Department for Business, Innovation and Skills: Venture capital support to small businesses - Public Accounts Committee Contents


1  Performance management

1.  Since 2000 the Department for Business, Innovation and Skills (the Department) and its predecessors have invested £338 million in a series of 28 venture capital funds, which have provided finance to over 800 businesses (Figure 1). The aim of the funds is to address a gap in the market, known as the equity gap, whereby small, new businesses with strong growth prospects find it difficult to obtain equity finance from private investors, particularly between £250,000 and £2 million. Investors perceive these investments to be risky relative to larger, later-stage investments and costly to manage.[2]

Figure 1: The Department's venture capital funds
Scheme name
Year commenced
Fund sizes (note 1)
Maximum investment
UK High Technology Fund 2000—one fund investing in nine underlying funds £126.1 mNo limit
Regional Venture Capital Funds 2002—seven funds
2003—two funds
Individual funds range from £12m-£46m

Total raised £226.5m

£500,000
Community Development Venture (Bridges) Funds 2002—two funds,
A and B
A) £28m

B) £12m

A) £500,000

B) No limit

Early Growth Funds 2002—one fund
2003—two funds
2004—three funds
Individual funds range from £3m-£5m

Total raised £91m

£100,000
Enterprise Capital Funds 2006—five funds
2007—one fund
2008—two funds
Individual funds range from £10m-£30m

Total raised £205m

£2m
The Aspire Fund 2008—one fund £12.5m

May raise up to £25m in co-investment

£1m
Capital For Enterprise Fund 2009—one fund investing in two underlying funds Individual funds £30m plus a co-investment provision of £15m

Total raised £75m

£2m

Note 1: Fund size relates to amounts committed by the Department and other investors or raised through co-investment; and not to current valuation. Co-investment is explained in C&AG's Report, para 1.10

Source: C&AG's Report, Figure 1

2.  The Department did not set clear, prioritised objectives for the programme and funds, and with the exception of one fund, did not state an economic objective, for example in terms of the intended benefits to businesses. No clear targets were set, with no explicit rate of return being defined at the outset, although Capital for Enterprise Limited argued that a target return was implicit in the incentive structure put in place for fund managers. The Department acknowledged that there had been weaknesses with setting objectives and establishing a clear means of evaluating performance. The Department had made some improvements to the more recent funds, for example including a financial objective for the Enterprise Capital Funds but it had failed to define key terms such as which costs were to be included in assessing whether the funds were cost-neutral.[3]

3.  The Department accepted the Comptroller and Auditor General's conclusion that in the absence of a robust measurement framework it could not demonstrate whether the programme represented value for money. The Department committed itself to demonstrating within the next two years whether it is achieving value for money, bearing in mind that it would be some years before the final financial performance of these funds is known.[4]

4.  Despite the inherent riskiness of this programme, the Department did not begin an interim evaluation of the Regional Venture Capital Funds and the Early Growth Funds until late 2008, eight years after the first fund was launched. The results of this interim evaluation were not published until the Comptroller and Auditor General published his own report in December 2009. The Department argued that it was not possible to evaluate the returns from these schemes until after about eight years of operation, bearing in mind that they may not reach maturity for 10 to 12 years. While it can take some years for financial performance to become clear, other aspects would have benefited from evaluation, for example, the impact of the funds on closing the equity gap, their success in attracting a flow of good quality business ideas, and whether the fund design was working as intended.[5]

5.  Businesses in receipt of support have reported benefits, in particular enabling them to press ahead quickly with their plans and making it easier for them to attract investment from other investors. The Department reported, for example that an average of seven new jobs per company were created though finance from these funds, 42% of companies reported they had started or increased exports, and 70% of all companies receiving investment were surviving.[6]

6.  The taxpayers' contribution to these funds is intended to be an investment, thereby offering the prospect of a return, but the performance of the early investments to date has been poor. The Regional Venture Capital Funds collectively show an interim rate of return at December 2008 of minus 15.7%. This is below the performance of similarly sized private European funds established at the same time of minus 0.4%. Current valuations of the Regional Venture Capital Funds, as set out in the Department's Accounts for 2008-09, show that the original Government investment of £74 million has fallen to just £5 million, suggesting that a large proportion of the taxpayers' investment is at risk. In part, this valuation reflects the fact that the taxpayer is bearing a much larger share of the risk on these early funds, compared to the private sector investors in these funds who currently expect a return of between two and 10%. Capital for Enterprise Limited considered that some good quality investments remained in these funds, although the recession was affecting the commercial prospects of some in the immediate term.[7]

