Examination of Witnesses (Questions 580-599)
9 NOVEMBER 2004
MR NEIL
KEMSLEY, MR
MARK FULLER,
MR PETER
CLAYDON AND
MR PETER
GARNHAM
Q580 Mr Fallon: What sort of returns
are you expected to make on that?
Mr Kemsley: We are expecting to
return at least the £36 million so that we can actually go
again without public support.
Q581 Mr Fallon: So your target is not
to lose money this time, is that right?
Mr Kemsley: That is right, which
was one of the reasons why we decided to take our fund management
in-house and have better control over it.
Q582 Mr Fallon: Why has the Bank of England
withdrawn support from 2006?
Mr Kemsley: I think that is a
question you might reasonably put to the Governor rather than
to me.
Q583 Mr Fallon: You must know why they
are withdrawing support.
Mr Kemsley: I think you will know
that the Governor of the Bank of England made a statement in April
of this year, at the time of the Bank's last review of SME finance,
stating that it was an area of activity from which the Bank was
going to withdraw.
Q584 Mr Fallon: I did not know that,
that is why I am asking. How serious do you think the `equity
gap' is in the north-west? How wide do you think it is?
Mr Fuller: It is difficult to
establish an absolute figure. I have got some statistics that
I can leave with you which actually tracks private equity, which
is venture capital and the private equity element that was talked
about earlier on, from the very early Nineties when there were
probably three private equity players represented in the north-west,
where the average investment was around £600,000, to the
statistics from last year where there are about 11 or 12 representative
firms and where the average investment is £1.7 million. What
was alluded to but was not brought out in the previous discussion
is that the difficulty in the gap, I believe, is as much down
to the advisers and the interested parties who are there "rain
making", who are making the deals happen, who are bringing
those deals to fruition. If you look at what has happened in Leeds
and the north-east, in Liverpool, there has been a trend over
the last six, seven or eight years of the accountancy firms migrating
to core city centres, so migrating to Manchester from Leeds, from
Liverpool and indeed the north-west, which has gone on at the
same time as the leading firms having a lot of representatives
moving very much up the scale in terms of the deals that they
are prepared to do. There is a gap there because those people
who are playing in that market are having to spend a lot of time
creating a new world to assist these businesses and that is as
much about us acting as principal and doing "rain making"
and creating long-term demand as was there historically when represented
by the accountancy firms. My view is that it depends on the stage
of deal as to what the `equity gap' is, but in some instances
you can say it is as much as £2 million.
Q585 Mr Fallon: Would somebody seeking
private equity in Liverpool not be better off getting on the train
and going to Manchester, where their corporate advisers may have
contracted to a new regional office, than going along with you
when you are going to lose their money?
Mr Fuller: There is no evidence
that I am going to lose their money.
Q586 Mr Fallon: You have just told us
you have lost £8 million-worth of public money.
Mr Fuller: The organisation that
I am part of and that I joined in 2002 when I came in to head
up the fund management business that is in-house employed me to
attract in a greater number of professionals that are experienced
in investing in SMEs and I have a good track record of doing that.
Previously, as is the case with a large number of funds in the
regions, the fund management was outsourced. I would argue with
the regional venture funds that are there and the sort of funds
that I have now time needs to be given to establish a track record.
If you look at my track record, I have got a track record of successful
investment through a regional venture fund in Manchester. I understand
your point, but I am investing the new £80 million and I
believe I will make a significant success of it and through that
I will be able to bring about a cornerstone of investment from
those European funds that went into this round and bring about
private sector investment and create a long-term viable regional
funder.
Q587 Mr Mudie: Today's discussion has
gone into areas that are very political. There are not very many
people in equities that have not made a loss in the last few years,
are there, to my knowledge? As I understand it, in Manchester
you had grant money which you put out and you hoped to recoup
from your equity funding and for a lot more people in equities
in the last few years it has been a bad market, has it not?
Mr Kemsley: Yes, it has indeed,
Mr Mudie. Just let me clarify one point in your question. We are
not in the grant making business.
Q588 Mr Mudie: You were. You mentioned
the £8 million was grants.
Mr Kemsley: We received the grants,
but the investments that we then make are done on entirely commercial
terms.
Q589 Mr Mudie: I thought you had been
given grants.
Mr Kemsley: No. The equity investments
that were being made from the period 1996 onwards in Merseyside
were very much going into start-up businesses. Of the £15
million of the equity we invested in total, probably 65-70% of
that was in the sort of business which Mr Mackie in his evidence
made clear was something which was very high risk and which the
traditional industry would not go near.
