Response of Cambridge Innovation Capital plc to HM Treasury’s consultation on ‘Financing growth in innovative firms’

Cambridge Innovation Capital plc (CIC) was founded in 2013 as an initiative by the University of Cambridge to create a trusted local entity that would be able to provide support and growth capital to promising businesses arising from the University and the Cambridge Cluster.

CIC’s ambition is to build category leaders in rapidly growing technology sectors. Building such companies requires patience: technology businesses which grow to a billion-dollar valuation in the UK have, on average, taken over eight years to reach that valuation.

Potential investee companies will typically, but not necessarily, have already received seed funding from early stage investors or incubator funds and will be seeking further funding to support growth. CIC also makes see stage investments where it believes that the opportunity presented justifies the increased risk of such early investments, and to acquire the right to invest substantial further funds in subsequent rounds.

CIC may only invest in entities that fulfil the following criteria:

the potential investee company must have a connection to the University of Cambridge or be based
in the Cambridge Cluster; and
the underlying technology of the company has the potential to create a new market opportunity or
significantly improve an existing market through improved performance or lower costs.

CIC operates broadly in healthcare and technology, with a particular focus on the inherent strengths of the Cambridge Cluster, including deep learning and artificial intelligence, wireless and wired devices, genomics, epigenetics and next generation biologics. The majority of these businesses will be based on many years of world-class research from Research Institutes in the Cluster or the University.

CIC is an active investor, looking for a substantial minority equity holding and board positions to actively manage investee businesses as they mature into global leaders. To date we have committed over £80 million to 21 high potential companies in the technology and healthcare sectors.

CIC’s Chief Executive, Victor Christou was interviewed by the Industry Panel during the compilation phase of the consultation paper.

We welcome the consultation paper which has been well researched and is full of robust data. The Patient Capital Review addresses an important subject for the long-term prosperity of the UK.

While CIC has successfully raised £125 million to date from a range of supportive, long term investors, there is still plenty of capacity for further capital to fund some of the excellent ideas that we continue to see within the Cambridge Cluster. Though CIC’s principal investment focus is in the area in and around Cambridge, we are certain that a similar imbalance between supply and demand for patient scale up capital exists elsewhere in the country. The businesses that we, and others like us, support have the potential to be the future industrial powerhouses of the UK if allowed to grow and mature properly.

We set out below CIC’s responses to the detailed questions included within the consultation paper.

1 Do a material number of firms in the UK lack the long-term finance that they need to scale up successfully?

Yes. As we have explained above, we have seen plenty of demand for CIC’s capital since it was founded but have not yet reached a fully funded mature steady state. CIC’s recent experience with companies within the Cambridge Cluster suggests there is still a lack of availability for scale-up capital, that is for funding rounds in excess of £10 million.

2 Where is the gap most acute by type of firm, stage of firm development and amount invested?

Sources of seed capital have increased in recent years and are now relatively numerous. However at scale up stage there is still a lack of long-term finance available, and in our experience this seems to be applicable across all sectors.

3 Have we correctly identified the UK’s current strengths in patient capital?

Yes.

4 In what order would you prioritise the UK’s weaknesses in patient capital?

We agree that a principal historical weakness in the UK’s provision of patient capital to rapidly growing businesses is the relative lack of scale up capital compared with US counterparts.
We also agree that a shortfall in capital prepared to invest in the type of businesses typically attracting patient capital has negatively impacted on their potential exit routes, and that this lack of choice has had a knock-on impact on the propensity of investors to invest in them at any stage prior to IPO.

However, we do not see it as a particular weakness that available patient capital has been concentrated in innovation hubs such as the Cambridge Cluster or the area around ‘Silicon Roundabout’ in London. In our experience the concentration of such innovation produces more and better entrepreneurial ideas, together with a well-developed innovation ecosystem to support it. The latter would include legal and financial expertise and, in Cambridge’s case, a number of serial ‘business angel’ entrepreneurs who can lend their experience, as well as their cash. This significantly increases the chance of an idea moving successfully from the lab to commercialisation. Such hubs should continue, and should continue to be supported by government.

5 What are the main root causes holding back effective deployment of and demand for patient capital?

In our experience, there is a greater demand than supply for patient capital.

However effective deployment of capital requires specialised investment manager with a deep understanding of both the industries in which they invest and the particular challenges of growing a
business from its early stages.

In addition, young, innovative companies are much more likely to thrive if they have easy access to wider supportive networks, including those providing legal advice, IP advice, recruitment and mentoring services – one of several reasons why innovation hubs arise.

