Science and TechnologyWritten evidence submitted by SME Innovation Alliance

1. The Select Committee’s questions lie at the core of concerns of the membership of the SMEIA (see below for a brief history of the SMEIA and affiliations and interests of the author).

2. We can report the consistently expressed opinion of the membership, however it is a frustration of all concerned that factual data is in very short supply, we believe this absence almost certainly lies at the root of the UK’s inability to improve its performance significantly in this sphere. There is a further frustration that the SMEIA and precursor bodies have been engaged with government at a high level over the last 20 years, and there are things which we “know” because they were disclosed to us in discussions bound by the Chatham House rule, which we therefore cannot attribute.

3. The “Valley of Death” is now a recognisable term, but it is really only the most extreme manifestation of a far more widespread and deep rooted problem. Mixing metaphors, the UK science and engineering industry is now suffering the “perfect storm” in which very many factors interact, nearly all of them negatively and in a very complex fashion. The SMEIA committee have spent enormous effort trying to separate cause and effect, and to work back to any more fundamental root cause, and we do now feel that we have a considerably better understanding, even though that understanding is far from complete. This analysis does however suggest that many of the matters which exercise debate with and within government, particularly with DBIS and the TSB, are still dealing with the surface symptoms, and are very far from tacking the deeper roots. Much of this document is therefore concerned with setting this context.

4. The SMEIA membership are small companies (mainly very small) in the high technology area, and the representatives on our committee and at our meetings are the senior officers of these companies, most of whom will travel widely, will normally do business internationally, and often interact with universities both here and abroad. We are therefore very aware of the ways that our competitor nations deal with similar problems: there is very considerable frustration at the comparisons that we make. We see that the UK could do so much better.

5. We conclude that the most fundamental root problem is simply that we are not culturally a technological nation. The media make some excellent science programmes, but consistently they “dumb down” the science. Senior BBC presenters feel no embarrassment in admitting ignorance (and incompetence) in science and practical matters. Bizarrely the BBC has rebranded the word “Technology” to mean only what we would call ICT.

6. We have a “generalist” civil service, and so our members and other industrialists have highly asymmetric conversations with senior officials. They believe that they do not need to understand the detail of what we are saying, and that they can make important decisions on “technical advice”. We disagree and believe that the lack of scientific and industrial expertise within the machinery of government, which should stay within departments and build departmental knowledge, is a severe impediment to UK policy formation, and again is in contrast to practice in our more industrially successful competitor nations.

7. This national attitude is certainly recognised in schools, which struggle to get sufficient pupils to take science subjects, and teachers to teach them.

8. This also extends to lack of understanding within government of industrial structures and organisations. Both industry and the unions have been screaming out for better technician training, whereas until very recently governments expanded the universities. In our more successful competitor nations the very high skilled technician is a very well rewarded, high status individual. It is not better or worse than an academically based career, but it is certainly different, and it would appear that this difference of function that is really not understood. Whilst UK employers in the engineering sector struggle to get academic engineers and scientists of adequate quality, they struggle far more to get technicians, on whom the output of saleable, revenue generating products largely depends.

9. HMG over many decades completely lost the plot on manufacturing. Despite a very public reversal of policy by the coalition government, there appears still to be little understanding of manufacture, with reversion to the old understanding lurking in the background. In the 1980s and 1990s it was true that the low wage economies had a massive advantage, simply because everything was so labour intensive. But with automation the playing field is almost level. Current policy is to concentrate on automated manufacture of high added value goods, whereas high technology automation of low added value, high volume (and high shipping cost?) commodity goods is equally possible, and may be far more effective in balance of payments improvement. Manufacture appears now to be a separate agenda item from the “knowledge economy”, whereas it should be seen as the prime means of exploitation of that knowledge (they are two sides of the same coin).

10. After the national attitudinal problem, the next most basic is probably the structure of our economic system. We own our houses and rent our factories is a pretty reasonable summary of the UK, and is in stark contrast to Germany. This is now getting right to the heart of the problem that the committee is investigating. The UK has high house because there has been no other sensible place to put the fruits of our earnings. If we want to finance businesses to generate wealth, then the banks have to have deposits, and savers have to get a healthy return on their cash, but savings interest is treated as “unearned income” and taxed. So there is little point HMT bemoaning the UK’s low savings ratio: they are in command and their policies have caused it to be so.

