VCM0034

 

Written evidence submitted by Midven

 

In this submission, Midven make the following recommendations:

  1. Government should commit to a broad programme of support for the funding of early stage technologies that could catalyse the UK’s capability in areas outside the Golden Triangle” of Oxford-London-Cambridge. We suggest that for a very modest investment of around £30m p.a. the government could make a substantial difference to the rate of “deeptech” company formation in areas where capital has historically been difficult to find.
  2. When considering technology start-ups and in particular “deeptech” companies, Government should pay equal attention to the non-University sector, recognising that almost by definition these small companies lack the voice and lobbying power of the leading Universities, often speaking as a block.
  3. British Business Bank (BBB) should re-introduce the Future Fund and position it as a clearly counter-cyclical investor, i.e., ramping its capital allocation up and down in response to the economic cycle.
  4. The UK’s mainstream financial sector is very poorly equipped to assess the opportunities offered by investment in venture capital (broadly) and “deeptech” (specifically). We strongly endorse the recommendation in the recent letter from the Council for Science and Technology that the government act to rectify the situation.
  5. The current limit of £12m for EIS investment (£20m for Knowledge Intensive Companies) over the lifetime of a company should be revisited.
  6. There should be wider adoption in government policy discussion of the label “deeptech to make clear the difference between companies (such as those in the UKI2S portfolio) that are themselves developing ground-breaking technology and “tech-enabled” companies that are simply using already available technology to develop new goods and services.
  7. Government should continue to support the R&D tax credit scheme and, importantly, to ensure that HMRC is properly resourced to implement it.

 

 

 


Introduction

  1. The UK Innovation & Science Seed Fund (UKI2S) is a privately-managed and government-backed evergreen national seed fund that invests in high risk and high return opportunities arising from the UK science base, leveraging private investment and growing jobs from the great science undertaken in the UK.
  2. The fund focuses on so-called “deeptech” companies that are typically commercialising technologies developed through years of research, usually funded by UK or EU research grants. These companies are often more difficult to fund at the early stage since they very often exhibit a very high risk profile with a combination of lengthy and expensive development cycles, long time to market, management, technology and IP risk that most investors will shy away from. However, these companies have potentially world-leading technologies that are capable of underpinning a globally competitive position, once established. Read more about UKI2S in the Appendix (para 34 et seq).
  3. The fund manager for UKI2S, Midven, is part of Future Planet Capital. Future Planet Capital Limited is an international venture capital and impact investor, The firm is focused on providing early stage to growth capital to leading entrepreneurs and businesses from the world’s top innovation ecosystems.

Response

Q1: 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.

  1. We recognise that there is a problem with the availability of domestic capital and that this is a real issue at the later “scale-up” stages. There has been an increasing focus from government on investment in companies in the “Series B and beyond” stage, which includes those in the “scale-up” phase. We are therefore supportive of government efforts to encourage further investment into the sector, such as amendments to defined contribution pension schemes (see later).
  2. However, we feel it is also critical that government understands that there continue to be problems with access to capital at various stages, not just at “scale up”. Put simply, if you don’t invest in the very first steps, there will be no companies coming through to the “scale-up” stage in future. Both stages justify strong support. In the sector where UKI2S operates, namely the Pre-Seed and Seed stage in “deeptech” companies, there remains a very substantial need for the kind of capital that UKI2S can offer. Pre-Seed and Seed funding needs to be ultra-patient and understanding of the high risk profile of technology development, as well as providing a high level of additional support alongside the money itself. This is simply not widely available within the private sector, especially outside the so-called Golden Triangle of Oxford-Cambridge-London, and we recommend that Government take the initiative in providing the necessary capital (see answer to Q8 below).
  3. We remain optimistic about future investment in deeptech companies due to the fundamental challenges they address and their ability to navigate any disruptive economic events (e.g., a recession).
  4. We do, however, expect there to be a correction on company valuations and a retrenchment of capital, especially at the Series B stage. This might be partially effective in displacing poor performing companies but will inevitably cause good companies to struggle, just when they should be scaling. The knock-on effect into the early stage would then cause a cohort of potentially successful companies to lose out.

