THE FUTURE OF GROWTH REPORT

WITH SUPPORT FROM , INDUSTRY AND THE BUSINESS ACTION COUNCIL

AUGUST 2020 THE FUTURE OF GROWTH CAPITAL REPORT

THE FUTURE OF GROWTH CAPITAL REPORT

Deloitte Innovate Finance ScaleUp Institute CONTENTS Deloitte is a leading global provider Innovate Finance is the independent The ScaleUp Institute is a private of audit and assurance, consulting, industry body that represents sector-led, not-for-profit organisation financial advisory, risk advisory, and advances the global FinTech focused on collaborating with policy tax, and related services. With community in the UK. Our mission makers, corporates, finance players, more than 150 years of hard work is to accelerate the UK’s leading educators and government at a local and commitment to making a real role in the financial services sector and national level. 03 Foreword difference, our organisation has grown by directly supporting the next 06 Executive Summary in scale and diversity - approximately generation of technology-led Our mission is to help the UK to 10 1. And Growth Finance Landscape 286,000 people in 150 countries and innovators. become the best place in the world 19 2. The Market Failures territories, providing these services to grow a business as well as start one, 22 3. The Gap Explained - yet our shared culture remains the Innovate Finance’s membership ranges and enable our existing high-growth 23 3.1 The Structural Growth Capital Gap Pre-Covid-19 same. Our organisation serves four from seed stage startups and global businesses to scale up even further. 27 3.2 The Cyclical Growth capital gap due to the Covid-19 crisis out of five Fortune Global 500® financial institutions to investors, 30 3.3 New challenges and opportunities going forward companies. professional services firms, and global Scaleup businesses are defined as 34 3.4 Scaling the economic significance of the Growth Capital Gap FinTech hubs. By bringing together companies which have increased 36 4. International Learnings and connecting the most forward- their turnover and/or employee 40 5. Recommendations In Depth thinking participants in financial numbers annually by more than 20 47 Next Steps services, Innovate Finance is helping per cent over a three-­year period. 48 Contributors to the report create a global financial services Nationally, the latest 2018 data from sector that is more transparent, more ONS showed that there are 33,860 of sustainable and more inclusive. these businesses generating more than £1 trillion to the UK economy. The national number of scaleup companies has increased by more than one-­third over the last five years. In parallel, we have a generation of scaling businesses who are growing at greater than five percent whose scaleup potential must be encouraged and fostered.

Our thanks to our partners, supporters and contributors to this document.

Publication date: August 2020 Available online at: https://growthcapital.report

Data used in this report is taken from the IDBR datasets 2010-2017. The confidentiality of all data held on the IDBR is protected by the National Statistics Code of Practice and associated Protocols and by specific legislation. In accordance with these requirements, data presented is rounded to prevent disclosure. Differences may exist in totals across tables due to disclosure methods used. This work contains statistical data from ONS which is Crown Copyright.

The use of the ONS statistical data in this work does not imply the endorsement of the ONS in relation to the interpretation or analysis of the statistical data.

This work uses research datasets which may not exactly reproduce National Statistics aggregates.

Report designed and produced by ScaleUp Institute. THE FUTURE OF GROWTH CAPITAL REPORT

FOREWORD

CHARLOTTE CROSSWELL IRENE GRAHAM CEO, INNOVATE FINANCE CEO, SCALEUP INSTITUTE

The Growth Capital Gap is not a new issue. It predates the two most recent economic shocks we have faced in the 2008-9 recession and the COVID-19 pandemic.

