19
Examination of witnesses
Greg Clark and Dr David Connell.
Q64 The Chair: We are very pleased to have with us two witnesses: the right honourable Greg Clark—former Secretary of State for Business, Energy and Industrial Strategy, and a former chair of the Science, Innovation and Technology Committee—and Dr David Connell, senior research fellow at the Centre for Business Research at the University of Cambridge.
You will both know that our inquiry is examining the perennial problems of scaling-up UK science and technology companies. Greg, you dealt with that problem while you were in BEIS and, David, you have regularly written about this, so perhaps each of you could set out in your opening statements what you feel is the diagnosis of these scale-up problems and what lies behind them. Perhaps you can discuss some of the policy solutions and recommendations that you have in mind.
Greg Clark: Thank you for inviting me. You kindly introduced me by talking about some of the things I did in the past, and I should say what I do now. You have a bit of a Warwick theme today, with Gus O’Donnell being an alumnus. I am chair of the Warwick Innovation District at the University of Warwick. I am also chair of the Society of Chemical Industry and a member of the Government’s Industrial Strategy Advisory Council, which, of course, is relevant to your discussions today.
You are absolutely right that the scale-up problem was one that we recognised during my time in government. The fact that you are discussing it today indicates that we did not manage to solve it. I think it is even more important as we look at the opportunities for UK business.
I think it is possible to solve it. Gus O’Donnell had some important things to say about that. I was reflecting before this session on how we used to fret a lot about start-ups, with our record on start-ups in this country not being as good as some other countries around the world. Even back into the entrepreneurial 1980s, we had about half the level of start-ups that we now have. So it is possible. It is not an ineluctable feature of the UK that we just cannot do these things. We turned start-ups around and one of the things that is notable about the UK is that many countries—Japan, for example—take a great interest in how we do that. I think it is absolutely worth while to concentrate on what we need to do for that.
Gus O’Donnell talked about capital markets, particularly pension funds. I think that is a very clear area for deep analysis and some policy change. If we have the asset or the advantage of the City of London, with its sophistication and depth of capital markets, it is galling that we find ourselves contemplating the fact that promising companies cannot, from the city—not just the City of London, but the city sort of broadly specified—be supplied with the capital they need, so they need to go overseas. That is important.
There is a regional and local aspect of that. Many members of the committee have experience of running and scaling businesses. My observation is that, when a business is moving from a start-up phase to a mature phase, it wants to have a relationship with the people financing it. It can be the case that, for all the importance of the City of London, it can seem quite distant from where people are in regional towns and cities.
One initiative that has taken place in recent years that I think is worth reflecting on and perhaps emulating is the Northern Gritstone fund, a scale-up fund, in effect, based in the north of England, in Manchester, but concentrating particularly on spin-outs and developing companies in the north. There is a kind of prototype for that in the Midlands called Midlands Mindforge, and that is an important aspect—not just the overall capital market reforms but looking at what can be done regionally.
I would recommend that an explicit remit—or part of the remit—should be given to some of the institutions that we have, such as the British Business Bank and Innovate UK, to look at what is a recognised problem and be tasked with intervening in this. Also, scale-up is not just about financing—it obviously includes that—but it is also about acquiring or developing the skills, attributes and wisdom, as it were, to grow. Institutions such as the catapults can play a useful role in helping to propagate businesses that have already started up and helping them to get to the next stage.
But the fact that there is a list suggests that there is not a single thing that we can do. But there should be an explicit focus on our national policy so that we can and should aspire—and we can expect, if we do it properly—to make a difference, just as successive Governments and others did as the culture for start-ups evolved over the years.
The Chair: We will obviously come on to further issues. David Connell, you have written a number of reports, including one called Selling the Family Silver.
Dr David Connell: It was called Selling Less of the Family Silver.
The Chair: Forgive me. Can you perhaps enlarge upon that and give us your diagnosis of the problem?
Dr David Connell: Thank you very much for inviting me. As you say, for a few years I have had an unpaid position at the Judge doing research on innovation and company start-ups. I have published quite a lot. My background before that was essentially in the technology centre as one of members of the senior management at one of Cambridge’s most successful but least well-known technology companies, setting up and running a small venture capital fund and then advising large corporations as a strategy consultant—companies like Rolls-Royce and so on.
The biggest problem for the UK in the innovation economy is the sale of too many of our most promising companies to foreign corporations, with the truncation of further growth in the UK. The Selling Less report with Bobby Reddy proposes a number of costed solutions for addressing this problem. I should like to summarise by listing the three main policy challenges the Government need to tackle to address this. The first is to get the balance of government funding for business R&D right—in particular, by moving some of the £9 billion a year that goes into R&D tax credits and the patent box into policies that can better help able and ambitious founders from whatever background to start and build a significant new UK business over the long term. Companies like ARM, Dyson, Mike Lynch’s Autonomy, Renishaw, Oxford Instruments, Sage and Aviva have all essentially avoided or delayed raising venture capital. R&D tax credits would have had little or no value to them in the start-up phase.
