Where leverage is lacking

Which comes first the funding or the finance-worthy business? Figures on venture capital funding across the different regions of the UK suggest the answer and indicate the scale of the task Wales faces to attract more investment, Rhys David says.

It is now conventional wisdom that Wales needs a bigger and more competitive private business sector, if more employment opportunities are to be created and greater levels of wealth achieved.

Moreover, if these new businesses are to be created, entrepreneurs wishing to start up and existing companies wishing to expand will need access to finance, the supply of which has been severely restricted since the start of the world economic crisis almost exactly two years ago.

This point was made strongly in the evidence presented in the IWA’s response to the Welsh Government’s economic renewal consultation earlier this year. This backed the idea contained in a report for Government by Chris Rowlands, a former director of 3i Investments, that a regionally-distributed commercial fund should be created to fill a gap he had identified in the availability of finance for investments between £2m and £10m.

The IWA document went on to suggest renewed efforts should be made to attract London-based and international venture capital funds to back entrepreneurs in Wales, focusing on the Welsh proposition – our universities and skills, logistics, accessibility, and attractive living and working environment.

When the Welsh Government’s strategy document, Economic Renewal: A New Direction was published, action on these points was promised. It contained a pledge to seek expert advice on where gaps currently exist and how best to leverage private sector investment, so that businesses and entrepreneurs in Wales gained access to debt, equity, and mezzanine finance from banks, venture capital funds and investors.

So just how big a role does venture capital – and its bigger brother private equity, involving acquisition of large stakes or total control of quoted as well as unquoted companies – play in financing growing and existing Welsh businesses at present? And how realistic is it to expect a bigger role that will make a significant difference to Welsh prospects in the current phase of economic recovery?

In a recent report the sector trade body, the British Private Equity and Venture Capital Association (BVCA), made plain the impact on its nearly 200 members of the recession. Funds invested internationally, including private equity were down from £31.6bn in 2007 to only £7.5bn in 2009. Taking venture capital on its own, and excluding the big deals that constitute private equity involvement, investment in the UK stood at only £296m compared with £359m in 2008 and £434m in 2007. The number of companies financed fell from 455 in 2008 to 388. Instead of making investments, the BVCA’s chief executive Simon Walker noted, the sector has concentrated on enhanced portfolio management over the past two years.

Investment by region (UK)
Region Number of companies % of companies Amount invested (£m) % of amount invested
2009 2008 2007 2009 2008 2007 2009 2008 2007 2009 2008 2007
South East 199 190 220 24 15 17 1162 1266 2493 39 15 21
London 190 297 334 22 24 24 647 3590 5730 23 42 48
South East & London 389 487 554 46 39 41 1809 4856 8223 62 57 69
South West 66 76 82 8 6 6 115 196 198 4 2 2
East of England 36 74 104 4 6 8 66 495 531 2 6 4
West Midlands 45 85 82 5 7 6 74 418 416 3 5 3
East Midlands 36 67 65 4 5 5 132 556 802 4 6 8
Yorkshire & The Humber 56 119 108 7 9 8 70 473 499 2 6 4
North West 55 171 154 7 13 12 124 321 600 4 4 5
North East 47 55 51 6 4 4 188 68 156 6 1 1
Scotland 39 75 73 5 6 5 315 1052 393 11 12 3
Wales 52 44 36 6 3 3 63 112 128 2 1 1
Northern Ireland 13 25 21 2 2 2 1 9 26 0 0 0
Total 834 1,278 1,330 100 100 100 2,957 8,556 11,972 100 100 100

It is, however, the figures in the report for investment by region that are most illuminating, showing as they do a not very encouraging picture of activity by the industry in Wales. The reasons will of course be disputed – it could be a deep-seated prejudice against investment in Wales but it is much more likely it reflects a dearth of opportunities for the venture capital sector providers to make the returns their business plans require.

In terms of the number of deals Wales was the only region that showed an increase over 2007 and 2008 in volume – 52 compared with 44 and 36 for the two preceding years. The amount invested – £63m – was, however, roughly half the figure two years previously and only a fifth of the total going to Scotland. Businesses in the north-east secured £188m, nearly three times the amount a year earlier from roughly the same number of deals as Wales.

Venture capital companies are investing in roughly one in every 200 VAT-registered businesses in Wales – one of the better regional returns – but Wales has seen one of the smallest increases in VAT registrations over the past three years – roughly 8 per cent compared with a UK average of 10 per cent and an increase of 16 per cent in the north east, a comparable region.

Perhaps the most telling table in the BVCA report, however, focuses on investment by stage by region (see Table 14 in the BVCA report). London and the South-East, admittedly by far the most populous part of the UK secured 82 per cent of first stage venture capital in 2009, 73 per cent of the expansion capital, 88 per cent of replacement capital, and 46 per cent of Management Buy-Out/Management Buy-In capital from providers in 2009. The figures for Wales were 2 per cent (first stage), 1 per cent (expansion), negligible (replacement) and 4 per cent (MBO/MBI), well below what might be expected on a simple population proportion.

The figures for which sectors the money was invested in are also revealing. Wales secured 6 per cent of the total investment in oil and gas, basic materials and industrial products, but a paltry £1m (too low a figure to show up in the percentages) in consumer goods, 1 per cent in health and consumer goods (compared with the North East’s 14 per cent), a negligible amount again in telecoms, utilities and financials and 2 per cent in technology. London and the South East secured 76 per cent of the funding going into consumer goods, 67 per cent going into healthcare and consumer services, 89 per cent for telecoms, utilities and financials and 45 per cent for technology. London’s share of the oil and gas, basic materials and industrials funding was by contrast 40 per cent.

The bias of funding towards London and the South East is hardly surprising, given it holds more than a quarter of Britain’s population – but it is also undoubtedly helped by being near to sources of finance in the City, by its much greater overall wealth compared with other regions and by the magnetic attraction it has for the graduate output of the UK’s (and to some extent the world’s) universities. Those with the highest level of skills are, after all, most likely to start new businesses (and seek finance) and to gravitate towards newer sectors of the economy, such as healthcare. Though the figures can change significantly from year to year on the basis of often only a small number of deals, funding coming into Wales, it would appear, is still predominantly being directed into older sectors.

How can we improve this position? The evidence would seem to suggest it is the structure of the economy as much as the availability of finance that prevents more deals being done. If Wales were more strongly represented in growing sectors, venture capitalists would be likely to show as much interest in the country as they do, for instance, in Scotland, which in both 2008 and 2009 was in third place behind London and the South East in amounts invested.

This issue is addressed in the strategy document, which recognises that the current sectoral mix represents an over-dependence on potentially slow-growing sectors. The Welsh Government’s Department of Economy and Transport will focus in future on six main areas: information and communications technology, energy and the environment, advanced materials and manufacturing, creative industries, life sciences and financial and professional services.

The Government has also identified priority areas for university research and development where the prospects there of spin-outs of new businesses are thought to be strongest. These are the digital economy, the low carbon economy, health and biosciences and advanced engineering and manufacturing.

It is clearly going to be a long time before Wales begins to show up more prominently and more positively in the venture capital charts for a number of very deep-seated reasons. The task the Welsh Government has set itself cannot be started soon enough.

Rhys David is former Financial Times journalist and writes on economic and business issues. He is a trustee of the IWA where he was Development Director from 2002-2008. While at Business Magazine 1988-91 he was responsible for developing with the BVCA the successful Venturer of the Year Awards.

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