Q3: 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.

  1. UKI2S commend the Treasury for tightening the rules regarding investment under the VCT and EIS schemes. This has had the desired effect of forcing these investors (particularly VCTs) to consider earlier stage and higher risk propositions, and they now represent a greater proportion of the investors whom we might approach for later stage investment than they did in previous years.
  2. However, we would recommend that the current limit of £12m for EIS investment (£20m for Knowledge Intensive companies) over the lifetime of a company should be revisited. We do not believe that restricting EIS investment serves a useful purpose in terms of the company itself, and doubt that the Exchequer benefits substantially from capping the amount. However, we are aware of at least one company in our portfolio where the cap has been reached and this has affected the appetite of two of the core high-net-worth individuals who have backed the company for some time. This has had a secondary impact on the confidence of other incoming investors who have suddenly seen the existing shareholders reluctant to invest. It seems to us that the likelihood of the cap being reached in a large number of cases is very low, whilst the risk of adverse consequences from the cap for a rapidly growing company is in fact very high.

Q5: The role of other key bodies, such as the British Business Bank (BBB) 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.

  1. UKI2S recognises and supports the role played by BBB, and in particular applauds the rapid introduction of the Future Fund to support the sector during the pandemic, which was critical for the continued existence of several of the UKI2S portfolio companies whose fund-raising plans were disrupted by the pandemic. However, this initiative has now been adapted as the “Breakthrough Fund” to support more mature companies, with no apparent intention to continue the support to early stage opportunities.
  2. We are fully aware that BBB has a number of initiatives in place to bring private sector capital into early stage companies, with our companies benefiting from investment by several Enterprise Capital Funds (a BBB “product”) such as Longwall and IQ Capital. However, we believe that there will always be a need for a vehicle such as the Future Fund and would strongly support its continuation.
  3. It should be recognised that the long gestation period for start-ups (our portfolio contains companies started in the early 2000’s) means that it is almost inevitable that they will have to weather at least one severe downturn in the economic cycle and consequent difficult fund-raising environment. We believe that there is a compelling argument for a vehicle such as the Future Fund to act as a counter-cyclical investor whose capital allocation may be very modest in good times but may be increased at any time to counter recessions or other economic turbulence affecting the early stage sector and the private investment appetite for high risk assets.
  4. We believe there is a good case for having a Future Fund vehicle that is sufficiently active in the markets even in good times to be known to most participants; this could be done with an extremely modest level of funding (perhaps as little as £20m p.a.) and would have the benefit of establishing continuing relationships between the Future Fund and market participants, something that is likely to lead to both easier operation if and when a rapid scale-up is required, and also to help the Future Fund in controlling the quality of the deals they do in times of stress.
  5. We are following developments in the establishment of ARIA and eagerly await further information on its role as “a distinctive part of the UK’s research funding landscape that complements and expands the UK’s funding capability” [1].
  6. ARIA has a high degree of autonomy in how it deploys its capital. We would strongly recommend that ARIA allocates a material portion of its capital to early stage investment in the technologies that it chooses to support. The particular risk in complex science and engineering based companies is seen very early at the Seed stage in that the development programme may fail. This is different to the market risk seen in more software based companies and means early investors in the “deeptech” space should be prepared for the potential of complete failure (not just disappointing revenues). This means that any effort to drive higher technical risk investment is to be lauded if we are to see the large global companies such as ARM being developed in the UK’s VC pipeline. 
  7. If current patterns of investment persist then technologies supported by ARIA will find the very early stages of commercialisation challenging, especially outside the Golden Triangle. Support from an “in-house” funding facility will greatly ease the process of transition to external support and we would welcome a discussion with ARIA to share our experience.