R&D tax credits are a great subsidy for VC-backed businesses such as start-ups based on research breakthroughs. However, very few are successful, and VCs must sell the ones that are in order to satisfy their investors. Programmes like the $6 billion a year US SBIR programme, sometimes known as the US’s seed capital fund and the EU accelerator programme, are much more appropriate, as are lead customer R&D contracts generally. That is the first challenge.
The second is that, in my view, the government machine lacks both the data and, for want of a better word, a brain to oversee the entire policy portfolio, do the analysis, explore options and monitor outcomes. For example, Innovate UK no longer publishes an annual report or any information at all on the £670 million expense with businesses. When I started investigating the R&D tax credits and patent box a few years ago—both of them, it has been suggested, are subject to gaming and/or fraud—the only analysis the Treasury had made of their impact took the form of highly complex econometric models based on simplistic neoclassical economic assumptions and with an extremely poor fit to the data. The Treasury official responsible for R&D tax credits—it is an extremely small team, by the way, of just two people—told me that they did not have the resources to do any analysis and tended to rely instead on the CBI. All this, of course, leaves Ministers and officials open to lobbying by the best-funded lobby groups.
The third challenge arises from the current Government’s little-known commitment alongside the Budget to maintaining the rules, percentages, et cetera applying to the R&D tax credits and patent box schemes unchanged for the duration of the Parliament. This obviously makes it difficult for the Government to make the kind of wholesale changes in the policy mix that I believe are required. I should say, by the way, that there is nothing wrong with UK start-ups being sold to foreign companies. In many cases, possibly even most, that is the best output for everyone concerned. But we must make it easier for ambitious and capable entrepreneurs, such as the founders I have mentioned, to build a substantial UK business and control that business in terms of future innovation and growth by retaining shareholder control.
The Chair: Baroness Young, you want to follow up on R&D credits?
Q65 Baroness Young of Old Scone: You heard my previous questions and have pretty well answered them—from the point of view of Dr Connell. I wonder, Greg, whether you have a view on the position that his book outlined, which is that we should do away with tax credits and have a much more focused and targeted investment programme. If so, who should do it?
Greg Clark: I can see the temptation—£9 billion a year, or whatever it is, is a lot of money in the science budget of about £20 billion a year, so you can do a lot with that. I would be cautious about dumping it or making any total change without some careful analysis. As David says, the analysis really has not been done, and it should be. The reason is this: much though we may come on to it through things like industrial strategy, it is desirable and possible for the Government to give backing, certainly not by picking winners of individual companies but by highlighting areas of research with a joint public and private interest.
There also is something in our economy whereby individual companies and individual entrepreneurs should be able to follow their own initiative and have backing for that. Gus O’Donnell, in response to a question of the committee, talked about moving away from the culture of conservativism in the deployment of public funds, and taking more risk. You might see R&D tax credits as being a bit of a risk. People are making investments into research and development and have some tax advantage to put alongside that. That said, what has been reported on the level of fraud, complexity and misapplication has to be first understood and then challenged. That is where I would come from. I would want, as it were, bottom-up backing for innovation or backing for bottom-up investments in innovation, as well as the top down. At the moment, that is part of the inherited offer we make to businesses. So we should not grab at a reform without carefully understanding it.
Baroness Young of Old Scone: I will pick a point that Dr Connell made, not on this particular subject but on the issue of sales of UK companies to international investors. Should we be stratifying this in our minds to make a difference between companies that move lock, stock and barrel to somewhere else—companies that are bought up primarily by money that implies that eventually they will cease to have any of what one could regard as truly UK characteristics? Should we be putting more constraints on international sales to ensure that at least a proportion of the jobs and the activities remain here in the UK, with some degree of intellectual property control as well?
Greg Clark: As Gus O’Donnell said, obviously the national security lens is important in this. We have a National Security and Investment Act that can address that aspect of it.
Baroness Neville-Jones: Does it? It certainly addresses inward investment, but I am not sure it prevents sales.
Greg Clark: It is quite extensive when it comes to the sale of UK assets. It gives powers. In fact, it requires notification, last time I checked. The authorities can suppress that. That is right. I am nervous about sending a signal that a firm founded in the UK may not be able to be sold in future. I should like us to have an environment in which—as regards my answer to the first question—companies can find capital here, find the support they need to scale up and do not have to go overseas.
What I worry about is not so much the current generation of businesses that have been founded, but the next generation. So if you have a brilliant idea and you are about to market it and found a business here, is someone going to whisper in your ear, “Well, don’t do that because, if it is as spectacularly successful as you think, you’ll never have it taken over in a competitive situation anywhere else. Do it in Silicon Valley, rather than take the risk that you will have a stranded asset here that the Government will not allow you to sell”.
I worry about that. I would like us to be self-confident, to be a place that people want to locate to because of the vigour of our innovation landscape, including research institutes. I want us to solve the problem of being able to scale up. Even though the motivation behind it is understandable, I would not want to be in a situation in which talented people are warned off setting up a business here. That is why I worry about that more general, strategic industry veto that Ministers—and I was one—could exercise.
Baroness Young of Old Scone: Dr Connell, where do you stand on greater controls on sales of UK companies?
