The Emperor’s New Clothes

The Role of VC in Financing Early Stage Technology Companies

30 May2011

2Capital for Enterprise Limited

The Creation of New Technology Based Firms

• Theory– Idea– Research– Concept– Development of a product/service– Prototype– Marketing– Business development

3Capital for Enterprise Limited

The Creation of New Technology Based Firms

THEORY

STAGE TYPE OF FINANCE SOURCE

Research Grants PUBLIC

Concept Proof of Concept PUBLIC/PRIVATE

Development of a product/service

Seed VC

Prototype Start Up VC

Marketing Early Stage VC

Business development Development Capital VC

4Capital for Enterprise Limited

• Venture Capital IS Important

– “High growth, innovative companies are disproportionately important for economic growth in the UK. Venture Capital is an important source of finance for these companies..” (Nesta 2010)

– EVCA/CMBOR 2002• Some 95% of the companies replying to the survey stated that, without venture

capital investment, they could not have existed or would have developed more slowly

• Almost 60% said that the company would not exist today without the contribution of venture capital

• An average of 46 additional jobs were created by each responding company following the venture capital investment.

Hence Governments and Commentators Regard it Highly

5Capital for Enterprise Limited

The Reality (?)

The Emperor’s New Clothes(with apologies to Hans Christian Anderson)

• Does VC deliver? Or does the promise keep us all enthralled and convinced?

6Capital for Enterprise Limited

The industry today?

• Declining investment

• 2005 -09– Seed and start-up -50%– Early stage -30%– Later stage -18%

7Capital for Enterprise Limited

The industry today?

• Declining funds raised

– Venture 50% reduction since 2006– But similar fall for small MBO and development

8Capital for Enterprise Limited

The industry today?

• Why is fundraising difficult?

– Cycle?

– Or other (rational) reluctance from investors?

9Capital for Enterprise Limited

The industry today?

• Why might investors be reluctant?

1. Proportionate over-allocation

2. Returns• UK Venture returns lower than private equity (LBO)• UK Venture returns volatile (IRR 21% to -7.6%)

3. Disenchantment with the model on offer

10Capital for Enterprise Limited

The industry today?

• Quality and consistency of fund managers– Range of fund performance

– And no consistently top performers?• But probably consistent under-performers?

Vintage year

1997 1999 2000 2001

Top quartile

18.6% 3.6% 2.8% 0.2%

Bottom quartile

-8.6% -13.1% -18.6% -16.8%

11Capital for Enterprise Limited

The Role for Government

• Because of Investor Reluctance and the Potential Economic Returns, there is a Case for Government Intervention – currently even at later stages

How (?)– Cornerstone Funds– Co-Invest– Tax Relief– Subordinate Investor– Leverage (Yozma, SBICs, ECFs)

But Industry Must not Become Reliant !

12Capital for Enterprise Limited

The industry today?

• The (common) model– Hard to put money to work and illiquid– Timing

• 10 + 2 year funds– But average holding periods 7-8 years (+IRR impact)

– Economics• 2(+)% fees

– On commitments for 5 (?) years, not money-at-work

• Monitoring, Directors, arrangement fees– Damaging to investee companies?

• 20% carried interest– Disappearing rather than collapsing hurdles?

13Capital for Enterprise Limited

The industry today?

– Transparency• UK data amongst the best in the world• But everybody is top quartile !• Too many great technology stories – not enough

great returns

– Scale• Small, inefficient funds Vs US model

14Capital for Enterprise Limited

The industry today?

• BUT !

– UK has the conditions for a very successful industry

• Great science• Growing entrepreneurial culture• Technologists becoming investors• Experience and expertise in investing• The City• Transatlantic links

15Capital for Enterprise Limited

Thank You