Q6: The merits of policy proposals for strengthening the venture capital industry in the United Kingdom, such as:

A) Opening new pools of capital for venture capital investment, such as pension funds, retail products (e.g., investment through ISAs)

  1. The venture capital industry has long been keen to persuade defined contribution (DC) pension funds to place a small fraction of their capital into venture capital. We are aware of ongoing discussions and the intention to act to allow this to happen. We would strongly support government action, including any changes to legislation, to enable this.

C) Any other possible Government or public sector intervention

  1. We strongly support any intervention to improve the mainstream financial sector’s understanding of venture capital (broadly) and deeptech (specifically). This was recognised by the Council for Science & Technology in their letter to the Prime Minister on 9th December 2021[2] who said: “The lack of such investors and asset owners with deep sector knowledge or entrepreneurial experience is a key weakness in the UK system … This creates a challenge for R&D intensive companies in particular, where the ‘knowledge gap’ between innovators and investors can hinder investors from adequately assessing the technical and financial viability of key technologies”

Q7: The effectiveness of any other government or public sector intervention in the venture capital industry.

  1. UKI2S strongly supports the expanded role for Innovate UK (IUK). In particular two schemes recently launched or piloted by IUK deserve highlighting.

18       

19       

19.1       Innovation Loans often allow companies to grow in anticipation of increasing sales; this is important since private investors are often reluctant to commit significant capital to expanding capacity until a company has an established level of sales. Innovation Loans can fill this gap and accelerate expansion.

19.2       Investor Partnerships. IUK has piloted a scheme that helps bring companies and investors together to reduce the risk profile for investors and stimulate higher levels of investment. This is done through the addition of grants from IUK but making them conditional on matched funding from investors. This allows investors to see their money leveraged by non-dilutive funding and produces two possible outcomes, both highly beneficial.

19.2.1    Companies can either attract investors who might normally only invest once a technology has achieved a higher stage of maturity, since they can be persuaded that the risk-reward balance has been greatly improved through the grant, or alternatively the grant can allow a more aggressive expansion of the technology, exploring additional applications at an earlier stage than investors would normally be comfortable.

  1. The R&D tax credit scheme is a substantial source of capital for UKI2S portfolio companies and is regarded as an essential part of the landscape. We would encourage Government to continue to support it and, importantly, to ensure that HMRC is properly resourced to implement it. Our companies are reporting that they are increasingly seeing a backlog of R&D tax credit claims. Since companies will plan receipt of the credits – which can be significant amounts – into their cashflows, a delay of a couple of months can cause real problems.
  2. We await the review into changes to the R&D tax credit, as announced in the Spring Statement. However, we would note that many of our portfolio companies have yet to report any changes in this area so far.
  3. UKI2S welcomes international initiatives from organisations like NATO, who announced a billion-dollar seed fund alongside the Defence Innovation Accelerator for the North Atlantic[3]. We urge the UK Government to take part as it supports key sectors for the UK including defence, healthcare, tech and transport. It also chimes with the UKI2S focus, in particular our newly established defence fund.[4]

 

Q8: 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).