Dr David Connell: I completely agree; we should let the market work. But to the extent that we are trying to move it slightly, we should be a bit more subtle. I would not abolish R&D tax credits: they are a great support in the right situation, but they do not help entrepreneurs start unless they raise venture capital. R&D tax credits increase the value of a VC’s investment by about 40%: invest £1 million and it is worth £1.4 million or a bit more than that.
If you are a founder and are, say, coming from a commercial company—you have a mortgage and kids—you cannot take your employer’s IP with you or recruit any staff, basically. You are going to spend quite a lot and it will take months or more to write a business plan and raise the money to start a business. It is a real challenge. It is not like that for academics, of course. You have to focus funding on the early stages particularly and help businesses to start. The best funding that you can get if you are an entrepreneur is a contract from an informed customer—a contract for developing a solution.
We could move some of the money, maybe just 25% or 30%, that goes into R&D tax credits and the patent box, which takes the lion’s share, into programmes that are more appropriate for helping founders and early-stage companies especially to get off the ground and build some value without giving away too much equity to the VCs, who will then take more and more until eventually they have control and they will need to sell the business. That is the way that I look at it.
Baroness Neville-Jones: I will just pursue that point for a moment. You just made a very important point about different ways of financing the early growth of a company. From reading some of the briefing, was your conclusion that, actually, the companies that manage to finance themselves by generating revenue, as distinct from those that get venture capital, tend to be the ones that make it to the market on their own resources? They are stronger from that degree of autonomy.
Dr David Connell: We think of the big names: all the entrepreneurs that we admire and that have been successful over a long period, such as Mike Lynch, Hermann Hauser and Dyson. Dyson had some of his own money, I think. It is not well known, but he launched vacuum cleaners through three separate corporate partners—a UK firm, a Japanese firm and an American firm. The licence fees, which he calls front money—upfront money—in essence enabled him to invest that in honing the product until he could eventually afford to launch it with his own money and a bank loan.
Let me just answer the question of how to do this in a slightly different way. In the US, there is a programme called Small Business Innovation Research. Under that programme, federal agencies have a requirement to spend a certain amount of money with any business, but new businesses particularly, in the form of contracts. So they are 100% funded contracts: you do not need any other money to start a business—it is 100% funded. Phase 1 is up to $330,000. You then compete for phase 2, which is up to $2 million or more if you can get the SBA to agree it. Then there is a phase 3, which is more discretionary. The defined budget for that is now $6 billion, I think.
Lord Berkeley: Still—in spite of Trump?
Dr David Connell: I am not up to date. Forgive me. It is a very important programme. In the UK, many people, including myself, have attempted to get something introduced. The SBRI programme—same letters in a different order—was introduced by David Sainsbury in 2001 and did not work. It was backed by two Prime Ministers, two Chancellors who put it in their Budget and one ex-Minister sitting around this table—two ex-Ministers, I think, if I include Greg Clark. I did a review for Theresa May in 2017, and it is still bubbling away at about £100 million a year, with lots of very small projects.
Baroness Neville-Jones: What is the key difference? It seems to me that you are telling a story of relative success. What is the key difference?
Dr David Connell: There are two differences. The first is that spending departments will not pay. Successive Governments have, in essence, given spending departments targets about how much they should put into this programme, or they have set, in the case of Gordon Brown and George Osborne, and announced commitments in Budgets that are basically like targets. So that is the first thing: they will not pay. We have to create a budget outside of the normal budgets that they can use.
The second thing is that you need to have an informed customer, who understands what their need is, understands what the competing technology is and through, let us say, subcontractors and other experts has the ability to specify the output and manage that in a proactive way—in the way, for example, that DARPA does. DARPA operates through contracts, but at a bigger scale than the US SBIR programme. If you are running a DARPA contract, you will have the project manager from DARPA ringing you up every Friday to ask you where you have got to. That is a bit extreme, but I believe that this is the kind of programme that we need to persuade the Government to introduce. That means it has to have the money and a policeman—I originally thought it should be the Cabinet Office, but it did not want to do it—to ensure that it is being run in a professional way.
Baroness Neville-Jones: It also needs the expertise, does it not?
Dr David Connell: That is part of it. If central government allocates £100 million to a particular department to run such a programme, it needs to ensure that that department has the expertise, one way or another, to manage it in the right way. That was what I proposed in my report for Theresa May, and I have updated it in the report that you mentioned: Selling Less of the Family Silver. I advocate £500 million; I think that is the right amount. That would be less than 10% of the current amount that is spent on R&D tax credits.
Q66 Baroness Northover: This is on the industrial strategy and is for Greg Clark in particular. It is extremely welcome that you are on the Industrial Strategy Advisory Council, so I wonder if we could draw upon your conclusions. You brought forward an industrial strategy under Theresa May. The Government are in the process of constructing a new industrial strategy, so we would like to know what lessons you learned from the one that you brought forward, which presumably also drew upon what worked and did not work, in your view, from the one that preceded that. What worked well, what should the new Government look to emulate and what should be avoided?
Greg Clark: As you said, the first piece of good news, in my view, is that there is an industrial strategy. With the one that I developed and introduced, we spent a lot of time thinking about how we could embed it so that it would endure, just as you were discussing in the previous session with Gus O’Donnell. It was not a change in the political colour of the Administration—perhaps it was, in a way—but sadly it was a new Conservative Prime Minister who ditched the one that we had developed.