11. This cuts the other way: because we rent our factories, most businesses have relatively low capital assets on their balance sheet to use as collateral for borrowing. Structurally, small UK businesses are in a far worse position to take risks. Because we rent both our premises, and often our means of production (machinery), companies do not generally build asset value over time. Again a lot of this is the result of long term government (lack of) policy. A study of any industrial estate will show a high rental vacancy rate and very little freehold property. HMRC policy gives far higher allowances against corporation tax for rental and lease, and by comparison almost penalises ownership.

12. The banks are now in sharp focus, and anecdotally there are currently many horror stories of loan facilities being withdrawn. However the banks are being asked by HMG to do something that they should not. “Normal” banking is not about the bank taking a risk with depositors’ money, but of providing cash against underlying assets, so that a company can realise some of its asset value as working or risk capital. As above, our small companies do not have those collateral assets.

13. Something we have urged HMG to research is the actual current means of funding small companies. Typically a business owner will have a massive overdraft, and in the last 20 years will also be a heavy user of credit cards. The reason is very simple: the credit card companies do not seek personal guarantees, nor the very onerous standard bank debenture agreement which will have a clause such as “the bank may at any time at its sole discretion and without any other cause seek a winding up order for the company”.: we believe that this is a major barrier to borrowing in the UK, and ought to be illegal. We would expect that HMG would discover that a large chunk of the current personal debt is in fact disguised small business borrowing.

14. A final structural element of the UK small business environment has been the progressively increasing influence, and actual effect, of all the vested interest groups. Each of the statements below looks, and is, a statement of the obvious, but is also an explanation as to why the UK environment for businesses is so complex. We have submitted opinions in Reference (2) cited below to DBIS, in summary;

(a)We have very complex tax law, largely drawn up by consultation between HMRC and the accountancy profession.

(b)UK commercial legal practice is disputational, every commercial agreement is written afresh, whereas some of our competitors enjoy standardised contracts.

(c)The patent system does not work for SMEs, see Reference 1.

(d)Our technical regulatory bodies now work almost entirely in the private sector, but administer the access to legally required compliance (= legalised printing of money).

(e)Our financial institutions are all focused on capital gain, short term aims, and export profit from clients to themselves.

(f)The public sector “business” support organisations achieve very little good for business.

(g)The universities now do appear to have the ear of government in an entirely disproportionate way, and almost all recent policy appears to have been determined by what the universities advise about “their” spin-out technology businesses, and does not align very closely at all with the advice that would have been given by the massively larger body of truly commercial technology businesses. SMEIA is aware that university based networks have been collecting data for submission to this call for evidence: this appears benign, but the questionnaire approach reflects the preconceived views and will thus inevitably skew the evidence.

15. A final and perhaps most important structural element of the UK business scene is that we have very few, long established medium sized industrial companies, we are missing the equivalent of the German “Mittlestand”. We also have relatively few big independent companies, whereas we are well populated with huge multinationals. This gives us a very discontinuous supply chain, the UK’s very large number of small companies struggle to sell their products to bigger companies, and the same applies to their technology, there is generally very little “pull” (demand) up the supply chain in the non-bio sectors.

16. It is in this general business context that the particular questions of the “Valley of Death” must be considered.

17. The general scenario is of a company with some germ of a new idea. Mainly the SMEIA member companies have the R&D capability in-house and so some early proving can be done out of “own funds”. It is then normally possible to apply for grant funding (from the SMART and other TSB funds). There are two problems with this process:

(a)There can be considerable delays (this has got better).

(b)Most funding schemes are “matched funding” (say 60%) and the problem is in finding the other 40%.

18. Generally these problems can be overcome, perhaps by a “Friends and Family” funding round to meet the matched funding requirement. A considerably better alternative is “procurement” funding, at 100+% of cost, as is very successfully operated by MOD/CDE.

19. This process generally leads to something that is effective “proof of concept” and which is patentable. Whilst the patent system is considered dysfunctional, if future funding needs to be raised, patents must be applied for, and a cost base starts to be established.

20. The lack of supply chain “pull” and continuity means that exploitation by partnering with a bigger organisation is less common than perhaps it should be.

21. This is the edge of the “Valley of Death”. It is recognised that total funds available “in the market” do not meet demand, but this is not quantified: HMG have no estimate of the need. It is however easily calculable by analysis of the figures from the www.pwcmoneytree.com website which lists US funding deals. By suitable scaling we could have a reasonable estimate of our shortfall: it is a massive number.

22. Access (ie contact with) to funding sources is now far better through investment networks, but the mismatch between need and available funds mean that investors can cherry pick. Generally the “network” angel investors will have the same attitudes as the VC community, which is in short term capital gain, whereas HNW individual investors operating privately, and PE houses, might have slightly longer term.

