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Last Updated: Monday, 18 September 2006, 23:06 GMT 00:06 UK
Funding myths that blight small firms
Doug Richard, Chairman of Library House and Vice-Chairman of the Cambridge Angels, previously a "Dragon" in BBC2's Dragons' Den, argues that wrongly focusing on a myth is diverting attention from the real issues facing small companies.

Venture capital is seen as vital in building small businesses and in ensuring the creation of new ones.

Doug Richard
Doug Richard says some sectors are more favoured than others

Indeed, the government is often heard heralding small business as the engine of growth for the economy and has developed many programmes to help - 3,000 programmes, to be exact, at an annual cost of 7bn.

By and large, this is a good thing.

However, there is one inherent problem: nobody really knows very much about the actual state of venture capital in the UK.

There are a number of theories floating around, some of which have formed the basis for much of government policy in this area.

For this reason, it has become key to identify what theories make sense and which are merely urban myths.

We, at Library House, decided to track the industry, to find out exactly what is going on, and recently published the first ever survey of venture capital-backed companies in the UK.

Capital flowing

What we found was clear. Overall, the UK venture portfolio is very much alive and well.

It is the second biggest portfolio in the world after the US; consisting of 619 independent investment companies, 86 public funds and 263 corporations holding investments.

Reaping the benefit of the 6.6bn in disclosed capital invested, 1,437 companies currently reside in the portfolio.

This is in stark contrast to one of the government's most cherished beliefs, one that drives policy: small businesses in the UK, in contrast with the US, suffer from an inadequate supply of capital in their early stages.

Many companies are simply not strong enough to attract the investors they so desire

To be precise, the government believes that UK innovation is being held back by a so-called "equity gap" - a range of deal sizes which are out of reach of business angels, but still too small to be considered by institutional investors.

This range is usually estimated at 250,000 to 2m. However, the report reveals that more deals took place below 2m than in any other size range - and a substantial 80% of those deals were squarely in the "equity gap" area.

As would be expected, findings also revealed that the public sector continued to contribute strongly to the level of funding available to SMEs and had doubled the funding available in the 100,000 to 500,000 range.

As an example, only last year the government launched a multi-million-pound equity finance scheme, whereby up to 40m is available through Enterprise Capital Funds (ECFs) to match private funding from venture capitalists or business angels.

Innovation hubs

From a regional perspective, while London, the most densely populated region of the UK, has almost 53 venture-backed companies for every one million people, it is Scotland that leads the way on this measure.

North of the border, there are 54 companies per one million people, with 435m institutional investment and an average of 3.2m per company.

Doug Richard grills an entrepreneur in the Dragons' Den series
Doug Richard made his mark in the first series of Dragons' Den

Along with London, Cambridge, Oxford and the Thames Valley, Edinburgh and Glasgow have become the best-known innovation hubs in the UK.

Library House attributes these developing clusters to the pool of experienced entrepreneurs, based within the regions, who have previously received venture financing.

It is these serial entrepreneurs who are essential in encouraging new ventures by others and are often active in backing these ventures as executives or as business angels.

So if capital is readily available, unwilling investors are not to blame for the lack of early stage investment. Rather, it is the companies themselves.

Many companies are simply not strong enough to attract the investors they so desire. We call this the "readiness gap".

Library House recognised this issue more than two years ago and developed the Gauntlet, which helps entrepreneurs understand how investors think and what they need to do with their business to prepare it for investment.

Some sectors suffer

The report also unearths a sector gap, clearly reflected in the number of companies receiving investments in each industry sector, as well as the total capital the sector receives.

With little surprise, the traditionally strong information technology sector clearly leads, with 487 companies receiving 2.02bn between them - 34% of all venture capital funds invested.

This leaves other, traditionally vibrant UK industries well behind, notably communications, which saw 190 companies receive just 902m (15.2%).

The crime here is that by focusing on a problem that doesn't exist, it obscures our attention from the problems that small businesses do face.

In this country, if you are in new media or software, for example, you are far less likely to receive funding than if you are in semiconductors or biotech.

This is especially unfortunate, given that the UK has an historic and continuing strength in the creative industries and we are on the verge of an historic convergence of creative and technical industries.

We believe that we are focusing on the wrong problem. UK programmes have been created to the benefit of the very few, while sectors such as new media, where we could have an advantage, are left to languish.

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