The UK Government is looking for new ideas that will stimulate investment and growth in the UK economy as we come out of a COVID 19 induced lockdown. Big ideas that will also address some of the structural problems that face the UK especially in regards to boosting innovation and productivity.
I like most of the ideas put forward by COADEC and organisations like Public.io. Do check them out. I have previously stated that to encourage and enable people to take the risk of starting an innovative new startup that the Start-up Loan scheme ( itself a product of the 2008-10 financial crash) needs to be revamped so it can better serve these much needed new founders.
I would also ask government officials to check out the initiatives that Capital Enterprise is engaged on and maybe provide additional investment and support such as:
- New BAME led accelerators, new BAME led Angel Groups and the ongoing work of our One Tech p[roject that seeks to address the illegitimate additional barriers facing Black, BAME and female founders of tech startups especially regarding getting the support, market opportunities and funding they need.
- Expanding our CAP-AI project ( we would love to take it national) that is supporting London based AI First startups to acquire the research partnerships, data, compute power and specialised PhD level talent, to build out their world beating models.
- Building with our partners in the Sheffield City Region (and our partnership with industrial giants in Taiwan) a 4th Industrial Revolution startup ecosystem. Would it not be great to create a startup manufacturing cluster in the North of England?
But a new idea that I thought is worth exploring is around how we get more private money into investing in startups. In 2018/19 £1.8bn was invested using EIS and SEIS into 3,905 companies down from its peak in 2016-17 and we can expect it to be much lower in this financial year. I am sympathetic to reviewing the EIS and SEIS tax breaks but rather than increasing the already generous tax breaks, I would just increase the upper limited to the amount that can be invested to an SEIS eligible startup from a paltry £150K to at least £300K and also change the SEIS rules so that any (non- property/ non financial intermediary) company that has not received S/EIS funding before, regardless of its age, can apply. This will make a difference to the amounts invested but it is not the fundamental reason why such relatively small amounts of capital is invested in innovation focused startups and scale-ups.
The big reason that there is only a relatively small amount of money invested by the British investors in startups or scale-ups is the lack of liquidity. Investors in these startups have not only an uncertain chance ( or to be brutal only a small chance) of seeing a return but they have to see their money locked up for many, many years. Exits are rare, hard to come by and take a long, long time to be realised. In the best seed stage portfolios ( such as my own AI Seed) over 50% of the startups raise follow on rounds, but the rest either fail, or in even more cases, settle on becoming small scale profitable lifestyle businesses. The investors’ cash gets trapped in these non-scaling startups without much hope of a buyer for their shares whilst their stakes in the scaling startups get diluted almost as fast as the valuation increases. So I would urge the government to create a buyer by:
Setting up a new fund to be expressly managed by either the BBB or probably the Business Growth Fund that is mandated to to buy the shares of individual SEIS/ EIS investors after the 3 years lock in period. So after 3 years from their initial S?EIS investment, the angel investors can either sell their shares to this new “Secondary fund” at the price they bought them for ( they should be still able to keep all their associated S/EIS tax breaks) or if there is a new round led by a bona fide institutional investor, the price paid by that investor.
But I can concede that there might be problems for any organisations buying the tiny stakes of angel investors regarding managing those stakes and just as importantly making a return from these stakes, especially if that stake is not in a startup that is scaling fast and not a startup that has attracted new outside institutional money . So I think four further amendments (that probably cannot be applied retrospectively, at least not without the permission of all shareholders, so might not benefit existing S/EIS investors) are required. They are:
- That there is a minimum stake in the startup/ scale-up ( probably 5%) that this new secondary fund needs to buy. Through the Future Fund, the UK government ( via the British Business Bank) is already managing small stakes in scaling startups, so the principle has been established. This requirement will force individual angels to get other investors to agree to sell their shares to get to the 5% stake threshold and going forward this would probably be a big fillip to encourage angel investors to invest through syndicates or nominee structures.
- That the secondary fund is given the permission and funding to keep investing in these startups (exercising their pro-rata rights to keep their stake at at least 5%) until exit.
- That these shares be converted into preference shares with similar liquidity preferences to debt ( maybe even government debt like money owed to HMRC).
- Finally, if the government is willing to go the extra mile to create liquidity in the market, then where shares are in startups/ scale-ups that are no longer likely to be able to raise VC or institutional funding that they automatically convert into debt after 3 years of the date of the original investment ( probably at a discount to the original price) to be then repaid on an agreed schedule by the company that received the original investment. Obviously if the company is in no financial position to repay this new debt, then these shares will need to be written off by the S/EIS investor and thereby allowing them to trigger their attractive loss relief. This will require a change in the S/EIS terms but for the government and the UK startup ecosystem this forced conversion/ write off time limit has the added benefit of increasing the type of startups ( Zebras rather than Unicorns) that could be attractive investment opportunities for seed stage S/EIS investors.
So here is my big idea- a government back Secondary Fund. If enacted I confidently predict that it would inject liquidity into the market, enable Sharpe ratios to properly applied into early stage S/EIS investments, boost re-cycling of returns into investing in startups/ scale-ups and thereby attract 3-4 times more investment then present into startups and scale-ups. Hopefully now is the time for big ideas.