So the first thing is that it is right to have one. Most countries around the world—Singapore was talked about—have proudly had a developing industrial strategy. It is not the same one that it had 20 or even 10 years ago. It is important to be able to make long-term policy, not just commitments but signals, on how the Government see the world so that investors around the world can know what we are about. We cannot expect them to read minds.
The second thing is that we need to crack this question of how it can endure. A short-term strategy is an oxymoron; it needs to be there for the long term. However, in a parliamentary democracy, as you discussed in the last session, there is an election every five years or even sooner, as Gus O’Donnell said. If the Opposition had a good prospect of being elected and were to say, “We’re going to abandon it”, that cuts away.
So I welcome it, not just from the personal point of view that the Chancellor and the Business Secretary have appointed me, as one of the predecessors to the current Business Secretary, to the council. That indicates a sense of continuity on a cross-party basis. Whether or not it is with me on it, I think that that is the right signal to send.
The way that I tried to go about it was with an industrial strategy council, but it was abolished by the Johnson Government and was not restored by the Sunak Government. This one is intended to be on a statutory footing, which is intended to give it a bit more stickability. Of course, any Government with a majority can get rid of that. Those are some of the things about having one and then making it stick.
The other thing is that it needs a focus on what it is about. The one that I developed had a focus on improving the level of productivity in the economy which, as everyone here knows, has essentially been flatlining since the global financial crisis. The current Government have chosen to have as their theme business investment, and that is perfectly sensible and credible. It is better to have one focus than many for obvious reasons.
The other lesson that I would give is that it cannot be an industrial strategy from just the business department. It has to be the Government’s. It has to be a whole-of-government exercise. There is a really important aspect of what a strategy is; it is clearly a plan for the long term.
But there is another dimension of a strategy, which is that it is integrative. It brings together policies that may be in different departments, and it should be a bit of a clearing house to make sure that policies being pursued by one department do not conflict with those by another. After the machinery-of-government changes that took place just before the last election, we now have a science and technology department, an energy and net zero department and a business department. All these were part of my Department for Business, Energy and Industrial Strategy. If they are going to be separate—Gus O’Donnell mentioned that there is a kind of constitutional, quasi-independence of the Secretary of State—it is all the more reason to have a strategy that brings them all together and to broker what the strategy is to be.
There are perhaps a couple of other things. It is right not to pick winners. That was always the charge against the strategies of the 1970s. But I do not think it is wrong, if I can put it this way, to choose some races in which we might be competitive, in areas in which the state and the public sector have an interest.
Look, for example, at AI and big data, which is one of the choices that we made as part of the industrial strategy challenge fund when I was in office. This was not favouring or backing any particular company and subsidising it, but it was to say that we have assets in this country, in our universities, research institutions and business environment, and an opportunity to maintain and perhaps press our advantage in an area. This was not speculation; it was possible to discern, even in 2016 and 2017 when I was drawing it up, that AI was going to be pretty important and that we should have an advanced position in it.
There are other areas in which we can do it and we did it through the industrial strategy challenge fund. That again was abolished. It was poured into UKRI when the industrial strategy was abolished. I think that it is perfectly reasonable for the Government, as a whole, to have a conversation with the research funding agencies and agree on some races in which we want to be competitive.
They are some of the lessons that I draw forward. As I say, I am one of 16 people advising the Government but, as everyone here knows, advisers advise and Ministers decide. It is for them to decide which parts of our advice they will run with.
Q67 Lord Ranger of Northwood: Thanks, Greg, for your comments. Both of you have a vast amount of experience in this area. Is there something about the language that we are using here, as well? From listening to what you were saying there, we always fall into the trap around an industrial strategy of talking about picking winners. Conversations are about whether it is a trade-off between X and Y or certain businesses; should the Government be involved in that? That is the debate that always comes up. However, as you described it there, and quite rightly, there is a conversation about capability, the sovereign capability that we are looking at for a sector—whether in AI, cloud or cyber. Especially when speaking from a technology perspective, these are imminent sectors that it honestly feels we are lacking in globally. Do we need to shift the conversation and the language to one of national capabilities, rather than industrial strategy, to get rid of the baggage?
Greg Clark: That is a good way of putting it and you are quite right. Take AI as an example: it has come, among other things, from our research institutions, much of which are publicly funded. If we are spending £20 billion a year, which is a lot of money, on public-funded research, the future development of AI will, at least in part, reflect what our publicly funded institutions contribute. I think that is the case.
It is dispiriting in many ways that, often, discussion of industrial strategy leads to eyes rolling, going back to the 1970s and subsidising British Leyland and all the rest of those things. That really is not the case. When I was introducing this to my Conservative colleagues, who would sometimes raise an eyebrow, I would say, “Can you imagine a chairman or chief executive of a business going to the AGM of the company and taking a question from the floor asking them to set out their strategy for the next few years? If they shrugged and said, ‘Well, we thought we’d play it by ear really. We don’t really have one; we’ll just see how it goes,’ I do not think they would last very long”.
