couple of kinks in the UK IIF plan as it stands.

The size of the fund – a proposed £1 billion – is certainly eye-catching, but it is also certainly unrealistic. The notion that even the most highly-regarded fund of funds manager could pull in £850 million of commercially focused third party money to invest in UK venture capital is outlandish in such a tight fundraising market. To put the figure in perspective, the amount raised by early stage venture capital funds across the whole of Europe in 2008 was €2.2 billion. The figure for all stages of venture capital across Europe was €5.5 billion.

Furthermore, if the fund did reach its £1 billion target, it seems unlikely that this substantial slug of money could be invested discerningly in UK venture without distorting the market. It could find itself backing any manager in the market – regardless of whether its track record merits it – just to get the money to work.

A more realistic prospect for the fund would be to widen the geographical remit to the whole of Europe and to retain a minimum allocation to UK-focused funds. It could go even further and diversify the asset mix into other asset classes, with a portion allocated to venture. LPs across Europe would be far happier known that their capital was spread selectively among the best-of-breed managers rather than being shoe-horned into a limited number of early-stage UK venture funds.

Notwithstanding the various barriers to developing the European venture scene, the UK government is without doubt moving in the right direction in aligning state capital with private sector cash to foster venture activity. The European Private Equity and Venture Capital Association, meanwhile, is currently working on a white paper that will propose a pan-European initiative based on a similar private/public model as the UK IIF, but without national restrictions.  It will be a tough task persuading various European authorities to place their trust and money in the hands of the private sector at a time when the political wind is blowing the opposite direction. We wish them luck.