  1. We commend government and BEIS for their investment in UKI2S, and while this submission is not intended to focus on UKI2S itself, we should note that the structure of UKI2S allows for the deployment of government capital that is focused on specific policy areas. The recent expansion of UKI2S has included four such themes, namely Fusion Energy (UKAEA) and related technologies, Synthetic Biology (BBSRC), Knowledge Assets (BEIS) and Defence & Security (MOD/Dstl). This therefore allows a policy intervention to be highly focused but at the same time to be managed within a governance and management framework that has a long and successful track record in combining public policy aims and commercial discipline.
  2. The venture capital industry has historically focused its attention on the Golden Triangle, with 82% of funding (Beauhurst data – 2019) in the Oxford-London-Cambridge area. There are many reasons for this but the one that is rarely articulated is the fact that the availability of capital itself is a determining factor.
  3. We have seen this at first hand, with the level of additionality of the UKI2S first stage funding being described by the consultants SQW as “the highest we have ever seen and suggesting that 75% of the UKI2S companies would not have been able to raise investment without the Fund’s intervention. In other words, the Fund made things happen that otherwise would not have done so. This catalysing effect of supportive capital is mirrored elsewhere, as in the example of Oxford University: in the decade prior to the creation in 2014/15 of Oxford Science Enterprise (the £620m fund focused on Oxford spin-outs) an average of 4.5 companies were formed each year. By 2019, over 20 companies per annum were being spun out, as the research base began to see the process of spinning out a company with the support of a local and trusted anchor investor as a properly viable route to develop the technology.
  4. This picture is gradually improving, with the recent announcement of a first close (£215m) of the Northern Gritstone Fund a welcome landmark. Bristol has also shown significantly higher levels of activity in recent years. However, these are not mirrored across the country and most regions remain under-supplied with capital. This is particularly true of the areas where government is hoping to drive growth through the levelling up agenda.
  5. In our view there is a very strong case for Government to commit to a programme of broad support for early stage funding technologies that could catalyse the UK’s capability in areas outside the Golden Triangle. A back of the envelope calculation suggests that the Seed stage investment requirement could be covered with an investment of as little as £30m - £40m per annum. Whilst this may not instantly deliver large numbers of jobs, the performance of the companies in the UKI2S portfolio demonstrates that these companies grow rapidly at rates of over 20% p.a. for a decade or more meaning that an initiative such as this can be expected to lay the foundation for the emergence of many significant businesses over the next decade.
  6. The desire to build the UK into a science & technology superpower is, of course, to be strongly supported. We have made the point earlier that the ecosystem needs to support the very early stage where UKI2S is active. But an ecosystem, by definition, is a broader structure and every part and stage of it needs to function for the whole to work. We are therefore very supportive of the moves to bring pension fund capital into the sector, recognising that the bulk of any such capital would be likely to target the later “scale-up” stage rather than the very early stages.
  7. We also fully support one of the key recommendations of the letter dated 23 September 2021 from the Council for Science and Technology (CST) to the Prime Minister: working with a range of industry and academic partners, the government should support the development of new specialist education and training programmes to build understanding of the value of intangible assets, S&T expertise, and entrepreneurial experience among UK investors and asset owners.[5]
  8. We would add three brief but – in our view – very significant comments.
  9. Firstly, on the balance of university and non-university technology based companies in government policy development. Much of the debate around early stage technology funding is framed in the context of universities and university spin-out companies. Yet a substantial proportion of the companies in which we invest, in which the underlying science is comparable in quality to the university spin outs we see, have little or no connection with universities. We would therefore urge Government to pay equal attention to the non-university sector, recognising that almost by definition these companies lack the voice and lobbying power of the leading universities. Incubators and accelerators such as CDL, Y-Combinator, Space Bootcamp and the ESA chain of incubators are generating an increasing flow of investable companies, as is the network of Catapults.
  10. Secondly, we see a potential tension between building innovation clusters and the levelling up agenda. A good part of the success of the golden triangle is precisely because of the concentration effect, with research excellence, facilities and a skilled workforce all in one place. Private investment is inevitably going to focus on such places, and we think that any government approach to venture will need to address this.
  11. Thirdly, we would encourage wider adoption in government of the label deeptech”. This distinguishes R&D intensive companies from other “tech-enabled” firms, helps to reinforce the understanding that deeptech is harder to fund and therefore may justify additional government intervention, and makes clear the linkage between the science base and the economic ambition.