6 What are the main barriers holding back effective supply of patient capital by major investors?

Chart 5.A, showing asset allocation choices, is very telling. The allocation of UK pension funds and insurers to unlisted equities is extremely low. Empirical evidence suggests that this is due to a combination of the fragmentation of pension schemes, the interpretation of pension scheme trustees’ responsibilities and the structure of compensation for fund managers who make the investment decisions.

If the proportion of assets allocated to unlisted assets within these institutional funds were increased even only slightly, it would have a material impact on the supply of patient capital given the weight of capital that they manage.

If such investment is being held back by a lack of expertise within the major investors concerned, then they should invest in patient capital investment vehicles, rather than directly in the underlying assets.

7 Which programmes (investment programmes, tax reliefs and tax-incentivized investment schemes) have most effectively supported the investment of patient capital to date?

The SEIS and EIS schemes have been effective at providing sources of seed funding. However the structure of these schemes, with full CGT relief available after three years, encourages relatively early exits for such investments, to allow for the capital to be recycled and more tax advantages received. This runs against the patient capital hypothesis and often leaves businesses in a vulnerable state just as they are beginning to gain commercial traction.

So far scale-up funding has been less forthcoming. This is at least partly due to the current structure and rules of these schemes, which do not encourage follow-on funding within their umbrella.

8 Are there areas where the cost effectiveness of current tax reliefs could be improved, for example reducing lower risk ‘capital preservation’ investments in the venture capital schemes?

We would encourage any refining of the current tax relief schemes to focus on higher risk growth investments.

In addition, we would welcome a redefining of the EIS schemes to encourage longer term holding, possibly by way of reintroduction of a taper as well as tax benefits for those undertaking follow-on funding into unlisted investments in which they already hold equity. Increasing the limits on growth, such as the current headcount limits and gross and net asset caps, would also encourage longer term investment strategies for tax driven schemes. We believe this would provide substantive support from the retail sector to long term patient capital provision.

9 Are there other ways the venture capital schemes could support investment in patient capital, in the context of State aid restrictions and evidence on cost effectiveness?

Current investment by the British Business Bank is restricted to GP/LP fixed life funds. The bank’s funds are unable to invest into the sort of corporate structures which most benefit patient capital business strategies.

We would recommend a relaxation of the rules to allow the British Business Bank to invest in all types of investment models, particularly if it is to step into the place of the EIF once the UK leaves the European Union.

10 When is it more appropriate for government to support patient capital through investment rather than through a tax relief?

In our experience, investment support is more beneficial and leads to fewer distortions in the market than tax relief. We were interested to read that this is supported by the evidence provided in Chart 6.C.

11 Is there an optimum minimum length of time of investment for entrepreneurs and investors to focus on the long-term growth of their company and, if so, what is it?

As mentioned in our introduction, building substantial entrepreneurial based companies requires patience: technology businesses which grow to a billion-dollar valuation in the UK have on average, taken over eight years to reach that value. However, the time to reach optimum valuation varies from subsector to subsector, with therapeutic based bioscience companies in particular taking longer than this.

This is considerably longer than the three year cycle encouraged by current EIS and VCT related tax reliefs as discussed above.

12 What other steps could government take to make current tax reliefs more efficient and effective, to provide the best support in line with their policy objectives?

As noted above, government could encourage longer term holding within the EIS regime by tapering the relief on holding and providing tax breaks into subsequent funding rounds into the same company.

13 What scale of new investment should the government seek to unlock and over what timeframe?

Others are better placed than us to comment on the quantum of investment needed in the UK as a whole. However as discussed above, the timeframe should be longer than that implied by the current venture capital schemes.

14 Should resources be focused on one intervention (e.g. a single fund of significant scale) or spread
over a number of different programmes?

We believe that resources should be spread over a number of different programmes to encourage competition between funds for good performance, as this will provide the most cost-effective long term intervention. It should be possible for several such programmes to be set up without individual funds being greatly sub scale.

Experience suggests that it takes many years to create innovation hubs from scratch. From a geographical perspective therefore we would recommend focusing resources into areas such as Cambridge where world class innovation already exists and there is the highest potential to create value for the whole of the UK by building world class businesses.

15 When considering how to replace EIF investment if the EIF were no longer an investor in the UK, to what extent should the government seek to replicate the EIF’s current activities in (a) venture capital and (b) private equity?

With respect to venture capital, whichever body takes on the role of the EIF should be able to invest in all types of investment vehicles including corporate structures. We discuss this further in our answer to question 23.