The Business Secretary, Chancellor and Prime Minister ought, with some confidence, to be able to say, “We have been given temporary charge of policy in the country. This is how we are going to deploy it”. I do not think that that should be controversial and certainly not party political.
Dr David Connell: The development of successive industrial strategy is important. Greg’s exercise was an excellent thing to happen in the last Government; I am not up to date with the current one but I have a couple of issues where I think it is not enough. Industrial strategy is good at focusing support on established companies in sectors that maybe have not been supported before. For example, film and games is an important part of the economy, which has not historically had a great deal of help.
But there are two issues. First, stuff tends to come in from left field. They are new areas of opportunity and the Government are pretty late at identifying them. We have the internet of things and nanotechnology. AI is an example; it has been growing in sophistication for some years, but government interest is a bit late. The application of AI is now mainly using more or less readily available technologies and applying them to existing businesses.
There was an excellent government programme in the 1970s called the Microelectronics Application Scheme, which did exactly that by encouraging all kinds of different companies to use microelectronics—new technology that they were not familiar with. Just to give a slight counterexample, Cambridge Antibody Technology is our most successful biotech start-up ever. When David Chiswell and others set it up in the 1980s—whenever it was; I cannot remember now—there was no venture capital available for antibody-based research and no grants. So he set it up with his redundancy money.
The other strand is trying to use the power of expert customers from both the public and private sectors, who know what is going on in technology in the world, can see what is bubbling away under the surface and have a feel for the problems that they think it could be addressed. Tapping into that resource is an important, different axis on which to address industrial strategy.
Q68 Viscount Stansgate: What role could the new industrial strategy have in supporting innovative science and technology companies, as distinct from what you might call the established sectors?
Greg Clark: I cannot speak for the Government because I am not a member of it, and they have not published this yet but, as a general point, it ties into the question that David just answered. How can you ensure that you are talking not just to the incumbents but, as it were, to the future incumbents? It requires a great and deliberate effort to do that.
One thing that we did that perhaps might give some insight into it is a programme that we had in the industrial strategy challenge fund called “commercialising quantum technologies”. Back in 2017-18, there were not that many incumbents in that putative sector. The challenge director, which was a role created within UKRI within Innovate UK, was to go out and have the conversations as to what was needed in the environment to do the research, in particular the development—since it was commercialising quantum technologies—without there being a significant number of large incumbents. So it is possible to do it, but it needs to be done deliberately.
Again speaking personally, having been in office when we created UKRI, Innovate UK needs to be a bit more agile and risk-taking in the way that it operates, perhaps channelling what Gus O’Donnell said. Bringing together Innovate UK and the research councils into a single body had its advantages, in not bifurcating, as it were, two important aspects—the R and the D.
My observation, and I hope it is not too uncharitable to the people who have worked and run it, is that it has adopted too much of the research councils’ culture. That is shorthand for having calls to say, “This is what we want to fund. We will entertain bids to be submitted over six months, and then we will peer review them. And then in nine, 10, 11 or 12 months, we will give you the answer”. The pace of the deployment of technology means that you can have things slip through your fingers. You might be aware of a company that either has developed a technology here, and now wants to get on with manufacturing or prototyping manufacturing, or a company from overseas that perhaps has some idea and technology and thinks that the UK would be a good place to do it. But the idea is that they tell their board, “We will get an answer from the UK in, you know, 9 or 12 months’ time”. Forget it; they will go elsewhere.
We need to deploy the public funds that we put into the development, which you might call scale-up, with much greater agility. Probably, that will include more risk. Some of them will not work. No doubt committees of this House and the other one will tut and say, “That is public money wasted”. Actually, it is not wasted in the scheme of things, because the counterfactual is the businesses that are lost by not being so agile. So there are reforms that we can do to capture the next wave as well as encourage the incumbents.
Viscount Stansgate: That means that, when the industrial strategy gets published, it is just as important, in your view, to have a means of talking to the new future that still lies ahead, which we do not necessarily recognise yet.
Greg Clark: It very much is. There is a bit of a danger that, when the focus is on the strategy being published, people will think that that is it: it is done; we have the industrial strategy. The truth is that, as in any business or organisation, a strategy is the combination of the policies that guide the decisions that you make into the future. It is mostly not a document. A document is helpful and an important staging post, but it is not just in the documents that what you say, Lord Stansgate, should be the case; it needs to be the practice of the Government that every Minister and official responsible should be prospecting. If they come across businesses that have the potential to expand or perhaps to be lured from another country, they should be connecting them. Other countries do this.
Q69 Baroness Walmsley: I will take you back to public procurement. David, following your comments about the US version, which has the same initials in a different order, you talked about two particular things that we do not have here. One was the scale of it—the $6 billion—and the other was the obligation on federal agencies and how they must spend their money. We do not have that here. I understood you to say that the problem in the UK is that the departments will not pay and therefore we need a separate fund, with the money coming from some of the R&D tax credits.
Then you talked about needing a policeman. You need the money to be monitored, reviewed and enforced, and this needs expertise. It strikes me that this is a problem right across Government. Greg talked just now about strategies; sometimes people think, “Well, we’ve got the strategy. Now it’s done”. We have lots of regulations in this country that are not followed up or adhered to, because nobody checks. This is a problem, is it not?