 


Annex

Case Study - Cobalt Light Systems (Now Agilent)

  1. Cobalt produces innovative products for non-invasive, through-barrier chemical analysis, for applications in airport security, hazardous chemical ID and pharmaceutical QC, using a technologically advanced Raman spectroscopy technique.
  2. A spin-out from the UK’s Science and Technology Facilities Council (STFC) Rutherford Appleton Laboratory it was funded from the earliest stages by UK Innovation & Science Seed Fund.
  3. Cobalt received the 2014 Royal Academy of Engineering MacRobert Award, the UK’s most prestigious prize for innovation in engineering for the Insight100™product, which identifies explosive threat materials inside containers in seconds without opening them.
  4. Privately held and ranked as one of the UK’s fastest-growing technology companies in 2014, Cobalt’s customers include 21 of the world’s 25 largest pharmaceutical companies, the U.S. Food and Drug Administration, and more than 75 airports across Europe and Asia-Pacific, including eight of the 10 largest European airports, with over 500 devices deployed at airport checkpoints.
  5. After being acquired by Agilent in 2017, the Cobalt HQ became the company’s global centre for Raman spectroscopy on the growing Harwell Science and Innovation Campus in Oxfordshire UK – a significant commitment to inward investment for UK research and development that has since resulted in a 50% increase in employment.
  6. The successful sale of Cobalt to Agilent provided UKI2S with additional funds to re-invest in ideas emerging from the UK’s world-leading research base.
  7. Cobalt is a good illustration of the commercialisation journey from research origins at STFC to global market. This outcome demonstrates strategy of providing very early investment to validate and develop research with high-growth potential.

Case Study – Perfectus Biomed

  1. Perfectus Biomed Group provides microbiological testing services relating to microbiology research, biofilm testing, cell culture and viral testing, services that proved vital during the pandemic as both public and private entities looked for high quality validation of the efficacy of anti-infective and anti-viral products.
  2. In 2013, investment from UKI2S was provided alongside The North West Fund for Biomedical to help support their growth and development, expand the company’s research team to meet the growing demand for testing and drive their expansion into new sectors.
  3. Founded by CEO Dr Samantha Westgate in 2012, Perfectus Biomed Group operate from their SciTech Daresbury laboratory in the North West of England. The company counts leading companies such as 3M, Smith & Nephew and Unilever amongst its clients and now employs over 45 staff. They have also expanded into the US through a successful merger in 2020 with Extherid, a similar but smaller operation in Jackson, Wyoming


Appendix

About the UK Innovation and Science Seed Fund (UKI2S)

  1. The UKI2S model is distinctive in certain key areas from most venture capital funds. Whilst it operates along “normal” commercial lines and is similar in structure to most VC funds, it is distinctive in being (a) wholly publicly funded and (b) designed to be “evergreen” (i.e., to reinvest returns in future generations of companies). The Fund targets the very earliest stages (“pre-Seed” and “Seed” rounds) and, consistent with the role of its funders (public funders of science including UKRI, Dstl and UKAEA) is focused on “deeptech” companies.
  2. These companies, usually based on several years of research in academia or elsewhere, can often find the first stage of investment very difficult. They typically combine multiple risks that investors seek to avoid, such as high capital requirements, lengthy time to market, considerable technical risk remaining, incomplete management teams and uncertainty as regards the potential market. The aim of UKI2S is to address this gap, investing to de-risk propositions and to help other investors become more comfortable through leading the tricky first investment rounds.
  3. UKI2S back companies at pre-Seed and Seed stage to develop a product, service or knowledge asset solving a significant global challenge. We invest for as long as it takes and support portfolio companies in finding private investment to match their ambition, whatever their capital requirements. We are active investors and will offer more than money in supporting companies to succeed. The Fund’s investment creates high-end jobs, drives up exports and increases productivity by creating new UK companies built on innovative ideas born out of the UK’s public sector research base. We aim to do this profitably by investing very early, where there is a clear risk, and patiently supporting and developing businesses.
  4. Bringing private finance into our portfolio companies is a key part of our role. Over the years our companies have raised over £730m from a range of co-investors from individual angels to large Venture Capital funds; UKI2S has played a significant and active role in this fund-raising, giving us a wide view of the landscape for early stage technology investment.
  5. Created in 2002/03 with Government funding, by the predecessor to the Department for Business, Energy & Industrial Strategy, the Fund has a dual mandate: 

48.1       To commercialise promising technologies emerging from publicly funded research by making early-stage ‘patient’ capital investments.

