Written evidence submitted by Parkwalk Advisors Ltd
The current state of the venture capital industry in the United Kingdom, including opportunities and threats, such as the availability of domestic capital to allow firms to scale up in the UK.
The venture capital industry in the United Kingdom is now, in many respects, a well-established eco-system with many investment firms who focus on a wide variety of investment sectors and several stages of funding. However, whilst there are a significant number of early-stage investors (as a result of EIS and other tax advantaged schemes), the UK continues to lack scale-up financial investors (especially from the UK itself) who are able to invest £10 million and over into investment rounds.
Whilst early-stage funding is readily available, there is a significant dearth of scale-up funding in the UK ecosystem. This is a particularly critical issue for deep technology and life science companies where there will be a very significant period of time where these companies will not be revenue generating and therefore the companies will be considered ‘too early’ for PE and corporate investors. Within our portfolio, we have a number of companies who have now exhausted, or will shortly exhaust, the EIS funding limits but they still require significant funding to continue their research and development in order to commercialise their products and become profitable. Without further funding, there is a risk that these companies will not survive.
In line with the Government’s goal to maintain and enhance its position as a science and technology superpower, it is very important that more of this scale-up funding is generated and deployed within the UK. At the moment, in our experience, a significant amount of the scale-up funding which is available (which is not much) is provided by non-UK investors. We would encourage the Government to consider amending the limits of the current EIS rules in order to allow EIS funds to continue funding these research and development intensive companies for longer.
In addition, we would encourage the Government to consider whether new schemes or incentives could be introduced to encourage the inflow of this type of investment.
The level of co-operation/integration between start-ups and established industry
In our experience, the level of co-operation between start-ups and the established industry is not very good and needs considerable improvement. Our experience is that many established industry players are generally disinterested in start-ups and, where there is some form of engagement, we have unfortunately seen harmful and predatory behaviour.
Outside of some of the more established UK industries such as pharmaceuticals and aerospace, our experience is that there are not many established companies who are willing to co-operate and integrate with start-ups.
The operation and effectiveness of the current tax incentives (such as the Enterprise Investment Scheme (EIS), the Seed Enterprise Investment Scheme (SEIS) and Venture Capital Trusts (VCTs)) in the venture capital market, including any options for change.
The introduction of the SEIS and EIS schemes over 25 years ago has led to a buoyant and well-developed funding ecosystem for spinouts/start-ups and Series A companies. Angel networks provide vital early-stage funding alongside or ahead of EIS funds which, in relation to the larger EIS funds in the market, are able to provide funding for companies until well into their Series B funding rounds.
We are mindful that the sunset clause remains in place in respect of the EIS legislation. In order to ensure that this vital early-stage funding remain available, we would encourage to Government to address this sunset clause - by removing it altogether or extending it to allow for review at a future date - as soon as possible. Although the sunset clause is set for April 2025, it is imperative that we receive clarification on the continuing availability of EIS as soon as possible - when EIS funds raise funds from retail investors, they do so with the expectation that it could, in some cases, take them several years to deploy those funds into investments. Each firm is different in this regard, but even for Parkwalk which aims for a 12-18 month deployment window, we expect that we will start to receive questions on the sunset clause very shortly unless steps are taken to address the matter.
In relation to EIS investments, a number of EIS investors (including ourselves) seek EIS advance assurance before investments. Over the past 6-9 months, we have encountered a number of very significant delays on certain applications as well as a significant number of follow-up questions on applications which do not appear to be pertinent to the EIS application at hand. Since the start of September 2021, of the 21 advance assurance applications we have made, 10 applications that have taken over 4 weeks for clearance and, of those, we had one that took 8 weeks before clearance was given and another that took 91 working days for a response. Historically, we have found HMRC response times to be good but the speed of response, and the disparity of views we receive from HMRC through commentary given and questions asked, has been very concerning and caused us significant difficulties. At times, the delays have caused co-investors to raise concerns about investing alongside EIS funds, which is clearly very concerning.
The operation and effectiveness of the regulatory regime(s) concerning venture capital.
There have been some very significant regulatory changes over the past few years that have significantly and adversely affected the UK venture capital industry. One of the most difficult of those is the National Security and Investments Act which has already caused significant delays to many investment and sale processes, even where those processes only involve UK investors. Whilst we acknowledge that the NS&I regime is new, the high-risk sector definitions are so wide that they capture most technologies which the UK would appear to be trying to promote as part of the UK’s desire to be a science and technology superpower. In addition, the fact that UK investors (even where they are FCA authorised and regulated) are treated no differently under the screening regime to non-UK investors means that a significant amount of the ISU’s time must be being spent on transactions which provide no national security threat or concern at all.
