Written evidence submitted by BGF
We are delighted that the Treasury Committee is exploring the state of the UK’s venture capital industry, and particularly the committee’s focus on the ‘ability of firms to source financing to scale up’. The matter of ‘scaling up’ is something about which BGF — as the UK and Ireland’s most active and dynamic investor of equity capital in growth-economy companies — has extensive interest and experience. In this submission, we set out our relevant views and findings, with a particular focus on this issue of scale-up financing.
BGF has invested over £3 billion, in more than 450 SMEs. Our present portfolio companies collectively employ over 70,000 people across the length and breadth of the UK and Ireland. Notably, around 75 per cent of our portfolio is based in regions outside of London. This reflects our extensive network of local offices across the UK, and our stated objective to help drive investment nationwide.
BGF was founded in 2011, with the aim of providing much-needed patient-capital funding to help innovative SMEs to grow. These SMEs urgently required capital, and particularly equity, but were unable to source it sufficiently in the market, owing to a long-time lack of relevant and suitably attractive supply. In particular, we provide minority investment, together with external support, delivered in a collaborative fashion aimed at growth companies. BGF’s model — making these minority long-term investments into the growth economy from an evergreen balance sheet funded by the major UK banks, reinforced by the largest pool of independent directors in the country (today, over 6,000), and generating strong returns — represented a sea change in patient-capital investing.
Our market-driven decentralised model not only drives local economic growth, but also has a lasting positive effect on individuals and communities in ways much greater than purely financial. Gains in innovation, productivity, and employment bring with them a renewed sense of responsibility, ownership, and the value of collaboration — as does a focus on entrepreneurship, skills, and best practice. BGF’s model, based on partnership and guidance rather than taking control, as well as the supply of growth capital, is at the heart of this. A strong sense of mission and purpose has always been at the heart of BGF’s approach, and has become even more relevant to the challenges and opportunities facing the UK economy today.
BGF’s economically and societally beneficial results have been developed and delivered by an independent team from the private sector for commercial returns. But it is crucial to note that BGF came into existence owing both to smart regulatory thinking, and the unquestionable benefit of governmental convening power — at a time of great national need, namely the financial crash. That ‘intervention’ has worked extremely well, providing a template for the sort of further changes the UK needs, now and looking towards the future.
Venture capital and growth funding
First, we believe it is essential to emphasise some clear conceptual distinctions. It is particularly crucial to recognise that the terms ‘venture capital’ and ‘growth funding’ refer to different — albeit sometimes overlapping — concepts. As above, at BGF, we focus particularly on what we call ‘growth-economy companies’, which exist within the vigorous midsection of the UK’s private sector. Specifically, we define these companies as those reporting turnover of between £2.5-100 million. There are around 22,000 growth-economy companies in the UK, and they are crucial to the nation’s economic opportunity, growth, and wealth; the growth-economy companies BGF invests in are innovative and exciting.
Sometimes, companies like these are referred to as ‘scale-ups’, to reflect their stage of development; sometimes they are referred to as the UK’s ‘Mittelstand’. Descriptive terminology aside, however, it is essential to recognise that these growth companies are different from the kind of company that typically seeks venture-capital funding. Indeed, a key part of the reason that ‘growth-economy companies’ — or ‘scale-ups’ — have faced a long-term funding gap in the UK is that they are generally too small to be funded by public markets, but are large enough to have outgrown venture-capital funding. As Sir Anthony Seldon outlined in a recent report for BGF:
“The problem is that short-term funding begets short-term thinking. Venture capital and private equity tend to seek out high-growth businesses with an almost immediate view on the exit route. In the case of private equity, these investors usually demand a majority shareholding, because when you control a business, you control when to sell. Not only do these characteristics starve many good businesses of long-term capital to grow, they act as a cultural barrier reinforcing the view that ‘the City’ is not built for growth economy companies. In other words, the attributes of private equity, namely short holdings periods and majority shareholdings, are not conducive to providing true support to the growth economy. The growth economy at large needs long-term capital, and potential investee companies need the option of only accepting it from minority investors – many growth economy companies will reject the capital otherwise. For these and other reasons, we believe the venture capital and private equity sectors will not, on their own, provide the necessary support to the growth economy.”
