Letter from Permanent Secretary, Department
for Business, Innovation and Skills
NAO REPORT—VENTURE CAPITAL SUPPORT
TO SMALL BUSINESSES
Thank you for forwarding the transcript of the
PAC hearing. I attach a copy with a few changes, broadly typographical
amendments, and one note of a correction to the transcript.
Mr Earley wishes to amend his statement to Mr
Griffiths at Q31 and Q32, and to Mr Bacon at Q37. This was incorrect.
Mr Earley gave a figure on the proportion of the fees which could
nominally be attributed to the taxpayer which was an estimate
prior to the RVCF programme launching. The correct figure for
the programme at inception is 29.7%.
The committee requested further information
which I am happy to provide. Mr Griffiths asked about the transparency
of the funds. Capital for Enterprise Limited has identified the
need to publicise better the performance of the Department's fund
investments and to this end has provided a breakdown on the funds
on its website, with regional analyses and benchmarking data.
CfEL has also extended the information about its activities on
the website; begun to issue a quarterly email newsletter to some
450 interested parties in the sector; and sponsored awards and
events for female entrepreneurs to promote the Aspire Fund.
Mr Bacon was interested in the fees paid to
the fund managers. Fund managers provide a source of general business
advice, help recipient businesses raise additional finance elsewhere
and assist in the development of business and marketing plans
and the recruitment of key staff, often taking a seat on the Board
of invested companies. One case study states that:
"I ring our Non-Executive Director several
times a week to bounce ideas off him or to get his take on things.
I find that side of it very valuable—it has been almost
as valuable as the money. This is something we didn't anticipate
when we applied for the funding".
(BERR RVCF and EGF Interim Evaluation: July 2009).
In the interim economic assessment of the RVCF
and EGF programmes, 61% of respondents held the view that the
assistance received from their Fund Manager had been of significant
or notable benefit. It is this intensive support that the small
cadre of firms with substantial potential require to succeed.
I attach further details of the fees paid by
the tax payer and details of the financial performance of the
funds. The information provided is in a format that we believe
does not breach our confidentiality obligations and gives full
details of the capital committed, drawn-down and invested, together
with the value of the portfolio and the net realised gains and
losses for each programme. The information is not broken down
by fund. Mr Earley is happy to meet with committee members to
present this additional detail in confidence as is provided for
in the legal commitments that we use to establish the funds, and
bearing in mind our agreements on confidentiality relating to
fund managers.
Finally we referred to the work of Professor
Josh Learner. I attach the relevant quotes that Mr Earley referred
to at the committee, a link to the publication that came from
and the bibliography. We have also learnt that the ECF's have
been used as a case study by London Business School and Harvard
Business School. The case study was discussed at an international
conference on public support for venture capital which was held
in November 2009 in Canada. Following the conference a formal
case study is being prepared for students at Harvard Business
School.
As I said in my concluding remarks to the Committee,
the NAO report is balanced. It identifies areas for further improvement.
It also acknowledges that the more recent schemes have learned
lessons and are more likely to protect the taxpayer. BIS will
continue to learn and apply lessons from the innovative and experimental
programmes it has put in place since 2000. However, venture capital
is, by its nature, high risk and the economic benefits and financial
results only become apparent over time.
We intervene because there is a gap in the market
and it is our view that the benefits this finance will deliver
in terms of growth, jobs, innovation, R&D and exports will
outweigh the costs of making the investment. We have begun to
explore outcomes for the earlier schemes through the interim economic
evaluations that have taken place, and will assess the final economic
evaluation once each programme of funds has closed. The Committee
wishes to review the performance in a few years and I will be
happy to return and present our findings on the value for money
of the interventions.
Simon Fraser
Permanent Secretary
1 February 2010
SUMMARY OF FUND PERFORMANCE AND BREAKDOWN
OF FEES FOR EQUITY PROGRAMMES
| | UKHTF
| RVCF | EGF |
BRIDGES | ECF | TOTALS
|
| Size of Fund | Private | 106.1
| 152.1 | N/A | 20.0
| 70.5 | 346.2 |
| Public | 20.0
| 74.4 | 26.5 | 20.0
| 134.5 | 275.4 |
| Commitment Drawn | Private |
103.4 | 89.7 | N/A
| 13.9 | 19.3 | 226.4
|
| Public | 20.0
| 74.4 | 26.0 | 18.0
| 32.0 | 170.4 |
| Fees* | Private | 16.5
| 31.0 | N/A | 3.9
| 3.0 | 54.4 |
| Public | 3.0
| 15.1 | 4.1 | 3.9
| 5.8 | 31.9 |
| Sum invested | | 119.2
| 132.8 | 20.9 | 26.5
| 38.4 | 337.8 |
| No of Investee Companies | |
245 | 356 | 136 |
29 | 45 | 811 |
| Net Gains/Losses on Realisations |
| (2.0) | (15.2) | (5.1)
| 4.0 | (1.3) | (19.5)
|
| Total Fund Value (portfolio value plus net current assets)
| 60.5 | 93.3 | 14.9
| 23.7 | 41.8 | 234.2
|
| Return of BIS as per Departmental Accounts (March 2009)**
| 0.0 | 6.0 | 17.8
| 11.3 | 30.6 | 65.7
|
* Fees calculated according to the nominal allocation between private and public investors
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| ** BIS 2008-09 Annual Accounts—Valuations as per funds audited accounts plus drawdowns to 31 March 2009
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THE FEE
STRUCTURE FOR
FUNDS ESTABLISHED
AS LIMITED
PARTNERSHIPS
Fees are controlled by the respective Limited Partnership
Agreements but in all cases it is the Partnership (ie, not the
investors individually) that is responsible for paying the fee
to the manager. The level of fee is intended to cover the costs
of the Manager with the Manager then incentivised to perform by
a share in the profit of the funds once those profits reach an
agreed level. For RVCFs this is usually when all investors, including
HMG, have their investment returned and the private investors
have a 10% IRR.
