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26 September 2017

Value shifts from ideas to large company investors

The question for governments and investors is whether a founding idea will create a company large enough in terms of revenues, profits or employees.

Author: James Mawson, editor-in-chief

The iconic image most people have of entrepreneurialism is of a founder working away in her garage, office or laboratory coming up with an innovative idea to help make the world a better place and then becoming rich by building the company. The question for governments and investors is whether the founding idea is worth enough to build the company large enough in terms of revenues, profits or employees to impact the world.

States around the world are looking at helping both ends by encouraging people to develop their ideas and start a company and then providing them with the money and resources to scale up, but without reducing the entrepreneurial spirit or crowding out private capital through unnecessary or misguided interventions.

It is a difficult balance to strike. But read between the lines of the UK government’s consultation on patient capital – money invested long-term in businesses to help them scale up to large companies employing at least 250 people – and it seems that the emphasis inside government and among its advisers is that more value and focus should be on investors scaling up the business rather than those coming up with the idea and helping the entrepreneur set up an enterprise.

That seems to be the big question underlying the UK Treasury’s review of patient capital – Financing Growth in Innovative Firms – which asks whether “a material number of firms in the UK lack the long-term finance that they need to scale up successfully”.

It also goes across a similar review being carried out on university startups and spinouts by the UK’s Department for Business Energy & Industrial Strategy – expected to report in about four months – and the broader industrial strategy set out in a green paper last year.

Following an earlier editorial in our sister magazine Global Corporate Venturing – Finding a venture investment edge – one insider to the UK’s spate of reviews, papers and consultations summed up the thinking thus: “The value of a patent is less because the pace of change is higher. The bigger risk is in commercialisation.”

Equally, the adviser said avoiding entropy and improving the innovation toolkit for these larger companies if they became public was also important. “It is a changing world of money. [Western] public companies are mediocre, lacking vision and are uninvestible.”

By contrast, the leading venture investors are increasingly Asia-based corporations active in China and the US and which combine pace and size of investment with business unit speed of execution and follow-through on opportunities. It reflects the changed world of venture that this past summer typifies in countless rounds of more than $100m.

  • Meituan-Dianping, the Chinese local listing and services portal formed in late 2015 by the merger of unicorns Meituan and Dianping, is reportedly in talks with investors to raise between $3bn and $5bn in a round that will feature a $1bn investment by an existing backer, internet company Tencent.
  • Telecoms firm SoftBank’s Vision Fund put $2.5bn into e-commerce business Flipkart, which was valued at $11.6bn at its last round earlier this year. The fund joined an investor base that already included Tencent, online auction platform eBay, semiconductor manufacturer Intel and media group Bennett Coleman & Co.
  • App developer DotC has raised $350m in a series B round led by digital marketing firm Avazu’s parent company Zeus that involved the ownership of Avazu being transferred to DotC in a deal that will give Zeus a stake of just over 30.6% in the company.
  • Online fresh produce retailer Yiguo has secured $300m in funding from e-commerce Alibaba’s subsidiary Tmall as part of a partnership agreement that will involve Tmall integrating Yiguo’s product into its existing offering.
  • Online business lending platform Kabbage has received $250m in funding from existing investor SoftBank, roughly doubling its overall funding in the process.
  • Peer-to-peer lending platform Dianrong has secured $220m in a round led by Singapore’s sovereign wealth fund GIC that followed a $207m series C round two years ago that included financial services firm Standard Chartered Bank and industrial leasing firm Bohai.
  • E-commerce software and services provider ShopEx has secured $104m in a series D round led by venture firm Joy Capital and its past investors include Alibaba, media group Bertelsmann’s regional corporate venturing arm Bertelsmann Asia Investments, Legend Capital, the investment arm of conglomerate Legend Holdings, and Legend Holdings.

And it would be less than a surprise to see strategic investors in other deals, such as BlueteamGlobal, a US-based provider of cyber threat and security services co-founded by ex-Morgan Stanley chief operating officer Jim Rosenthal, which raised more than $125m, or healthcare companies such as Medtronic interested in Auris, a health care company developing less invasive medical interventions and that has just raised $280m in its series D round.

Bear in mind this is (apart from Flipkart), only one week’s larger deals, too. It is about half the total annual venture capital funding in the whole of Europe in 2012 or 2013 (of just more than €3bn in those calendar years). And with none of these larger rounds above based in Europe it is also hard to see many European investors in them either, let alone leading.