48.2       To earn a financial return on investments, to be retained and re-invested (to keep the Fund active and make it at least partially self-financing in the long term – i.e., the “evergreen” status referred to above)

  1. UKI2S has generated substantial economic impact through its investments. According to an independent review (SQW, March 2020, figures updated April 2022):

49.1     Additionality. UKI2S plays a key role in establishing companies; over 75% of the 70 plus companies backed by UKI2S would not have existed without the finance and mentoring of UKI2S

49.2     Leverage of private capital; UKI2S funding of almost £22 million has been followed by over £730m of private investment ranging from angels to large multi-national corporate investors, meaning that the UKI2S portfolio has attracted over £30 of private investment for every £1 of public funding.

49.3     R&D Intensity. Approximately 50% of total investment into UKI2S portfolio companies is spent on R&D. Or, to put it another way, the annual spend on R&D by the portfolio companies is approximately 3 times the total investment by UKI2S since the Fund’s inception nearly 20 years ago.

49.4     Regional distribution. Some 80% of VC investment is concentrated within the Golden Triangle. For UKI2S, in spite of several important partner sites being located in Oxford & Cambridge, the figure is under 50%.

49.5     Over 1,100 high quality jobs have been created by portfolio companies, with an average salary of over £50,000, reflecting the highly skilled and productive nature of the roles.

49.6     Around 95% of all sales by portfolio companies are exported.

49.7     UKI2S has monitored the impact of its portfolio companies over nearly two decades. Over this period the average compound rate of growth in metrics such as employment, co-investment and R&D spend has been around 20% over at least a decade.

  1. UKI2S partners with UKRI and several other national research councils. We enable our Partners to deliver on their core agenda by producing economic impact from their own activities. Each fund manager works closely with Partners to stay true its mission. UKI2S naturally aligns with the Treasury's Plan for Growth, the Innovation Strategy, the Levelling-up strategy and wider government aims to ensure innovation thrives in the UK, reaches the target of investing 2.4% of GDP on R&D by 2027 and enshrines its place as a science superpower.
  2. UKI2S and partners are now working with the BEIS Knowledge Assets Team, to unlock the value of public sector knowledge assets and increase the economic contribution of the UK’s public research organisations.

 

June 2022

10

 


[1] https://www.gov.uk/government/publications/advanced-research-and-invention-agency-aria-statement-of-policy-intent/advanced-research-and-invention-agency-aria-policy-statement#personnel

[2] https://www.gov.uk/government/publications/letter-to-the-prime-minister-on-investment-in-innovative-science-and-technology-companies/letter-to-the-prime-minister-on-investment-in-innovative-science-and-technology-companies-html#:~:text=The%20lack%20of%20such,viability%20of%20key%20technologies

[3] https://www.nato.int/cps/en/natohq/news_194587.htm

[4] https://www.gov.uk/government/news/delivering-dsis-one-year-on#:~:text=A%20%C2%A311m%20Evergreen%20pre%2Dseed%20Equity%20Defence%20and%20Security%20Investment%20fund%20(D2S)%2C%20delivered%20as%20part%20of%20the%20UK%20Innovation%20and%20Science%20Seed%20Fund%20(UKI2S).

[5] https://www.gov.uk/government/publications/letter-to-the-prime-minister-on-investment-in-innovative-science-and-technology-companies/letter-to-the-prime-minister-on-investment-in-innovative-science-and-technology-companies-html