We believe it is crucial, therefore, that accurate distinctions are drawn between concepts such as ‘venture capital’ and ‘patient capital’, for the needs of the UK’s growth economy to be satisfactorily assessed, understood, and met.
The current state of the venture capital industry
Taking into account the distinctions drawn above — and the inquiry’s interest in ‘scale-up financing’ — we will answer this particular question with specific regards to the state of access to capital for UK growth-economy companies.
Here, we believe it is important to note the persistent equity capital gap, especially outside of London and the South East — sometimes referred to as the ‘Macmillan Gap’ — that has, for decades, damaged the development of growth companies. This damaging funding gap arises, and persists, owing to a shortage of appropriate funding options, an historic over-reliance on debt, artificial barriers to access, and a poor level of awareness of the benefits of long-term equity capital. The gap is nothing new, but it worsens during times of crisis. This, we believe, is the main reason that insufficient UK start-ups go on to become world-leading scale-ups. It is no accident that the US leads the world in technology, in part because it also leads the world in cultivating the right ecosystem, including funding for these companies.
The most effective relevant action the government can take now, therefore, is to use smart regulatory thinking to free up existing appropriate sources of capital for the growth economy. The right regulatory reforms could have a significantly positive impact, and quickly.
Beyond this, it should also be noted that, with regards regional need and the important ‘levelling-up’ agenda, there is no ‘one-size-fits-all’ answer here. Local funding requires local knowledge and respect, and crucial to achieving a level of investment in local communities that truly meets local demand is a fully ‘joined up’ approach — involving key service providers such as banks, lawyers, accountants, and investors, alongside key public-sector bodies, namely universities and Innovate.
Operation and effectiveness of the regulatory regime(s)
We will continue to focus here on the unlocking of institutional capital for the growth economy, with an emphasis on the reform of pension-fund regulation. We firmly believe that properly enabling the deployment of funds held by DC Schemes into the growth economy would provide much-needed capital for this area of national importance. Simultaneously, it would allow everyday savers the opportunity to diversify their portfolios, and invest some of their pool in higher-returning illiquid assets, supporting growth and innovation in the UK economy and local communities. This would democratise access to assets and opportunities which have, to date, been largely the preserve of the very wealthy.
We are pleased therefore to note the reference, in your Call for Evidence document, to the option of ‘opening new pools of capital for venture capital investment, such as pension funds’. Now, the government has of course been attempting to enable a general solution along these lines, via various routes, and in response to various consultations. Yet unfortunately, it must be emphasised that there has been little real change, as yet. The need to proceed carefully with regulatory reform is understandable, but it is nonetheless frustrating that the clearly-identified goal of unlocking the pension funds remains resolutely unmet.
As acknowledged by the focus of various previous government consultations — many of which we have made submissions to — a long-running particular problem to enabling the solution described above relates to the charge cap. This is not to say that a charge cap is not required: it is prudent and responsible to keep a close control on such costs, with a view to consumer protection. Rather, it is to emphasise that the scope of the charges, as currently applied, results in trustees only being able to invest in the most generic investment strategies, on a passive basis, at the expense of driving higher absolute returns.
This has two significant and obvious drawbacks. Firstly, higher absolute returns have been sacrificed by an overly narrow and rigid focus on cost, so that the resulting net returns are much lower, which, compounded over the decades ahead, will dramatically lower saver returns and future pensioner entitlements. This cannot have been the intended consequence. Secondly, the default investment strategy, driven by a focus on fees versus returns, has led to an overly conservative and rigid approach, predominated by investment into large cap public companies and bonds on a global basis. This is starving the domestic economy — and, in particular, illiquid investment into high-growth companies — of the capital required to drive significant longer-term returns. Not only, therefore, do we face an important opportunity to increase saver and ‘pension pots’, but also to fund the growth economy. Without a shift of approach, the UK risks being an also-ran in the global innovation race.