So really my question is about where this policing should be done. Should it be done in the individual departments? Is there a role for DSIT or should it be by the Cabinet Office? Should there be any co-ordination or is it just an obligation on the individual departments?
Dr David Connell: That is an important question and a very difficult one, actually. My view is that there should be some kind of oversight committee, which would be populated mainly by people from an industrial and entrepreneurial background. Their job would be to ask each agency or department to which a pot of money was being given for a series of programmes to explain how that money was going to be managed and in what areas they are going to run competitions. As Gus O’Donnell said, civil servants and government departments do not have the people with the experience and the background to do this job, and they have a lot of pressures on them from above and sideways to make it difficult. That is what I mean by a policeman: a demanding oversight committee with teeth, which probably has to publish an annual report. That is my answer.
I would like to answer a question that you have not asked me yet—maybe you will—about how to deal with the institutional problem. Can I answer that?
The Chair: Yes, by all means do.
Dr David Connell: As I said, the problem is that there is no data and no co-ordination across departments. We have Innovate UK, which looks a bit like a research council—it is adopting that flavour—we have R&D tax credits and we have DASA, the Defence and Security Accelerator, spending some money. We also have other smaller agencies.
What I propose, which is in the report, is that the Government establish something that is a bit like the OBR, not in terms of what it does but because it will be a small group of capable analysts and reporters, if you like, acting independently of government to require certain levels of sensible reporting from spending departments. It should pull it all together to see where the money is going and whether progress is being made.
It should also focus on outcomes rather than just outputs. That Innovate UK has attracted an extra £500 million, or whatever it is, of investment from the private sector into programmes is an output, not an outcome. The outcome is whether we are creating significant businesses and jobs. Thank you for letting me do that.
Q70 Baroness Walmsley: I noticed, Greg, that earlier you talked about the importance of place. Can you say something about this issue in the various parts of the country where we have metro mayors? What role do they have? Do they have enough powers, levers and influence in this sphere to bring growth in their region?
Greg Clark: This is hugely important. Just as a nation needs the right policies in place, and the right attitude and vigour on the part of Ministers to have a successful economy that is attractive to investment, so does each place. Investment does not happen in the abstract. It always and everywhere happens in a particular place, and the conditions there are incredibly important—from the infrastructure to the ecology of innovation, universities and research institutions.
The creation of mayors, whose role has been interpreted—correctly, in my view—as principally one of economic development, is absolutely crucial. It is a big opportunity now. The Government are requiring that every mayoral combined authority should have an economic development strategy for themselves, but they should be done in conjunction with the national one. I think that is important.
For all the importance of policies—and they are important—this is an age of activism. I was very struck, and some of you will have known him, when Sir Howard Bernstein, who was the chief executive of the city of Manchester—a big figure—died very sadly and prematurely. He was phenomenal. When I was in the office of Business Secretary, if I had overseas investors coming to see me in Whitehall, somehow Howard Bernstein would get wind of it. He would be down on the train and be sort of loitering about on the ground floor. He would say, “Well, you should come and see Manchester. I can show you the sights that we have available here”. Sure enough, as often as not, they would extend their visit and he would personally conduct them around. What has happened with the regeneration of Greater Manchester owes a lot not just to policies but to leadership from Sir Howard, but also Richard Leese, for example, and now Andy Burnham, who are following that approach.
These things are important. It is not all desiccated policy-making—and I confess to being a policy enthusiast, if not a geek—as you need to be active. Mayors offer a great ability to do that, as well as Ministers.
Q71 Baroness Neville-Jones: The reason we are conducting this inquiry is the worrying rate at which British companies get bought up at the scale-up stage. We have already ventured into the territory of causes and the reasons why so many get bought out at that stage, particularly by Americans. Of the things that we have not said and ground that we have not gone over with you, what options are open to UK Inc? I mean, it is obviously Government but may be other parts of the system as well. I would be interested in the thinking of both of you on that.
Greg Clark: I touched on this earlier. I would prefer to solve the problem about why companies feel that they need to go overseas for funding and I would like people to come to us.
Baroness Neville-Jones: I do not think we are searching for legal impediment; we are searching for much more constructive solutions.
Greg Clark: The national security and investment regime is still comparatively new. This might be comparative to what I said about Innovate UK; it also needs to be agile. Even if it comes up with a sensible decision, prospective investors into the UK—sometimes that can be through acquisition as that is the nature of a capitalist economy—may think that it will take 12 months to get an answer. I know that there are time limits and targets in the investment scrutiny regime, but they are important.
My view is that, having established this new regime shortly—it has been going for three years now or something like that—we should have a stocktake. It was designed to bring us to the level of other countries. Sometimes there is a tendency in the UK to kind of gold plate things, and we take longer or are more exacting. Now would be a good time to have a benchmarking exercise to make sure that that regime is competitive and not either overelaborated or underpowered—if I can put it that way.
Dr David Connell: You are asking what mechanisms there might be to encourage or help more founders to keep companies in the UK. There are four things that I think could make a difference, but these are in the report, in the main.
