Examination of Witnesses (Question Numbers
60-79)
DEPARTMENT FOR
BUSINESS, INNOVATION
AND SKILLS
AND CAPITAL
FOR ENTERPRISE
LIMITED
13 JANUARY 2010
Q60 Mr Bacon: It is an agreed Report.
Mr Fraser: Yes, that is true.
You are referring there to the national programmes.
Q61 Mr Bacon: Yes.
Mr Fraser: Indeed in so far as
we have identified that there is risk of concentration in the
South East, we are seeking to ensure that there is an appropriate
regional distribution. I take your point. In fact last week Lord
Mandelson asked Lord Davies of Abersoch to report to him on this
whole point about ensuring that there is an effective national
programme, which I think is what the Report is seeking for us
to have, but also ensuring that there is a proper and effective
pipeline of regional investment. In addition, I would draw your
attention again to the fact that there are existing schemes, also
run by the RDAs as regional schemes, which are not covered in
these national programmes.
Q62 Mr Bacon: Mr Earley mentioned
the fact that the businesses in the regional scheme were currently
valued at £5 million. In total figure 11 says there are 576
surviving businesses. I do not necessarily expect you to publish
this on a broken-down business-by-business basis but have you
done some analysis of what those 576 surviving businesses are
worth or might be worth or might be worth going forward?
Mr Earley: Yes, we have. Every
year the funds are required to value each individual portfolio
company and to have those valuations audited against industry
standard valuation guidelines. We also asked the fund managers
for their best estimations of the maximum and minimum exit values
for each of those invested-in companies so we can have an ongoing
assessment of the likely returns to all investors in the funds.
It is important to point out as well that it is the Department's
investment, which I explained earlier was subordinated, which
is reduced from £74 million to £5.9 million. The private
investor investment in the funds ranges from an IRR currently
of 10% through to 2 funds which are slightly negative.
Q63 Mr Bacon: But because of the
way it was structured you take the hit first.
Mr Earley: Yes; exactly.
Q64 Mr Bacon: How much of the information
you have just been talking about is published or is it all for
your own internal consumption?
Mr Earley: Most of it is for reporting
to the Department so they can understand in full what the investment
portfolios are doing. We are very happy to report as much detail
as the Committee would like in confidence to the Committee. We
are constrained as to how much we can put in the public domain.
We are putting as much as we possibly can in at the moment without
compromising those agreements.
Q65 Mr Bacon: Really what I am getting
at is, of those 576 businesses, do you think you are looking at
some golden acorns that in five, eight, 12 years' time will be
making the taxpayer very happy?
Mr Earley: We very much hope so.
Q66 Mr Bacon: What is your analysis?
Does your analysis suggest that is the case?
Mr Earley: Our analysis suggests
that there are some really potentially fantastically successful
businesses in the portfolio. Whether or not that potential can
be realised in current economic circumstances is what we pay the
managers for. They have to work very hard to realise the potential
of the investment. As you know, with venture capital very few
investments generate returns to the funds.
Q67 Mr Bacon: May I just go back
to the size of the investment? You said that the EU have now recognised
that £500,000 is really far too low and if the equity gap
is really up to £5 million then one presumes that the ceiling
ought to be roughly of that order. What is the EU ceiling now?
Mr Earley: I believe the current
EU ceiling is €1.5 million. For our current programme we
have persuaded the European Commission that because of the way
it is structured, with the Department taking less risk than private
investors, they will allow investments up to £2 million per
investee company and follow-on investment up to 10% of the total
value of the fund. We think we have a better commercial understanding
from the Commission than the general rules elsewhere.
Q68 Mr Bacon: Am I to take it that
you now take the view that it would be better to put larger sums
into a much smaller number of businesses, not necessarily just
a handful but, instead of 576 or a total of 810 invested in, that
it might have been better to have invested a lot more in, say,
70 or 80 businesses?
Mr Earley: Yes, but we need to
bear in mind that these are funds to address the equity gap where
private investors will not invest and there is certainly evidence
that private investment funds invest in tranches above
£5 million and certainly some between £2 million and
£5 million. It would be wrong of the Government to displace
private sector investment.
Mr Fraser: We are in fact seeking
to rationalise the programme going forward so that we have a fund
looking at smaller investments. We also have the UK Innovation
and Investment Fund which has just been launched which is looking
at slightly larger figures, particularly in the high tech sector
and that is, pari passu, investment which is not subject
to state aid. We are also considering the Rowlands report on growth
capital which is slightly larger amounts for growth rather than
start-up and we are at present working on the establishment of
a fund to support that area of the market. We are seeking to rationalise
but to be able to address different parts of the venture capital
market.
Q69 Mr Mitchell: Continuing the theme
of fees for the investment advisers, what were the fees paid to
them for? Were they paid for coming to a deal or were they paid
for getting private capital in or were they paid on the basis
of the success of that particular deal?
Mr Earley: The fees are paid for
managing the fund, which is raising the fund, structuring the
fund, attracting the private investor, finding the investments,
structuring the investments, making and monitoring the investments.
Q70 Mr Mitchell: So it is for coming
to the deal.
Mr Earley: It is for coming to
the deal; it is also for assisting the development of the business,
assisting the additional financing of the business and exiting
the business.
Q71 Mr Mitchell: You will not know
that until the end of the period, will you? Is a fee paid as soon
as a deal is come to and then another fee for assisting and supervising?
Mr Earley: No, there is a flat
rate fee which is structured as a percentage of the commitments
to the fund which is paid quarterly in advance of the fund managers
throughout the commitment ... ...
Q72 Mr Mitchell: So you assume that
they are continuing to assist and supervise.
Mr Earley: Yes and we monitor
them very closely to ensure that they are and where they are not
acting at the rate we expect them to be acting, we have taken
action in the past and reduced fund sizes and had rebates and
reductions in fees.
Q73 Mr Mitchell: Are they paid in
any other way or are they just paid on a fee basis?
Mr Earley: Some funds also take—
Q74 Mr Mitchell: No, I mean the advisers.
Are the advisers paid in any other way than fees?
Mr Earley: The fund managers are
paid in fees and sometimes they take a fee from the underlying
company as well but we take those into account in the totality
of income to the fund manager.
Mr Fraser: This is covered in
paragraph 3.10.
Q75 Mr Mitchell: So they get it both
ways.
Mr Earley: No, because if they
are taking a good deal of money from the underlying companies,
we would say that is actually damaging the prospects of the underlying
company and we would take that into account anyway in the fees
they pay.
Q76 Mr Mitchell: Who are these jokers,
the fund managers? How do you pick them?
Mr Earley: There are an awful
lot of organisations who would like to be fund managers in this
area. We are very careful to learn from historic performance and
we pick fund managers who can demonstrate an ability to perform
well in this area; stable, competent, well motivated teams, ideally
with a track record, if not collectively then certainly individually.
Q77 Mr Mitchell: You pick them on
the basis of their past performance as reviewed by you.
Mr Earley: Yes.
Q78 Mr Mitchell: What instructions
are they given to be cautious with public money? What are they
told their brief is?
Mr Earley: Their brief is to maximise
the returns from the investments they make within the constraints
which are set by the legal agreements governing the operation
of the funds.
Q79 Mr Mitchell: At the end of the
period, assuming the investment is successful, you said to Mr
Bacon that you had some golden acorns. By the same token, you
must also have some disasters. Is any account taken of either
in an ultimate figure?
Mr Earley: We expect a high number
of write-offs in the funds and for those write-offs to come earlier
in the life of the funds.
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