Further, the ever-increasing regulatory burden placed on venture capital fund managers by the FCA continues to add more and more hurdles to the operation of the venture capital ecosystem. For example, the FCA’s proposed introduction of a new consumer duty is of real concern within the venture capital industry and will significantly increase the workload and regulatory burden as fund managers seek to determine how to ensure fair ‘outcomes’ for investors for the first time.
The role of other key bodies, such as the British Business Bank and the programmes which it oversees (including the Future Fund and British Patient Capital), and the Advanced Research and Invention Agency, and how they can support the venture capital market.
Understanding that there is a shortage of scale-up funding in the UK (as noted above), we have seen the deployment of Government funds into the area in which we operate.
Firstly, we have seen investment from the Future Fund into 13 of our portfolio companies. We have seen a number of our companies experience significant problems when it comes to the conversion of these loans - dealing with the Future Fund conversion has led to significant delays in funding rounds and, in some cases, has made it extremely difficult to complete the funding rounds at which the FF note should convert. In one case, there is a material chance that the FF’s approach to the negotiations on conversion of the loan will lead to the relevant company’s need to enter into insolvency proceedings rather than accept a rescue package from angel investors.
We have also recently seen direct investment from British Patient Capital. Whilst we welcome the availability of these funds, our experience is that these monies come with non-standard, off-market terms which makes the funding unattractive to companies when compared with traditional venture capital terms, and that make it very difficult for UK investors to invest alongside BPC. This is extremely disappointing - BPC’s investment should be a source of funding that start-ups and scale-ups in the UK are fighting for in order that the Government is supporting some of the most exciting and innovative companies, but the current terms requested by BPC mean that, in our experience, the BPC money has become almost an investor of last resort.
The merits of policy proposals for strengthening the venture capital industry in the United Kingdom, such as:
- Opening new pools of capital for venture capital investment, such as pension funds, retail products (e.g. investment through ISAs)
- Generating home-grown talent through the education system
- Attracting international talent through the visa system
- Any other possible Government or public sector intervention
We think that the unlocking of pensions funds for new pools of venture capital investment is absolutely key to the development of the venture capital sector, but also key for the long-term performance of pension funds. We do not think that investment through ISAs would be of positive benefit to the industry - venture capital remains a niche investment for which only certain profiles of retail investor will be appropriate and opening VC investment up to more people through ISAs would be inappropriate. One might also argue that such a move would be in direct contrast to the FCA’s desire to impose its new consumer duty.
We would be extremely supportive of policy proposals for supporting the generation of home-grown talent though the education system. 25 years ago, before the introduction of EIS and the beginnings of the start-up ecosystem within the UK, there was significant concern of the ‘brain drain’ of academics and home-grown talent to the US and other jurisdictions. With the supportive start-up VC industry now in place, there is less concern about the ‘brain drain’ of top academics from the UK, but there is still more to do.
Whilst we note that the Government has introduced several schemes over the past decade to encourage international talent to the UK through the visa system, we believe there is more to do. For example, one of the key challenges that we see talent experience are restrictions on dependents joining them in the UK.
We would recommend that the Government seek to understand the industry on a day to day basis on the ground by visiting fund managers and start-ups to discuss the challenges with them further.
The effectiveness of any other government or public sector intervention in the venture capital industry.
From our experience, Innovate UK grants and R&D tax credits work very well and are an excellent help to early-stage and scale-up technology and life science companies.
We would like to see BPC’s terms of investment change to industry standard terms in order that it becomes an investor or choice rather than an investor of last resort.
The effectiveness of government policy around venture capital in meeting wider government objectives (for example: around “levelling-up” and tackling regional inequality, the aim for the UK to be a science and technology “superpower”, net zero).
We agree that levelling up is an important agenda but it is absolutely key that the historically more successful parts of the UK are not levelled down in order to achieve this more quickly. Lessons could be learned from the Golden Triangle and why its start-up ecosystems are so much more advanced than other areas within the UK. From our experience, there is a very significant amount of knowledge and experience within the technology transfer offices for the Golden Triangle universities that, if shared with other universities, could lead to more UK universities spinning out more start-ups. We think that Government investment into technology transfer skills, especially in areas which require levelling up, could be very beneficial.
As noted at the start of our responses to this Inquiry, key steps need to be taken to deal with the lack of scale-up investment monies within the UK - without this, the levelling up objective is very difficult as early-stage monies will continue to be concentrated in those areas they are currently concentrated in.