Essentially, delivering good returns in a balanced and risk appropriate manner should be the goal — not the lowest fees, irrespective of returns. The contrast with the current situation afforded to savers in similar schemes in Canada and Australia is stark to the extent of serious unfairness. Moreover, we cannot and should not rely on international pension funds to do the job of the UK pension funds industry.
It has been recognised in previous government consultations that, on a global basis, the active management of assets is more expensive than passive investment, because the former requires more specialist skills. And patient-capital investments are particularly resource intensive over a long period of time: from the initial investigation and investment, through the management of a portfolio company, to an exit. The nature of patient-capital investing in SMEs is that capital is invested in relatively small amounts, but via a large volume of transactions. Each investment typically requires hundreds of hours of research, discussion, negotiation, and management — and, in order to invest on a local basis, offices and staff are required across the country. Indeed, 85 per cent of BGF’s investments are made within 50km of one of our 14 local offices across the UK.
The private equity and venture capital industry has proven the success of specialist investment managers, with a focus on higher absolute returns, in turn incentivised by performance fees. So-called ‘carried’ interest has a critical role to play in this, by reducing upfront costs to investors, attracting talent, and paying on results. This shows how the model can and should work. However, from a policy standpoint, the UK is not short of either private equity or venture capital. Rather, the lack of scale-up capital is well documented. This is where smart regulation and ‘intervention’ are needed: to ensure a sufficient allocation of DC pension funds to support the UK growth economy. This needs to be clearly identified to ensure the right policy outcomes, which are proportionate to the need and the opportunity.
Now, the specific reform we have suggested previously — to address the problems arising from the current regulatory situation, as outlined above — would work by way of introducing a focused exemption to the rules. This approach recognises that the broad objective of keeping fees low in a DC Scheme is a good one to be encouraged, but that a blanket restriction reducing investment options is not.
Specifically, under the approach we have proposed, performance fees would be excluded from the charge cap solely where they relate to investments that meet certain specific and pre-determined criteria. These criteria would be in line with policy objectives to encourage and promote investment in sectors that have been determined key to meeting the future needs and preferences of the UK economy, and/or to helping level up wealth creation across the country, and levelling up more generally. They would apply irrespective of the choice of vehicle used to make the investments, i.e., whether it be an LTAF or limited partnership. These criteria would include:
Effectiveness of government policy around venture capital in meeting wider government objectives
As above, too many UK growth-economy companies are lacking the equity capital investment they need to grow. This entails obvious damage at the firm and local level, with a potentially devastating impact on the cities across the UK that are fundamental to any concept of ‘levelling up’. But the failure of these crucial innovative companies to grow to meet their potential also stands in the way of the government’s national goals to diversify wealth creation, and to launch a successful ‘Green Industrial Revolution’. The road to ‘Net Zero’ must be paved with investment as well as good intentions. The UK needs the ability to address this by successfully harnessing the long-term savings industry, for the benefit of both savers and business, but we have to date failed to grab that opportunity. We very much hope that the Treasury Committee’s inquiry will help to make that opportunity a reality.
 Anthony Seldon and Stephen Welton, ‘From Survive to Thrive’, BGF, October 2020: https://www.bgf.co.uk/wp-content/uploads/2020/10/From-survive-to-thrive-funding-the-growth-economy-to-kickstart-an-investment-led-recovery-1.pdf.
 This name derives from findings on the matter identified in the 1931 Macmillan Report: ‘Committee on Finance and Industry (Macmillan Committee): Report of Committee (Cmd. 3897)’: https://discovery.nationalarchives.gov.uk/details/r/C1851842.
 See, for instance, the 2021 ScaleUp Annual Review for relevant data: https://www.scaleupinstitute.org.uk/scaleup-review-2021/introduction/.