23. Very good projects can get funding, but often on conditions that the company feels are too onerous. The investor’s requirement for capital gains will mean a high “burn rate” of funds, normally seeking more funds in one or more subsequent rounds, with an “exit” for the funds by selling the company on, these days predominantly by a trade sale. The effectiveness of this method of company development is questionable, and very variable between scientific sectors.

24. It appears to work well in the medical, pharma and biotech sectors, where a lot of the initial R&D work is done in universities, and where the nature of the technology is readily transferrable, with the big pharma and medical companies encouraging this business method.

25. Anecdotally it seems that HMG has adopted this as the “standard model” upon which technology policy is based, whereas it is in fact only applicable in bio based sciences.

26. VCs are prepared to take a loss and abandon a project, and this means that the technology will be lost, and this constitutes continual attrition of the industrial technology base that the UK could have had.

27. The VC funding model is also a systematic means to export UK technology. The vast majority of funds come from overseas. If a company has three funding rounds, and if 80% of funds are non-UK, then mathematically the chances of control remaining in the UK after three rounds is 0.8%!

28. Attendance at any investment network meeting will show that bio-science start-up companies aim to give investors an “exit” by a sale to the large multi-nationals for sums in the region £20–£50 million. This is sufficient for a return to the investors and kudos to the R&D teams, but it is selling UK technology short, precisely why the big companies in these sectors are so willing to buy.

29. The alternative for a company with an idea is not to take this funding, and in general such companies will continue, but will not grow, and will not manage to make much money from their technology (DTI did say it had figures from the 1990s to support this).

Recommendations

30. The first is that there are no quick fixes. There are a list of things which our members will consistently say should be done, and a few things which should not be done, but the overriding and consistent message is that this is a structural rather than a particular problem, and it will only be fixed if the underlying problems described above are dealt with properly and systematically.

Research Needed

31. In pursuing this policy the first thing that is necessary is for DBIS and HMT establish and publish some background facts, including:

(a)What annual sum of risk investment money is needed for the UK match our competitor nations in the commercialisation of technology?

(b)What is the shortfall of working capital in the industrial sector, and how are business actually funded now?

(c)What is the rate of export of UK technology through the VC funding?

(d)Investigation of the effects and distortions of all the vested interest groups in the UK

(e)What proportion of genuine innovation happens in each of the SME, large corporate and university sectors?

(f)A thorough revisiting of the patent system as it effects the SME sector, something the recent Hargreaves review promised but did not do (SMEIA has these promises by email)

32. The Dos

(a)Set up a national industrial bank or banks, or mutual banks, to bring competition into general commercial finance, to the general bank lending sector.

(b)Set up new institutions (see CrowdCube.com) that can be effective to bring the general public’s and mutual funds to play in the risk finance sector.

(c)Pull the TSB back from playing at “Dragon’s Den”, themed competitions, timed “calls” and get them to stick to funding projects quickly and simply on pure merit.

33. The Don’ts

(a)Expand the “business support” networks: they are a distraction and simply cost money.

(b)Allow publicly funded institutions any role in “picking winners” or strategic planning of funding themes.

(c)Use any panels of the “Great and Good” to judge or select winners: such panels will always pick the well presented, apparently “safe”, project and miss the exciting and good.

Author and Affiliations

The author of this report is Tim Crocker, on behalf of the SME Innovation Alliance (www.smeia.org). SMEIA was formed about two years ago to represent the views of small high technology companies, working across all sectors. It had its origins in part in the two remaining SMART clubs set up in the early 1990s by DTI for the winners of the SMART awards. Member companies will typically be multiple award winners (SMART, GRD, TSB, CDE, FP7) and the principals will most commonly have a strong scientific or R&D background prior to setting up their own companies. Tim Crocker (www.scimar.co.uk) is a physicist and electronics engineer, with 38 years in the electronics industry, five of them as a government scientist, with academic work in deep sea sonar. He has a large patent portfolio, is CEO of his own company, has been founder of seven other high tech companies, and is currently a director of four of them. His is the lead researcher on motors and electronic drive components within the SAFEDRIVE FP7 project which is developing hybrid vehicle technology. He has other recent technical and commercial interests in wind turbines and LED lighting.

Reference Material (obtainable from the SMEIA website)

1. The Economic Failure of the Patent System, by John Mitchell.

2. Joint submission of SMEIA and the East of England SMART Club to the Willetts R.I. review, by Martin Lawrence and Tim Crocker.

February 2012

Prepared 12th March 2013