Q590 Mr Mudie: But in the Eighties and
Nineties both your organisations were dealing in areas that the
private sector did not touch. For example, you saved a bus company
in my constituency that 20 years later is still providing jobs
in my patch and I was involved in terms of being leader of the
council, I thought you did a marvellous job, but you could not
have got the private sector to touch it with a barge pole. Is
that not the case?
Mr Claydon: I think the important
lesson for us was that in those early years proving a market was
what it was all about. If you take the first three funds that
we managed which are now realised funds, that was £32 million
invested and we have generated an internal rate of return of 12.2%
on that. So private investors in those funds have had their money
back and more, and that has been the platform that we have used
to build new funds, including to win the mandates for regional
venture capital funds.
Q591 Mr Mudie: We have all these terms
and then we change them and move on to using different terms.
I was speaking to the previous witness about an investment gap,
you have referred to a financial gap and then we have an equity
gap. They are all different things and they all relate to different
things, but venture capital is what we are looking at. You are
both in business because up in the regions the private sector
are not as well represented as they should be or as they are in
London and, therefore, people trying to get venture capital up
in the regions are at a disadvantage. That is how I see the situation.
Mr Claydon: Could I offer our
perspective on the `equity gap'?
Q592 Mr Mudie: Yes, carry on.
Mr Claydon: There are three particular
aspects of it that we see very strongly and in a way they are
identified in the BVCA statistics. If you look at the amount of
BVCA investment that goes into early stage and start-up companies,
it has declined by 7% over the last three years, 2000 to 2003.
If you look at the amount of investment by BVCA members that has
gone into companies seeking sums of between £½ million
and £2 million, that has fallen by 41%. There are areas where
it does not seem as though the BVCA's membership is boosting its
level of activity in serving the marketplace. What we see in the
marketplace is that you can cut the equity gap in perhaps three
different ways. Firstly, there are high-tech companies, early
stage start-ups, companies which maybe have a product but not
yet any sales and it is extraordinarily difficult for those to
find finance. Secondly, it is the geographic consideration as
well: if you look at London and the south-east, the investment
rate per 1,000 VAT registered companies is double what it is in
Yorkshire or the south-west region, two areas where we run venture
capital funds. The third element is, this area of £½
million or £2 million, because of this decline in interest
by the BVCA membership, we find is an opening chasm and we are
particularly exercised about it because when we see companies
that we backed through the regional venture capital funds moving
on and looking for follow-on finance, where are they going to
be able to raise it if there is no liquidity in this £½
million to £2 million marketplace?
Q593 Mr Mudie: I could get any of the
big firms to come in and set up in the city centre of Leeds a
big development that was bound to make money, but when I spoke
to that same national developer about coming to some of the suburbs,
the Seacrofts etc, although there are investment opportunities
there, they did not want to know. They wanted to come and take
the easy stuff and go and I think that is why the regions are
suffering.
Mr Garnham: To my mind the majority
of the members of the BVCA are in business to make superior returns
for their investors and that fundamental means that activity will
tend to go towards where it is easiest or more likely that they
will gain those superior returns. If that means investing in larger
transactions or if it means investing in the south-east of England,
that is what they will do. Without some sort of control mechanism
or direction mechanism to focus venture capital in other areas
it will not naturally go there. One of the areas it will not naturally
go to is small business opportunities, early stage business opportunities
and not least because, with all due respect, people from London
have to get on a train and travel to go and see them and having
got out of the train in the centre of Leeds at City Square, they
have then got to get a taxi or get to Seacroft somehow, and this
is about making money for the investors. We manage three of the
regional venture capital funds. If I may pick up on the earlier
point about the London fund only having done one deal, that was
a statistic from July last year. London has now done 20 deals
at over £4.6 million invested. We took the deliberate decision
to look for good quality investments to be producing the right
sort of returns for our investors. We are not in the business
of providing subsidised investments to our investee companies.
Public sector support in the funds comes into the fund itself
and the private sector investors, not the investee companies.
Getting the message through to the market that this was not a
grant culture has taken time and effort to do.
Q594 Mr Mudie: In view of the amount
of investment going in in the south-east and London and in view
of the productivity output gap and the difference in incomes up
north, is there a case for not putting Government money into these
areas?
Mr Garnham: Let me distance ourselves
from the BVCA statistics. Those statistics perhaps are somewhat
confusing because they do not differentiate between the types
of deals that are being done and the size of transactions that
are being done. Trying to raise less than £½ million
in London for an early stage business is just as difficult as
trying to do it in the north-east of England. Trying to do a £25
million or £100 million transaction is more likely to be
done in the south-east of England and that skews the BVCA statistics
in a particular way. I would argue there is an equity gap, it
is increasing and it is national.