As the Treasury’s consultation said: “UK corporates make a small but important contribution to investment in patient capital, most typically in venture capital. The UK was the second most attractive destination for corporate venture investment – 100 investments in 2016.”

The $93bn SoftBank Vision Fund is based in the UK but apart from its $502m round for Improbable in May it has struggled to find suitable large targets in Europe, instead focusing on the US and Asia. Other deals, such as the $8.5m B round for UK-based children’s literature publisher Wonderbly is perhaps more indicative of how “fewer UK firms receive follow-on investment compared to the US, and those that do receive less”, according to the Treasury consultation, as the global series A and B round average size in the second quarter was $11.9m.

In this context, governments trying to focus on why the old continent has effectively missed out on much of the greatest wealth-creating opportunities of the past generation is worth reflecting on. None of the 10 largest internet companies is based in Europe, although Germany has in the past few years seen the flotation of conglomerate Rocket Internet and some of its portfolio companies, such as e-commerce firm Zalando and food delivery service Delivery Hero.

But in the UK, there appears concern in the consultation paper about the relative lack of similar success stories in its country. The Treasury looked at one vintage, the 239,649 firms started up in 1998, and found that while 11% had survived their first 15 years, only a few – “less than 100” – such as fashion e-commerce firm Asos, computer animation company Double Negative, investment ratings agency Financial Express, market research firm YouGov, life science e-commerce company Abcam, green energy supplier EcoTricity, clothing brand Jack Wills and women’s activewear producer Sweaty Betty, had scaled up to employ more than 250 people and remained independent in this period.

As the consultation perhaps pointedly noted: “Some of these firms remain private firms and appear not to have received investment from external investors.”

This raises the question of whether existing tax breaks and investment programs have worked. The consultation asks: “Which programs – investment programs, tax reliefs and tax-incentivised investment schemes – have most effectively supported the investment of patient capital to date and when is it more appropriate for government to support patient capital through investment rather than through a tax relief?”

The Treasury calculated the cost of its tax breaks at between £1.6bn and £3.6bn a year. Venture capital investment in UK-based private firms is about £4bn a year, but if the country had the same level of investment as the US, total venture capital investment in British firms would be around £4bn a year greater, according to the Treasury’s consultation paper.

Scheme

Cost per £1 of additional investment

Total invested

Tax amount

SEIS

£0.87 to £1.11

2014-15, 2,290 companies received £175m  

£152m to £194m

EIS

£0.57 to £0.73

2014-15, 3,265 companies raised £1,816m   

£1,035m to £1,325m

VCT

£0.90 to £1.22

About £400m/year since 2011-12

£360m to £480m

ECF

£0.20 to £0.34

Since 2006, 23 funds worth just over £550m (as of end January 2017)

£110m to 187m over 10 years

VC

£0 to £0.40

approximately £4bn a year

£0 to £1.6bn

Source: HM Treasury, analysis Global University Venturing

The secretariat of the industry panel supporting this review, led by leveraged buyout doyen Sir Damon Buffini, has separately modelled an overall range of between £3bn and £6bn a year between the current annual supply of capital and that in a fully functioning UK system.

Its analysis pinpointed UK university spinouts as a potential area for greater focus as it found the number of investments in spinouts rising from 45 in 2011 to an average of 85 a year from 2014 to 2016, but the total amount invested falling slightly from £370m in 2011 to £340m a year from 2014 to 2016. As a result, the UK is considering setting up a National Innovation Fund under the British Business Bank.

But unstated in the consultation, which has regulation as one of its focus areas, is the broader issue of how these entrepreneurs and investors can navigate the tricky issue of how, having effectively missed some of the latest deep tech and innovation trends of the past few decades, the UK can navigate the future given the oligopolistic nature of the economy.

As Mauro Guillen, professor of management at Wharton School, said in his blog about how in the age of big data companies from large markets would have an advantage: “Perhaps the single most important factor in the future development of technology will not be the process of innovation itself but how effectively companies align themselves with large transformations in the marketplace so that they can gain scale quickly.”

Life for entrepreneurs, whether at the early or later-stage, remains a hard journey it seems.

Disclosure: The UK Treasury included data provided by our sister publication Global Corporate Venturing for its section on corporates’ role in patient capital.

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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