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7 August 2017

Editorial: The UK wants to be a land of unicorns

The UK government has published a consultation into patient capital, indicating a shift in focus towards scaling up firms away from a perceived fixation on generating new spinouts.

Author: Thierry Heles, editor

The UK innovation ecosystem is lagging behind its American counterpart when it comes to having startups become unicorns and to make up that shortfall the government needs to shift its focus – that is the fundamental idea driving a consultation published by the Treasury department last week.

Figures published in the document, titled Financing growth in innovative firms, are startling: venture capital investments in private businesses in the UK stand at approximately £4bn ($5.2bn) a year, which may seem a lot at first but in fact equates to only about half of the level of investments in the US. Follow-on rounds are rarer for UK-based companies than US-based ones, too – and actually, the remainder of Europe outperforms the UK in third and fourth funding rounds, though the mainland drops below Britain’s performance for later stages.

It should be noted upfront that the consultation could be criticised for holding up the US as the gold standard – it hardly considers China, or indeed Asia, apart from acknowledging that 23% of unicorns in the world are based in the People’s Republic.

The percentage is below that of the US, at 54%, but notably a report by China Money Network in May 2017 revealed that out of 102 Chinese unicorns (worth a combined $435bn), six of the top 15 startups operate in the fintech sector – an area that the UK, and London with its global financial hub in particular, has been very keen on.

The geopolitical and cultural differences with China may have played a reason in largely ignoring that ecosystem in the consultation, though when it comes to patient capital the country and the region are essentially without peers: Tsinghua University alone committed $1.5bn to a commercialisation fund dubbed Tsinghua Technology Transfer Fund as part of a $7.6bn initiative to support research activities over five years, for which the institution received the GUV Award 2017 for fundraising of the year.

The same is true of government venturing, where so-called government guidance funds have been sprouting up across China and raising jaw-dropping amounts of cash, such as the $17.4bn fund created by Tianjin City, a $21.8bn vehicle launched by the Beijing government and a fund reportedly being raised by the provincial government of Hubei with an $80bn target. Other governments have also been busy, with Singapore state-owned investment firm Temasek last month revealing a portfolio value of $197bn– a jump of nearly 13.4% over the previous year.

And when it comes to corporate venturing, one need look no further than Japan-based telecoms and internet group SoftBank’s $93bn Vision Fund, which is targeting a $100bn close and has attracted limited partners such as China-based electronics contract manufacturer Foxconn and US-based technology company Apple as well as multiple sovereign wealth funds including the Kingdom of Saudi Arabia’s Public Investment Fund.

While editor-in-chief James Mawson has taken an in-depth look at what the consultation means for corporate and government venturing, one question remains: what does the consultation mean for university venturing?

With details around the government’s National Investment Fund, also announced last week, still incredibly vague (neither a structure or a target size have been decided), only one thing is clear when it comes to that initiative: it aims to help startups become unicorns.

That realisation dashes any hopes that the National Investment Fund could be a proof-of-concept vehicle, a wish harboured more or less openly by many technology transfer offices up and down the country. In fact, the government appears to have little to no interest in the early-stage.

The consultation albeit recognises that spinouts are “typically pre-revenue, research and development-intensive and reliant on significant external equity investment” and that they “play an important role in the wider investment market”.

Numbers collected by high-growth company database provider Beauhurst, cited in the document, show that between 2011 and 2016, spinouts were responsible for 9% of investments and 12% of capital.

Intriguingly, the consultation counted 45 spinout deals in 2011 and an average of 85 per year from 2014 to 2016, with a total of £370m invested in 2011 to £340m per year in 2014, 2015 and 2016. The activity is mostly concentrated in London and the southeast, the east of England and the southwest – with other regions across the UK struggling more to attract capital.

The figures do not line up with data collected by Global University Venturing, which shows that, between 2013 and 2016, spinouts from University of Oxford alone raised almost $2.25bn between them, closely followed by University of Cambridge at just over $2bn.

Only in third place do we find a US institution, with Stanford University’s spinouts raising approximately $1.94bn.

Ignoring that discrepancy for a moment, the consultation does not even dispute that the UK is good at generating spinouts. It challenges the notion that the ecosystem is good at supporting young businesses through to an initial public offering (and indeed beyond that) and to scale to more than 250 employees – the point at which, under EU guidelines, enterprises seize to fall into the SME category.

There is a concern that the consultation may shift the focus onto later-stage funding too much, particularly when it comes to spinouts.

Unicorns are great, but rare. So how do universities and their TTOs continue to gain value from knowledge transfer when it is made easier to raise a series E round (which a TTO may or may not able to afford to join) than it is to secure proof-of-concept backing or when founders (including TTOs) are forced to take a lower equity stake to begin with?