Q595 Mr Mudie: Mr Claydon and Mr Garnham,
how does deal flow differ between the three regions? You ought
to change the name of your term. You are frauds. You have gone
away from the fair county of Yorkshire and you are now working
all over the country. How does it differ between the three regions
in which you operate?
Mr Garnham: Again, if I could
just clarify a little bit of terminology. There is a lot of demand
for capital, but what we do not see is that demand being translated
into suitable opportunities. The deal flow opportunities that
we tend to see in London tend to be newer stage businesses, good
quality management teams and good growth potential professionally
managed. In London there are very few manufacturing opportunities
but Yorkshire has more manufacturing opportunities, more owner
managed businesses, more lifestyle businesses. We cannot make
people accept equity. Even though as professionals detached emotionally
from an opportunity we can see how it would benefit a company
to be able to grow and utilise the capital as a good means of
providing economic generation, we cannot force people to accept
that argument. I come back to Mark's earlier point, there tends
to be a lack of creative deal makers in the region that can explain
that to management teams and get the education through to the
markets of why equity may not be a bad thing. Unfortunately for
Yorkshire that flight of knowledge is going across the Pennines
to Manchester now. We have seen it taken out of south Yorkshire
and put into Leeds and the environs; it is now tending to drift
across the Pennines. In the south-west we have got the creative
type of opportunities, a low manufacturing base but very widely
scattered. Trying to find the good opportunities is a very difficult
physical task in the south-west of the country.
Q596 Mr Mudie: Mr Fuller and Mr Kemsley,
you note in your evidence that the number of enquiries received
from Merseyside Business Link has recently been disappointingly
low. Have you discovered any reason for this? Do you have any
concerns about the ability of Business Links to provide venture
capital advice to the small businesses?
Mr Fuller: I will answer the second
question first. Yes, there is but I am not sure that they should
necessarily be providing that advice at that level. Just to correct
things and it may have been misstated in our evidence, we have
seen a recent improvement from Business Link, but over the term
that we have been investing in this new round of funds it has
been disappointing. The purpose of our small firms fund, which
I would describe as a loss leader to our overall funds, this is
the £3,000 to £100,000 straight loan fund, it is investing
loans in what I would call equity risk situations, it is very
similar to what Peter has got over in Yorkshire, is to bring as
much inward investment alongside the pound notes that we provide
and it is genuinely trying to back those businesses where you
believe that there is going to be the greatest likelihood of job
creation because you can see a lot of venture-type transactions
where you do not expect a huge amount of job creation and you
expect quite a bit of wealth creation in terms of capital value.
With those funds the skill is picking the right ones and minimising
the amount of money that you lose in those funds. Business Link
has gone through a number of iterations on Merseyside and has
now reached, hopefully, its last iteration. We are working very
hard with them now to try to bring to the services that they provide
an element of financial knowledge, because my personal view for
all of these SMEs is that the first question should be whether
or not they are financially sound because if they are not they
need to be put in a financially sound situation. You are talking
about very small businesses. They could be nice businesses, they
could be family owned, they could be lifestyle, but they are SMEs
and by definition they need to have one contact with a customer
or with a supplier and that can actually be life threatening to
them. Part of what our organisations in the long term are there
to do is to deal with that. Business Link is coming round but
it needs to improve.
Mr Claydon: We work closely with
Business Links in Yorkshire and the Humber, in the north-west,
in the south-west and in London, but looking at the statistics,
given that we are essentially an equity provider, it is perhaps
no surprise that about 4% of the enquiries we receive are from
Business Links. You go back in time and you see it has not really
changed. When I checked with one of the other regional venture
fund fund managers to see what their experience had been, the
comment back was that their experience was 3% was roughly the
figure they were seeing. I think what one recognises from that
is that the Business Links are really not in this market, they
are not actually providing the advice to companies that are likely
to be raising equity finance, those are companies which have real
growth prospects and it is much more likely that the smaller accountancy
practices or maybe even the corporate finance specialists in London
or in Manchester or Leeds will be helping those companies. One
thing that I would particularly highlight is that I think in the
recent Snyder report on facilitating finance there was a recommendation
to the Government that there should be a new qualification, an
SME funding adviser. This would be something that was developed
essentially amongst the smaller accountants and that could sit
beneath the corporate finance level of expertise, and if that
was pursued I think that would be a major help and assistance
to the venture capital industry and help an enormous number of
these smaller businesses to get the advice that they properly
need and which at the moment they are not getting. One of the
other recommendations of the Snyder report is that perhaps the
Regional Development Agencies ought to think about providing some
kind of subsidised support to assist those SME funding advisers
to deliver a service just to get that market developing and I
think that would be a very useful way for Regional Development
Agencies to move the agenda forward.