16 Beyond replicating existing EIF investment if required, what areas should government focus on to increase investment in patient capital?

As discussed in the response to question 6, the government should focus on mobilising some of the capital from pension and insurance funds to encourage asset allocation from these subsectors, by way of regulatory guidance or otherwise.

17 When considering how to support increased investment, should the government consider supporting one or more of the setup of a public-private partnership, a new incubated fund in the BBB
to be sold in part or full to private investors once it has established a successful track record and a series of private sector fund of funds to invest in patient capital?

In structuring this proposed support, the government should be looking to make that support as costeffective as possible. Introducing competition for funds is most likely to focus the minds of those managing them on the most efficient capital allocation, with the long-term result that returns and cost-effectiveness are maximised. We therefore think the third of these options is most desirable – a series of private sector fund of funds investing in patient capital.

As noted in our response to question 14, we believe that the greatest return on this investment will be afforded if it is focused on existing innovation hubs.

18 If desirable, what steps should government take to encourage investors to form a new publicprivate partnership to increase investment in patient capital?

As discussed above, we believe that pension and insurance funds should be encouraged to allocate assets to unlisted securities including patient capital investments by way of government issued regulatory guidance or similar.

19 What steps should the government take to support greater retail investment in listed patient capital vehicles?

Venture capital is an inherently high risk investment so a responsible investor should allocate just a portion of their portfolio to patient and other venture capital in constructing a balanced portfolio. Given this, other than reintroduction of the taper or introduction of reliefs on further funding rounds for existing EIS investments, we think that individuals should be encouraged to make investment in patient capital vehicles by way of their pension funds rather than directly.

20 Will focusing resources on increasing investment provide better value for money than changes to the tax environment?

We refer to our response to question 10.

21 Beyond measures already being considered to support more effective asset allocation decisions by DB pension funds across their portfolio of investments, what further steps should be taken to support investment by DB pension funds in patient capital?

A supportive regulatory environment for pension fund trustees to make such allocations would be helpful.

In addition, these trustees will need expert fund managers remunerated on a suitably long-term basis to manage the underlying patient capital assets on their behalf.

22 How can individual DC pension savers be best supported to invest in illiquid assets such as patient capital?

This is an important and growing source of investment funds, given the move of most employers away from defined benefit to defined contribution schemes.

Many DC savers will receive professional financial advice in compiling their pension savings. In most cases the financial advisor will propose a blend of investments across assets classes in a similar way to that in which any other investor produces a balanced portfolio. If these advisers are subject to similar regulatory guidance to the pension fund trustees of DB schemes, then logic dictates this should provide a similar incentive to invest in patient capital, given that both DB and DC savers both require the same thing – sufficient investment to provide an income on retirement.

23 Are there barriers to investment in patient capital for other investors that the government should look to remove?

If the role of the British Business Bank is to expand to invest in patient capital, then the bank’s remit should be expanded to enable it to invest in balance sheet investors and evergreen funds.

24 What steps should government take to support the next generation of high potential fund managers to develop their knowledge and skills and to raise their first or next fund?

There are a number of existing, well-respected international training and development programmes such as the Kaufman Fellows Program. We believe that it would be a better use of resources were UK fund managers to become more involved in such programmes rather than attempting to start another untested scheme from scratch.

25 What further steps, if any, should government take to increase investment into university spin-outs specifically?

See our response to question 23.

26 What further steps should be taken to increase investor capability in the public markets to invest effectively in firms requiring patient capital to grow to scale?

There are several actions that could be taken to improve the public market investment profile of firms that require patient capital. An expansion of the provision of patient capital at a pre-IPO stage will allow such firms to grow to further towards maturity before undertaking an IPO. Further publicising the performance and potential of such companies, for example by the creation of suitable benchmarking indices should help to expand research coverage and the range of expert investors in this area.

There have historically been few UK based specialist funds only investing in cutting edge technology and biotech funds, and generalist investors have shied away from these companies, feeling that they do not understand sufficiently the risks inherent in them. However, if pension and insurance funds are encouraged to allocate a portion of their funds to patient capital, then these organisations will build up expertise in such sectors as this is where patient capital tends to invest. As there is a strong read across in skill set between managing listed investments in cutting edge scientific based companies, and managing similar pre-IPO investments, then this historic barrier to setting up specialist funds will dissipate.

It should be added that the optimal exit for many companies supported by patient capital will be by way of trade sale, not IPO.