Brian McCaul, chief executive of Qubis, the tech transfer office of Queen’s University Belfast, previously wrote in the Global University Venturing magazine that there are good reasons why universities want a large stake to begin with, dismantling the myth that the US is more founder-friendly one by one and taking particular issue with the fact that the equity stake usually serves as “a scapegoat for the perceived inefficiencies of university-to-business technology transfer”.

To its credit, the consultation notes that “changes in ownership reduce a founder’s ability to retain control of their business, reducing their own motivations for considering specific ownership structures that require founders to relinquish all control of their business. Equally, if a founder’s shareholding is diluted excessively, their motivation for driving the business forward may also be diluted excessively.”

Some – or indeed most – institutions would arguably be more disadvantaged if they were forced to take a lower equity stake to begin with and buy their way back in through later rounds. University venture funds such as Oxford Sciences Innovation, the UCL Technology Fund and university-affiliated vehicles such as Cambridge Innovation Capital may have the resources to do that, but regions that already struggle to attract venture capital today will suffer even more.

As McCaul wrote, attracting cash is “very much connected to the issue of place and context – in Northern Ireland this is harder than in San Diego or the southeast of England.”

Putting the US on a pedestal by only considering the macro-picture actually ignores a key factor: not every institution in America is equally successful in raising money for its spinouts.

The cliché that the UK's institutions should try to be more like Stanford University also overlooks that Stanford is in an incredibly unique position of being literally up the street from Sand Hill Road, the heartland of venture capital in the US, and Silicon Valley. Really, the only place that could be considered remotely similar in Britain would be the golden triangle of London, Oxford and Cambridge. But the government’s own figures show that London is already receiving more capital than other places.

That did not stop the UK government from seeking the advice of Katharine Ku, director of Stanford’s Office of Technology Licensing, last year into how a model of less equity could work for UK institutions. Ku at the time recommended that universities license inventions in return for a fee rather than equity – yet young companies often have little to zero money to spare.

And what about those other US institutions? At this year’s GUV:Fusion conference, Leslie Millar-Nicholson, director of the Technology Licensing Office at Massachusetts Institute of Technology (MIT), pointed to the privileged reality in which MIT finds itself, remarking just how much easier it was to secure funding for spinouts than it had been in her previous job with University of Illinois at Urbana-Champaign.

How the UK government foresees solving the problem of making sure a spinout from a university in Northern Ireland or the north of England can make it through to a later-stage round remains a mystery.

Yes, a government venturing fund such as the National Investment Fund could certainly help here, as could regional university venture funds – which the consultation does not pick up on, despite the enormous potential such schemes could have.

What are universities meant to do to avoid soon being forced into accepting a 10% share rather than a 50% stake in spinouts? Voice their concerns to the government’s consultation, which is open until September 22.

What if the government ignores these calls and goes ahead anyway? Perhaps now is the time for smaller institutions to genuinely consider regional university venture funds – calls that have already been getting louder in the ecosystem anyway.

The danger then, of course, becomes whether there are enough experienced investors to avoid a long-term issue such as shareholders backing take-overs as with the ongoing IP Group and Touchstone Innovations saga.

The UK may be sailing towards unchartered waters and it can certainly consider itself lucky that it has some of the finest tech transfer leaders among its people. But that the consultation does not appreciate the enormous dedication these people put in every day is perhaps yet another sign that it does not really understand the sector and is blinded by its unicorn dream.

There is another factor the consultation brushes over: infrastructure. In its 76 pages, it names incubators and accelerators only once each – the first in a graph about the ecosystem, the second to say that there are 163 accelerator programs in the UK. That is a heartening number, but it hardly offers an in-depth picture of those programs’ impact.

What is more, the document does not name any of them – surprisingly, not even SetSquared, the collaboration between universities of Bath, Bristol, Exeter, Southampton and Surrey that has not only been named the best incubator in the world but that surely could also serve as an inspiration and a model for other small to medium-sized institutions looking to boost their local ecosystem.

True, incubators traditionally serve early-stage businesses, but as programs such as Y Combinator in the US prove, they are often instrumental in setting companies up for unicorn status later down the line.

It is, in principle, a good thing that a consultation is taking place because the ecosystem does undoubtedly need more mature startups and more patient capital. There is also no doubt that TTOs will adapt to whatever Westminster may throw at them. Let’s just hope it will not be too much of a curveball.

Copyright Mawsonia Limited 2010. Please don´t cut articles from www.globaluniversityventuring.com or the PDF and redistribute by email or post to the web without written permission.

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