The first is reduced dilution in the early stages of a company’s growth through procurement, private sector contracts or minimally dilutive grants like the EU programme that I talked about, which is about £600 million. There is lot of enthusiasm for that. That is the first thing.
The second thing is dual-class shares. What happens with a company as it grows and raises successive rounds is that the founder management have smaller and smaller shareholdings, so they cannot control strategic decisions like sale. One way of reducing that problem is founders’ dual-class shares, which give them more control over those kinds of decisions. Dual-class shares are pretty common in the States: Facebook’s founders have dual-class shares and Google refused to IPO unless the founders were given dual-class shares. There are many other examples but, for various reasons that I do not fully understand—my co-author of the book, Bobby Reddy, is an expert on this stuff—that either is not possible or is much more difficult in the UK. So that is the second thing.
The third thing, potentially, which is not in the report, is venture debt, which is basically loans that can convert to equity if the company borrowing the money cannot pay it back. That has been reasonably common in the later stage of funding companies. I am not up to date with the level of venture debt, but it seems to have declined in usage. There could be scope for some imaginative thinking to create a vehicle here with some kind of government support, partial guarantee or something.
Baroness Neville-Jones: Who takes on the debt as things stand?
Dr David Connell: These are different kinds of funding. In equity, you get a share of the company. In bank debt, you have security over debtors or something. Venture debt is a bit like venture capital; venture capital-ish sort of businesses make venture debt available in a specific amount to companies in their late stage, sometimes on the basis that they will either get a good interest repayment or, if it looks as if the company is going to fail or not do very well, they have a good chance of getting a share of the equity when it is ultimately sold. That is how that works. It needs some imaginative thought, but there could be a role there.
There is one final specialist area—employee ownership trusts. I happen to know about those because the company that I helped build now is one, which means that it is owned by its employees rather than its early founders, like me and others. Employee ownership trusts are fairly common in the UK but mainly in service firms like Ove Arup—companies like that—and Atkins, possibly. Such trusts are much less common in manufacturing companies.
One of the known problems with employee ownership trusts among that sector is that the company borrows money in order to pay off the previous shareholder over a period of years. That is a burden on the company, which may well be profitable but, if a way could be found of providing some kind of government-supported debt in some way, that could make it more attractive to make a company move it into an employee ownership trust. It would also result in less restriction on its ability to invest in further growth during the period, typically eight years, when it is paying back the money.
Q72 Lord Drayson: I draw your attention to a problem that has been raised already but I am ideally looking for some suggestions for action around the lack of scale-up capital in the UK. By that I mean the £100 million rounds. We are talking not about venture capital but about companies that are already successful. Dr Connell, you mentioned Cambridge Antibody Technology, which went public on the London stock market in 1997. That generation of companies had access to scale-up capital, like CAT did. Greg, you worked with John Bell pretty closely on your industrial strategy for life sciences, and he gave evidence recently to this committee talking about how life sciences is currently dying through a lack of scale-up capital.
There has been lots of talk about the Mansion House reforms, and there is, in effect, an intellectual argument taking place between the City and the entrepreneurial founder community. What do you believe the Government need to do? What action needs to be taken to fix this, given the urgent flight of capital that has taken place from the UK capital market?
Dr David Connell: First, we need to ask why there is a concern about scale-up capital. Clearly, it is available in some cases. Oxford Nanopore is a classic example and has had huge amounts of cash. We are at a position where plenty of companies have been backed but are unable to find the capital that they need to go forward. Is that because they are unlikely to succeed ultimately—obviously, they want to try to succeed and will be looking for more capital—or because there is an absence of organisations with the ability to spot a real winner and put the money in? I do not know the answer to that. There is huge lobbying coming, particularly from the biotech sector but also from other sectors, from companies that would like more scale-up capital. Of course, they would, would they not?
Lord Drayson: I am looking for your advice to this committee that we will give to the Government. What should this Government be doing? There is clearly a problem. The evidence base is strong that there is a problem. What do you believe the Government should do?
Dr David Connell: I do not have the answer to that.
Lord Drayson: Fair enough.
Greg Clark: I am no expert, but Gus O’Donnell was talking about how little of our capital is deployed in equities generally and in terms of scale-up, compared to other countries and the growth potential. The reforms that Jeremy Hunt started and Rachel Reeves is continuing are important to that. I mentioned earlier that it is important to have some local funds or more regional funds. I mentioned Northern Gritstone having a more accessible source of capital locally; that can be important.
You mentioned John Bell. He was influential when I was developing the industrial strategy, particularly in the life sciences. We have people like John. The other example par excellence is Kate Bingham. If you want to know about how to get companies funded, Kate is a genius with a track record. I suspect that it is a number of things, such as the financial reforms having greater regional focus.
I should emphasise that universities are also important. It is the case that the biggest single source of scale-ups in the UK over the past few years has come from and been helped by universities. Admittedly, that is often at an earlier stage, but universities are good partners in this. I suspect that a suite of reforms is needed.
Lord Drayson: Can I push you a little on this because, as you say, it started with Jeremy Hunt and the discussion is continuing. There has been no actual action that has made any difference. Speaking as a former Secretary of State, what can a Government practically do to address this lacuna?
