Memorandum submitted by The YFM Group,
(formerly Yorkshire Enterprise Group)
INTRODUCTION
1. The YFM Group, formerly Yorkshire Enterprise
Group, has a keen interest in regional productivity agendas as
a provider of risk capital and business competitiveness services
to small and medium sized enterprises (SMEs) across the UK.
BACKGROUND
2. Born out of local government in 1982
the YFM Group is, today, an independent investment, business development
and property services company owned by its senior staff and active
throughout the UK. Since the early 1980s we have invested over
£120 million in equity and debt finance in growing SMEs.
Our business development arm, which only operates at the moment
in the Yorkshire and The Humber region, has orchestrated some
20,000 consultancy assignments at a gross cost of £60 million.
3. The three operating arms of our business,
YFM Private Equity, YFM Venture Finance and YFM Business Development,
currently have responsibility for a quarter of a billion Pounds
of fund management and consultancy programme contracts. YFM Private
Equity and YFM Venture Finance are authorised and regulated by
the Financial Services Authority (FSA) and YFM Business Development
holds the Customer First quality assurance standard for providers
and deliverers of publicly funded business support.
4. The five investors who have committed
most to funds that we manage are the European Investment Fund
(EIF), DTI, European Commission, Barclays Bank and ING Bank. Our
YFM Private Equity arm is the Investment Adviser to three Venture
Capital Trusts (VCTs) which have collectively over 3,000 shareholders.
In the 18 months ending September 2004 we deployed monies from
11 different funds investing £20.4 million in 69 companies
in sums ranging from £50,000 to £2.5 million. At 30
September 2004 we had 154 investee companies in the UK.
5. The first four funds we managed, launched
in the 1980s and early 1990s, invested £32 million in total
to generate a gross internal rate of return (IRR), as at 30 June
2004, of 12.2%. The EIF and two major pension funds who invested
in one or another of these early fund initiatives have subsequently
backed other funds we have launched.
6. When we put forward our bids for the
fund management contracts for the London, South West and Yorkshire
and The Humber Regional Venture Capital Funds (RVCFs) our track
record was scrutinised by the DTI's financial advisers and by
prospective investors. We were able, with the help of cornerstone
funding from the DTI and EIF, to raise £50 million for the
London RVCF (the Capital Fund) and £25 million apiece for
the South West and Yorkshire and The Humber RVCFs. Our success
now and in the future is dependent on our ability to meet and
exceed financial return targets and any other subordinate delivery
targets set by our investors.
7. In 2002 YFM Business Development won
a three year contract to deliver for the DTI and Yorkshire Forward
the Government's Manufacturing Advisory Service (MAS) in the Yorkshire
and The Humber region. Through this and other contracts we are
currently managing a thousand consultancy interventions a year
in locally based companies. Again the success we have achieved
has been built on our ability to meet and exceed the delivery
targets set by Government Departments, Yorkshire Forward and other
local public sector business support agencies.
8. We currently have some 80 staff and an
extensive, national network of third party agents, contractors
and contacts that we have built up over the last two decades.
Our main offices are in Leeds, Manchester, Bristol, London, Sheffield
and Hull. The YFM Group is an Investor in People company.
9. Representing us are Peter Claydon and
Peter Garnham. Peter Claydon is Group Commercial Director. He
has worked in local government and, briefly, in the Civil Service
on corporate planning and economic development agendas and has
been involved with the YFM Group since it was established in 1982.
He is responsible for the Group's product development work with
public sector partners, for marketing and external relations and
for the Group's property services arm. Peter Garnham is Managing
Director, YFM Venture Finance. Before joining the Group in 2001
he worked in the corporate finance and merchant banking arms of
UK and overseas banks and then for one of the UK's largest accountancy
practices. He is responsible for the teams that manage RVCFs and
a number of other regional and sub-regional fund contracts.
DEMAND
10. Whilst SMEs account for 99% of the total
UK business stock only a small proportion of SMEs take advantage
of the external equity finance available through business angels
and the venture capital community. The British Venture Capital
Association (BVCA) estimates that over 88% of the companies backed
by its members in 2003 could be classified as SMEs. This means
that 1,100 or so SMEs in the UK won equity backing from BVCA members
in 2003. At the YFM Group, where for the most part we are investing
sums of less than £1 million, we completed investments in
44 companies in 2003 often in syndication with other BVCA members,
business angels or corporate investors.
11. The latest Bank of England Finance for
Small Firms report published in April 2004 reveals that only 3%
of SMEs raising external finance make use of venture capital.
This percentage has not changed over the last decade. For those
of us seeking to develop the role played by external equity in
the SME marketplace the 2003 Global Entrepreneurship Monitor (GEM)
report for the UK offers some interesting insights. The GEM report
notes that 4% of the 22,000 adults it surveyed had been successful
in raising equity finance. The report goes on to suggest that
"around 8% of firms could, with appropriate mentoring and
coaching, become suitable for equity finance". If the GEM
data can be taken as a guide to the potential scale of the market
then there would appear to be a substantial reservoir of unsatisfied
or latent demand in the system.