Q597 Mr Mudie: Is there a partnership
in place in your regions in terms of the RDA and the local authorities,
the banks, yourselves, working on the infrastructure, all playing
your separate parts to make sure things happen but it needing
partners doing different things to bring it together? Do you have
those sorts of partnerships emerging? The East Midlands say that
they have such an infrastructure of partnerships.
Mr Claydon: In so far as the regional
venture capital funds are concerned, the Regional Development
Agencies have been very proactive in assisting with the marking
and the presentation of these new instruments and making sure
that they are integrated with their other activities. For example,
we completed a deal for a company in south Yorkshire, but part
and parcel of the package is other funding streams which the Regional
Development Agency is able to bring to the equation. We also have
a very close symbiotic relationship with the banking community
who we cannot live without and they cannot live without us, so
it works extremely well. At times we are competing and at other
times we are co-operating, but the relationship is very strong.
Mr Fuller: We only have operational
links with the RDA. Our relationship is very strong in terms of
helping bring a range of financial opportunities, so we work with
the RDAs in that respect. We also work with the local authorities,
of which there are five on our patch, in terms of their direct
interest for companies located in their area. We work, where sensible,
with the banks. I would not say it was particularly helpful and
I would actually say in a number of areas, because of the way
the banking world has changed, with the spread of the Small Firms
Loan Guarantee scheme, that has actually caused us problems in
a number of areas. The Small Firms Loan Guarantee scheme was not
supposed to replace overdrafts, but I think if you look at it
the statistics that would suggest that it has. The way that banks
have organised themselves is such that they are very much sales
led organisations with monthly targets. I think for the very small
business locally where there is a shortage of advisers we are
all trying to do our bit in putting those together and it is a
long-term thing, where we can spend time understanding the business
needs and put a blend of funding in place that is appropriate.
Where a company may have a problem, there are sufficiently experienced
people around who can come together and perhaps encourage all
of the parties, the banks and the equity providers to assist that
business. That becomes very difficult when you are not involved
and you are asked to intervene to bail a bank out.
Q598 Mr Heathcoat-Amory: Mr Claydon and
Mr Garnham, you have a contract to manage three of the regional
venture capital funds, London and the Yorkshire and the south-west,
which is my region. The first assessment of these funds indicated
that each of them had made only one investment which the Small
Business Service rather heroically called "a solid start".
Can you give us an updated picture and tell us whether you think
there is a sufficient flow of good quality proposals coming through?
Mr Garnham: As I mentioned earlier,
our emphasis from the start of these funds was to get them in
place, get them up and running, on a proper footing and get the
message out into the market to attract the good quality transactions.
Across the three funds we have now done 32 investments of over
£7.2 million, and in the south-west in particular we are
looking at six investments at £1.5 million. Remember, these
initial investments have to be restricted to a maximum of £250,000.
What we are seeing there, comfortingly to me, is an increasing
number of better quality opportunities coming through. Initially,
picking up on the earlier statistic of some 500 turn-aways in
London, we were faced with a wall of opportunities which had been
on the shelf for some time, if I could put it that way, which
had been around the market and were being put forward with a view
to public sector funds providing grant money. There were a lot
of disappointed people initially. A lot more work than we originally
anticipated has gone in to educating the market, particularly
due to the lack of deal makers who can handhold the management
team to prepare a proposal to something that becomes credible
for a reviewer and that really is where the education aspect comes
back into the market in my view. Management teams and entrepreneurs
are driven, they know their product, they are not necessarily
the most skilled people in translating that into something that
people in dark blue suits understand and that is where the interface
needs to be.
Q599 Mr Heathcoat-Amory: But this is
still only a tiny proportion of the funds allocated. I come from
the south-west, you come from Yorkshire, and we do have quite
a sophisticated capital market in the south-west based on places
like Bristol. We are not all uneducated persons. There is a tradition
of West Country entrepreneurship which we are quite proud of.
It is not clear to me at all that simply adding some publicly
funded investment funds to the pot is doing the trick at all.
Are you still confident that the long-term performance of these
capital funds is going to be good and in line with initial expectations?
Mr Garnham: The investment period
is six years, so we still have four and a half years left. For
the Objective 1 funds it was five years. It is a six-year investment
period followed by the managing out of the funds, so they are
certainly medium term funds. Given the rate of pick-up and our
work in progress now we are confident that the fund will be invested
by the end of the period. What we hope is more important but will
only be realised later in the piece is that those investments
will be good quality investments that will be returning the required
capital to the investors.
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