Greg Clark: The first thing they can do is to make things possible that previously were not. I would characterise the reforms that have been made as signalling that it is possible to make a broader range of investments.
But the next challenge is to cause people to do it, and that is a bigger discussion. I do not have any particular expertise to contribute to the committee on that.
Dr David Connell: We need to define scale-up capital.
Lord Drayson: It is a £100 million round.
Dr David Connell: That is what I thought—very significant rounds that will come from really big players in, say, the private equity world, the very large fund world or from an IPO, I suppose. This is a difficult problem, and the issues I have discussed need to be factored in. It is a difficult problem, and I do not have the answer.
Q73 Baroness Walmsley: We have heard some concern about the lack of science and technology sophistication among investors. What can we do about that?
Greg Clark: I have mentioned Kate Bingham, who is perhaps the exception that gives an illustration. If she is not giving evidence, she might contribute a paper to the committee—she is very public spirited. It has broadly been the case that the scientific disciplines in which people are trained have not always been the source of the people who are making decisions on investment. One feature of intellectual life and the way things are proceeding is the breakdown of disciplinary silos, and the idea that you can have people who might be educated in the sciences, and in STEM generally, who go on to careers in, say, policy—the Civil Service has a target, as you know, to increase its level of scientific accomplishment. Generally, breaking down those barriers and expanding the opportunities for people to be scientifically educated is important.
I have always personally found one thing surprising. If you want to go into the law as a profession, you can pretty much do anything as a first degree and you can do a law conversion course that then equips you for a legal career. The way that our education system works is that, as we all know, you have to choose—you have to reduce your choices at A-level. Lots of people, in my experience, study the humanities at degree level, having done humanities-dominated A-levels, but have an aptitude for science and technology that is just as much as that of people who happen to have chosen that. So one thing I have always thought is an opportunity for universities is to have the equivalent of a law conversion course: a STEM conversion course, in which people who have perhaps done an undergraduate degree in the humanities can equip themselves with some of the rudiments that might enable them to be more, as it were, scientifically literate. But that is a personal hobby-horse that I am afraid I signally failed in government, including as Universities Minister, to do anything about. But perhaps, now that I work in a university, I can.
The Chair: But you have also just argued for the baccalaureate system.
Greg Clark: Indeed—you might infer from that that greater breadth might be beneficial.
Q74 Baroness Neuberger: You have given us a huge amount of food for thought. Both of you have been deeply involved in trying to do something about scaling up and getting this right—so far, we have not succeeded—and you have done it in very different ways, obviously. We will have to give some recommendations to government. What should they be? What should we be saying to government so that we make it work this time? What should we say that they should do?
Greg Clark: First, continue with the financial reforms and—to Lord Drayson’s point—address the question of making behaviour change, not just changing the rules. Secondly, push perhaps the British Business Bank and the National Wealth Fund to be more active in this space, and to have that as part of their remit.
Baroness Neuberger: Should they be pushed to be less risk averse?
Greg Clark: Yes, that comes with it. I would say that they should have a regional presence as well as a national presence. The British Business Bank does that and is an important source. I would work in that respect with the mayors and make sure that they have institutions available that can help.
I would also reflect on the fact that it is not just access to capital. Sometimes, people sell out because they do not feel equipped to manage those businesses to the next scale. In so far as we provide help and assistance, often through universities, that is a very worthwhile focus of it. Going back to what I said about Innovate UK, as well as the British Business Bank and others, I would have that as an important part of their remit.
Dr David Connell: I could make a lot of proposals, but they are all in the report. I will give two specific ones—the top line. The first is to establish this OBR-type organisation to be the brain of all this stuff—an independent brain that collects the data, looking at outcomes and so on, probably reporting to the Chancellor.
The second is to deal with the medium-term constraints. My view is that we need to refocus the overall budget; we need to sharpen up all of it but refocus it in slightly different ways. The problem we have is that the Chancellor has already committed to spend £9 billion—£10 billion—on two schemes that are flawed, in my view, for the next four years.
So the second thing, over the next year to two years, say, is to set up some large-scale pilot programmes of the other things that might make a difference. One of them is something like the EU accelerator programme. Another thing is proper procurement-based funding and SBIR-type funding.
By the way, I should add that the Procurement Act has really queered the pitch here, because it has confused the first customer for an established piece of technology with funding R&D to develop a piece of technology that a customer uses. It is not only that; it has also ensured that the data will not be available because it does not have to be reported, and lots of the numbers are very small. That is rather unhelpful. Those are two of the things, and there might well be others as well.
I recommend setting up some significant pilot programmes, with a view to, when possible, taking a view on whether it is appropriate to move a bit further in refocusing the funding.
On the procurement-based thing—this applies to other aspects of policy—the key thing is an informed customer. One of the best programmes that Innovate UK seems to have done is the quantum computing programme, which essentially makes a lot of use of the contract-based funding—SBIR-type funding. It is able to do so because it has created a customer: the national computing centre at Harwell. So it has the skills to make the decisions.
The Chair: Thank you both very much. This has been a useful session, and we are grateful to both of you for giving so much of your time and wisdom.