12. We at the YFM Group currently see some
2,000 investment propositions a year but our very strong impression
is that the demand for equity finance varies significantly from
one sector to another and from one geographic area to another.
We see less resistance to the idea of external equity finance
from owner-managers in new economy businesses. Equally, in our
experience, dealflow is stronger in London and the South-East
than it is in other UK regions. BVCA statistics on investment
by standard regions show that take-up rates, ie companies invested
in per 1,000 of total VAT registered businesses, are twice as
high in London and the South East as they are in two regions where
we manage RVCFs, the South West and Yorkshire and The Humber regions.
13. Entrepreneurs complain to us and to
others that they face particular difficulties in raising equity
finance for start-up and early stage hi-tech businesses. Whilst
we and other venture capital companies would argue that there
is money available for good propositions BVCA statistics tend
to support the argument that for hi-tech start-ups and early stage
deals there is a very considerable mismatch between expressed
demand and the supply of equity capital. In 2000 11% of monies
invested by BVCA members in UK based companies was targeted at
start-up and other early stage businesses. Last year the equivalent
figure was 7%.
14. It is perhaps worth noting that when
we invest in early stage hi-tech propositions to manage risk and
to secure follow on funding we are always looking for syndicate
partners and ideally for an involvement from corporate investors
who might ultimately be customers for the services or product
being developed by the prospective client. One result is that
it is more complicated and takes longer to complete an investment
in a hi-tech early stage business than it takes to complete more
conventional venture capital transactions.
15. At a generic level we see a number of
separate but related reasons for the current mismatch between
the demand for and supply of small amounts of equity finance.
These include:
(i) fear of loss of control and worries on
the part of owner-managers as to how the relationship with an
external equity backer will work post-investment if business plan
targets are not met or are exceeded;
(ii) poor awareness amongst owner-managers
of the circumstances in which different financial instruments
might most appropriately be applied;
(iii) a costs and financial returns "expectations
gap" between prospective clients and the providers of equity
finance;
(iv) a dependency culture as opposed to an
investment orientated culture that may be encouraged by public
sector grants for particular initiatives or for business activity
in geographic areas;
(v) an absence of professional advisory support
where there is little immediate prospect of fee income for the
provider;
(vi) more attractive investment opportunities
elsewhere that discourage institutional investors from backing
fund initiatives that are targeted at companies seeking to raise
modest amounts of equity finance; and
(vii) high transaction costs (relative to
the monies invested) that encourage equity providers to migrate
up-market to larger and larger deals.
PROVIDING A
SERVICE
16. A number of the funds that we manage,
notably regional or sub-regional funds, have received cornerstone
funding from public sector sources. The three RVCFs we manage
are structured, assuming targets are met, to deliver a commercial
IRR to the private sector investors that have backed them. With
the Objective 1 and Objective 2 funds that we manage, ie the South
Yorkshire Investment Fund, North West Business Investment Scheme
and Partnership Investment Fund the aim is to provide the public
sector with a return at the end of a 10 year term sufficient to
allow the launch of follow-on or legacy funds.
17. The three RVCFs for which we are responsible
have been operational for two years. Only a handful of deals were
completed in the first year. As market awareness has built up
investment activity has accelerated. By 30 September 2004 we had
completed 32 investments involving 28 SMEs with almost £7.6
million of RVCF monies committed to those businesses. As a follow-on
to first round or second round RVCF backing other funds, managed
by ourselves or by other venture capital companies, have invested
in a number of these companies. One investee company Avanti Screenmedia,
has achieved a Stock Exchange listing. To date one investee company
has failed and valuations attributable to some others have been
downgraded. We would expect to experience further failures within
the portfolio. However a number of our investee companies are
showing excellent promise. Given that we are only two years into
a 10 year project, we are encouraged by the way in which dealflow
is building up and by the positive reaction that there has been
to the RVCF initiative in the marketplace.
18. More specifically we are responding
to the challenges identified in para 15 above by:
(a) working hard with those professional
intermediaries and business angels interested in the smaller business
to build awareness of the RVCF offering and to secure cost effective
delivery of support services that prospective clients need;
(b) using case studies to promote understanding
in the small business community of the benefits of using venture
capital;
(c) re-engineering, automating where we can
and streamlining appraisal and due diligence processes to reduce
transaction costs and to allow attention to be focused quickly
onto the best investment prospects; and
(d) facilitating peer group networking through
investee company Chief Executive Officer and Non Executive Director
(NED) clubs.