7.  Even though investment took place at a time when the economy was booming, some funds struggled to invest as much as initially envisaged (Figure 2). Capital for Enterprise Limited argued that because of the experimental and innovative nature of the funds, there could be no certainty about how much they could invest, and fund size at the outset was largely based on estimates of how much the fund managers could persuade the private investors to invest. This under-investment is, however, all the more surprising given that the taxpayers' interest in these early funds was subordinated to that of the private investors, thereby leaving substantial risks with the taxpayer.[8]

Figure 2: The amount of un-invested funds where investment periods are closed
Fund
Total raised from the Department (£m)
Total raised from other investors (£m)
Total fund size (£m)
Invested businesses
Gross cost of investment (£m)
Fund management costs (£m)
Total un-invested funds (£m)

Note 1
UK High Technology Fund
20.0
106.1
126.1
245
112.0
19.5
0
Regional Venture Capital Funds
74.4
152.1
226.5
356
132.8
46.1
47.7
Community Development Venture (Bridges) Funds
20.0
20.0
40.0
28
26.5
7.7
5.8
Total
114.4
278.2
392.6
629
271.3
73.3
53.5

Note 1: For the UK High Technology Fund the un-invested total does not directly reconcile to the difference between the total fund size and the gross cost of investment and fund management costs owing to exchange rate differences and because management fees can be paid out of income and capital proceeds.

Source: Qq 41-47; C&AG's Report, Figures 1 and 11

8.  Some of the funds have proved expensive to manage. The fund management costs of the Regional Venture Capital Funds to December 2008, for example, were particularly high totalling £46.1 million or 36 % of the £132.8 million invested. Around 30% of the total fund management costs will be met by the taxpayer, in line with its contribution to the total size of the fund, provided the funds realise a sufficient return to pay off other investors' capital plus a 10% return, otherwise the taxpayer will bear a bigger share. The total final cumulative cost of fees paid will not be known until the funds are wound up.[9]

9.  Fund Managers are paid an annual fee and can earn a share of the final proceeds provided the fund is profitable when it is wound up. The fees are intended to cover the costs of managing the portfolios, including providing advice and other support to invested businesses. Capital for Enterprise Limited has procedures in place for monitoring the performance of fund managers and in two instances had used its influence to reduce fees to fund managers by £0.7 million where they had made lower investments than initially expected. But it did not set out in agreements with fund managers what constitutes underperformance and therefore any reduction is a matter for agreement with the fund manager.[10]

10.  Until late 2009 the Department had published no information on the performance of the venture capital funds. The Department accepted the need for greater transparency and Capital for Enterprise Limited had published on its website aggregate information in December 2009 about the funds, including the amounts invested and where investments had been made. No information had been published however on the performance of the individual funds. Capital for Enterprise Limited argued that legal agreements governing the operation of the funds, in line with practices adopted in the venture capital industry, restricted publication of certain information on commercial confidentiality grounds.[11]


2   Qq 49 and 108; C&AG's Report, paras 1.4, 2.7 and 2.17, Figure 1 Back

3   Qq 3, 10 and 97; C&AG's Report, para 2.3 Back

4   Qq 1, 113 and 119; C&AG's Report, paras 16 and 2.14 Back

5   Qq 1, 54, 55 and 103; C&AG's Report, paras 2.19 and 3.15-3.17 Back

6   Q 22; C&AG's Report, paras 2.4-2.6 Back

7   Qq 4-9, 34-35, 53-54, 62, 65-66 and 100; C&AG's Report, paras 2.16 and 2.17 Back

8   Qq 41-47; C&AG's Report, para 2.16, Figures 1 and 11 Back

9   Qq 14-16, 21, 30-32 and 37-40; C&AG's Report, paras 2.16 and 3.14 Back

10   Qq 47,53-54, 69-81 and 112; C&AG's Report, paras 3.11-3.13 Back

11   Qq 24-30, 33, 36, 64 and 104-105; C&AG's Report, p 10, recommendation 17e and para 3.19 Back


 
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