The Fee is paid (by the Partnership) as a first call on any
income to the fund. This income could come from profitable exits
or from investments that produce a yield. In the early years of
any Partnership this income is not expected to be sufficient to
cover the fee and so the Partnership is able to borrow (interest
free) from the investors by drawing down part of their commitment.
This loan is repaid as a priority before any profit is distributed.
This mechanism allows for the funds to theoretically invest the
total commitment without a reduction to cover costs.
The Partnership is owned by the investors so all are theoretically
liable for fees. For RVCF and UKHTF the HMG money was drawn first
as part of the agreed subordination but the loan for fee is still
repaid to the Partnership as the first call on profits.
The above structure is known as a Priority Profit Share.
Because of the structure fees are considered to be paid by the
Partnership as a whole with no actual split between private and
government investors. If there were to be a nominal split of fees
paid between the partners however, that split would logically
follow the proportionate share of the partnership attributable
to each partner. In the case of RVCFs, this would mean that 32.8%
of the total fees could now nominally be attributable to the tax
payer.
This differs from the estimate of "around 25%"
made by Mr Earley during the hearing. At the hearing Mr Earley
gave a figure on the proportion of the fees which could nominally
be attributed to the taxpayer which was an estimate prior to the
RVCF programme launching. When the funds were established the
public sector proportion of the total fund sizes was 29.7%, higher
than the 25% initial expectation. However when it became evident
that the funds would not invest all the monies available, Capital
For Enterprise Limited renegotiated the contracts reducing the
size of the funds to better align with what was likely to be invested.
Because the public sector contributions to the funds had already
been drawn down, these reductions impacted more on the private
investors, hence the public sector now has a 32.8% interest in
the funds and nominally pays that split of fees.
JOSH LERNER
Josh Lerner is the Jacob H Schiff Professor of Investment
Banking at Harvard Business School, with a joint appointment in
the Finance and the Entrepreneurial Management Units. Much of
his research focuses on the structure and role of venture capital
and private equity organizations. (This research is collected
in The Venture Capital Cycle, MIT Press, 1999 and 2004,
and The Money of Invention, Harvard Business School Press,
2001.)
Below are the quotes referred to by Mr Earley at the PAC
Hearing:
"A second important lesson is the need for patience.
Far too often, policymakers have expected immediate returns from
their venture capital initiatives. The historical record teaches
us that building a venture capital industry is likely to take
many years. The "increasing returns" nature of the venture
capital industry means that pioneering funds and entrepreneurs
are likely to face many challenges. Impatiently abandoning a venture
capital initiative after a few years because it does not seem
to be yielding fruit is an all too frequent mistake of policymakers."
"It is instructive to observe that all venture capital
markets of which we are aware were initiated with government support.
These markets do not appear to emerge without some form of assistance.
This leads to the question as to what it is about these markets
that requires the need for government support, at least in their
formative stages."
(Quotes taken from: A study of New Zealand's venture capital
market and implications for public policy Lerner, Moore and
Shepherd, 2005)
BIBLIOGRAPHY OF
MOST RECENT
BOOKSThe Boulevard of Broken
Dreams: Why Public Efforts to Boost Entrepreneurship and Venture
Capital Have Failed—and What to Do About It. Princeton:
Princeton University Press, Forthcoming.
Innovation and Its Discontents: How Our Broken Patent System
is Endangering Innovation and Progress, and What To Do About It
(with Adam Jaffe). Princeton: Princeton University Press,
2004.
The Money of Invention (with Paul Gompers). Boston: Harvard
Business School Press, 2001.
Venture Capital and Private Equity: A Casebook. New York:
John Wiley, 1999. New York: John Wiley and Sons, 2001 (second
edition) (with Felda Hardymon). New York: John Wiley and Sons,
2004 (third edition) (with Felda Hardymon and Ann Leamon). New
York: John Wiley & Sons, 2008 (fourth edition) (with Felda
Hardymon and Ann Leamon).
Venture Capital and Private Equity: An Instructor's Manual.
New York: John Wiley, 1999. New York: John Wiley and Sons, 2001
(second edition) (with Felda Hardymon and Ann Leamon). New York:
John Wiley and Sons, 2004 (third edition) (with Felda Hardymon
and Ann Leamon).
The Venture Capital Cycle (with Paul Gompers). Cambridge:
MIT Press, 1999. Paperback edition, 2001.
The link below is a comprehensive bibliography of his publications
on Venture Capital and Entrepreneurial Finance
http://www.people.hbs.edu/jlerner/publications.html.
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