19. We are also looking at ways of building
connections between the work of our RVCF investment teams and
work being carried out by other YFM Group staff and the staff
of partner organisations responsible for other publicly funded
schemes. The three Regional Development Agencies (RDAs) who sponsored
the RVCFs we manage have taken a keen interest in progress and
in providing practical assistance in awareness building and market
development. In Yorkshire, where we are responsible for the delivery
of the MAS, we have introduced MAS consultants to investee companies
who are now reaping the benefits in terms of enhanced productivity.
Indeed we see opportunities for involving MAS consultants in initial
appraisal as well as post investment support work wherever we
find ourselves working with manufacturing companies.
GOVERNMENT POLICY
20. It is our contention that the RVCF model
has been well designed and that the iterative, market testing,
approach adopted could well be emulated in other areas of public
policy and programme development. Given that the RVCFs have a
10 year term there will, inevitably, be some problems that emerge
along the way but thanks to the process adopted they are likely
to be few in number.
21. Venture capital investment requires
a long term view. At this point in time it is far too early to
say whether or not RVCFs will be successful in paving the way
for a much greater involvement by private investors in funds that
provide equity in sums of up to £0.5 million. By the beginning
of 2008 we would expect the existing RVCFs to be fully invested.
Thereafter the key priority of the investment teams will be to
secure profitable realisations and a return of monies to RVCF
backers.
22. The conundrum for all RVCF stakeholder
interests will be how to maintain the momentum on new investment
work when the existing RVCFs have deployed all of their funds.
Planning for a further round of RVCFs will need to start in 2006
so that new RVCFs can be launched in late 2007/ early 2008. A
2006 start is likely to be too early for worthwhile evidence from
the existing RVCFs to be available for use in fund raising work
with institutional investors. If cornerstone funding is available
once again from the DTI to support a further round of RVCFs it
is much more likely that once again institutional investors will
be prepared to get involved.
23. The Government's Small Business Service
(SBS) announced plans last year for the piloting of a new Enterprise
Capital Fund (ECF) scheme that will give growing companies access
to investment capital in sums of between £0.5 million and
£2 million. The Government's ECF proposals are currently
being scrutinised by the European Commission for compliance with
State Aid rules. Assuming clearance is achieved then one might
anticipate that the first ECFs would be launched next year. Whilst
we have reservations about Government thinking on the structuring
of ECFs we have written to the European Commission supporting
the SBS proposal. We have highlighted the 41% fall since 2000
in the amount invested by BVCA members in sums of between £0.5
million and £2 million as evidence of need. We would expect
that 200 to 250 companies backed by the 9 English RVCFs will,
in due course, be looking for follow-on finance and are seriously
worried that without ECFs there will not be enough liquidity in
the sub £2 million market place to underwrite the continued
growth of these companies.
24. The introduction of ECFs could also
lead to a widening of the pool of fund management expertise active
in dealing with smaller transactions. Whilst we would accept that
more competition in this part of the venture capital market may
well benefit both investors and investee companies we would not
wish to see the quality assurance standards and competency thresholds
set by the Financial Services Authority in any way compromised
though we would wish to see greater clarity in certain areas of
compliance eg in the giving of business advice and the making
of financial promotions.
25. Our experience in appraising applications
for RVCF monies is that there are propositions that we currently
reject that with appropriate mentoring and coaching could be made
"investor ready". When we decline such propositions
we encourage the owner-managers to take advice, to re-shape their
proposals and then to pitch again for investment backing. However,
a problem at the moment is that it is hard for these businesses
to find high quality advice and support at a price that they can
afford.
26. As we understand it the SBS, following
a number of investment readiness pilot studies, has invited RDAs
to take the lead in addressing this market gap. We see this as
an important area that needs early attention and that merits the
design and implementation of a portfolio of solutions to meet
the differing requirements of different parts of the SME community.
CONCLUSION
27. The BVCA has commissioned studies that
show how external equity finance can help improve the performance
of privately owned businesses and by implication assist in boosting
regional productivity levels. The YFM Group is particularly active
as a provider of equity to those SMEs that are looking to raise
finance in sums of less than £1 million. Based on experience
to date in managing RVCFs, other regional and sub-regional funds
and funds that have a UK wide investment remit we would recommend
that:
(i) the Government should give early consideration
as to how cornerstone funding might be organised for a further
round of RVCFs that might be launched in late 2007/early 2008;
(ii) the European Commission be pressed hard
to give its approval to the ECF model as a means to addressing
problems of liquidity in the sub £2 million market place;
(iii) without compromising present quality
assurance standards and competency thresholds that apply to venture
capital companies, further efforts are made to secure clarity
and transparency in the regulation of the giving of business advice
and the making of financial promotions; and
(iv) the SBS works with RDAs to ensure that
in each of the English regions a portfolio of investment readiness
services is developed, each element targeted at a different SME
market segment, to pave the way for the equity finance that is
available through RVCFs and other public sector backed regional
and sub-regional fund initiatives.
YFM Group Limited
27 October 2004
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