Rethinking public funding

Despite the significant increase in publicly-backed UK funds investing in early-stage companies private investors won’t touch, such funds have not yet made attractive returns. NESTA’s Jonathan Kestenbaum wants to change that.

There was certainly a lot of enthusiasm buzzing through the room at the launch of the NESTA’s new £50 million ($100 million) early-stage fund last week. But despite the excitement, there was a healthy degree of scepticism among the attendees as well.

The National Endowment for Science Technology and the Arts is, after all, considered by many to be a government charity. Established by the UK government in 1998 to invest in innovation and improve the climate for creativity, the endowment’s early years were marked by more idealism than actual returns. So when NESTA chief executive Jonathan Kestenbaum stepped to the podium and told the current and potential investors gathered that the new fund was going to have a strictly commercial focus and attract private investors to the area by generating significant returns, the reaction was mixed.

One attendee turned to another and said, “It’s the ‘new NESTA,’” tongue firmly in cheek.

The fund is looking to invest up £10 million each year, offering individual start-ups seed money of up to £250,000 and investing £500,000 per company over the course of its development. The fund will focus on the ICT, healthcare, technology and environmental technology sectors. Companies will also receive ongoing mentoring and business support from NESTA.

Kestenbaum: aiming for new heights

“With the private sector vacating early-stage funding after the dot.com era and the government now shifting its focus to more developed businesses, the UK is facing a potential dearth of investment in this area,” said Kestenbaum. “Our fund is designed to plug this gap both directly and by demonstrating the viability of early-stage investment to third parties.”

When Kestenbaum joined NESTA in November 2005 he immediately set about revamping the endowment, vowing to turn it into a model of efficiency and profitability that would prove that publicly-funded vehicles could indeed generate attractive returns. The former chief of staff to Sir Ronald Cohen of Apax Partners has adopted a take-no-prisoners attitude in his quest to drive public funding to profitability.

But the challenge remains daunting. Publicly-funded early-stage vehicles, set up to address the low level of seed funding in the UK (six percent of all private equity investment in 2005), have so far generated disappointing returns. This is despite a significant increase in government support to the area. Today 26 percent of all active funds that invest in small- and medium-sized enterprises are publicly-backed either in whole or in part, and an additional 24 percent are Venture Capital Trusts that benefit from targeted tax relief, according to a study by SBS.

The key to changing this state of affairs, says Kestenbaum, is to demonstrate to private investors that you can get good returns from investment in SMEs, it just takes some time. He’s betting that the new fund has the right formula to do that. The vehicle will be overseen by an investment committee of VC specialists including Adrian Beecroft, former chief investment officer at Apax Partners. The money will be split between NESTA Ventures, which will invest in companies, and NESTA Capital, which will invest in SME funds as an LP or co-investor. Kestenbaum says all eligible companies will need to be based in the UK, target a market of at least £100 million, have innovative technology with firm intellectual property, experienced management and a clear exit strategy.