Many will be familiar with the struggles faced by promising, scaling businesses - both the new and the established. We fast-growing companies seeking to access the capital they should build on what is already in place and expand or realign need to achieve their potential. In our own careers, which current efforts to help those same innovative businesses. It have focused on making finance better through innovation will require a coordinated effort to bring forward the changes I am very pleased by the focus that this report provides on the importance of the UK developing deeper pools of in financial services and ensuring this innovation flourishes we recommend, encompassed by a new national strategy, patient capital that really allow the providers of finance to“ grow with the businesses in which they are investing for the with the right backing, we have seen first-hand how the issue providing us with a blueprint for a growth legacy on which to long term. Now more than ever we must address this problem and get it right at a National and regional level. has persisted. It has held too many innovative businesses build. back from achieving their true potential, and stymied wider economic growth as a result. Furthermore, this strategy will enable us to accelerate Colin Mayer, Peter Moores Professor of Management Studies, University of Oxford Saïd Business School the unlocking of institutional and corporate funding for In May 2020, building on the work of our two institutions, those businesses and to build on a network of national we were asked to lead working groups, on behalf of the development banks, with strengthened reach into local Business Action Council and the Recapitalisation Project, communities, that puts the British Business Bank and British to look at finding strategic finance solutions in support of Patient Capital at its centre. We are also calling for an our entrepreneurs and their businesses in the medium to expansion of Innovate UK’s role and scale to deliver, along longer term, looking beyond the current crisis. We have since with a more heightened focus on R&D by reassessing our engaged our wide ranging ecosystem of investors, banks, deployment of the OECD’s Frascati Manual and the creation businesses, government and industry, who have a key interest of a ‘Future Opportunity Fund’, to support emerging and in ensuring scale-up companies can rely on a redefined socially inclusive areas of our economy. infrastructure for accessing growth capital. As we look forward to the Comprehensive Spending Review, As the ScaleUp Institute has evidenced these businesses we hope this report can provide insight to policy makers on are an important part of our economic makeup for many reasons. They are innovative, diverse and productive. They the current challenges and an outline of the opportunities create high quality jobs, they are internationally focused and for collaboration between the private and public sectors on they span an array of sectors. Providing them with access the way forward. to growth capital would accelerate a bigger ecosystem of We are truly grateful to everyone who has given their scale-up companies, creating more jobs, and more economic thoughts, insights and expertise to aid our research. Our growth across the UK. We must seize the huge opportunity thanks go in particular to the excellent team at Deloitte, that the UK can gain by backing these companies. led by Richard Kibble, for the resource, contribution and Today’s challenge of fuelling a sustainable economic collaboration upon it. recovery, and with a new relationship with the EU on the We look forward to progressing the recommendations with horizon, means it is now the time to make bold moves to government and private sector stakeholders. We see this invest in tomorrow’s successful businesses through greater report as a tool and a convening point to support the desire collaboration between the public and private sector. across industry and government to - together - build back ‘The Future of Growth Capital’ report lays out a plan for better with a robust, national blueprint for growth. The how the UK can respond to Covid-19 and better back its private sector across finance and industry stands ready.

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For decades the UK has sought, bit by bit, to move the includes demand-side constraints, limiting the awareness, dial in addressing the structural growth capital gap. It is sophistication and willingness of management to the use now imperative for us to be bold and make the quantum of external capital to drive growth. The result is that the leap needed to ‘bounce back’ and address - in this new UK economy is not benefiting from the dynamic growth decade - the significant opportunity that innovative that scaling companies can deliver across many sectors scaling businesses represent for the UK and lay to rest the and regions. Layered on top of this, we now have the unresolved challenges these companies face when they additional cyclical challenge presented by Covid-19, which EXECUTIVE SUMMARY seek to grow. means we face the risk of significant, long-term impact and going even further backwards in the OECD scaleup The importance of small and medium sized businesses to rankings. the health of the UK economy and its citizens’ prosperity is well-known, however SMEs are not homogenous. Based upon contemporary analysis, and wider assessment Within this large grouping of small businesses there exists of historical reports, we estimate the UK long-term a rich and diverse collection of fast-growing, productive and innovative enterprises. These scaleup companies Structural gap to be equal £5 billion - £10 billion every have great potential to expand rapidly, to create new year. Whilst not a new problem it is one we have taken products and solutions, to create new jobs, and to improve a relatively gradual, incremental approach to addressing livelihoods. Across multiple years, they have consistently rather than the definitive bold step it requires. The current emphasised the importance of addressing barriers in access crisis has significantly impacted this sub-scale growth to talent, leadership, markets, finance and infrastructure ecosystem and has exacerbated the gap which has been to help them on their journey. Across the first half of effectively doubled by the impact of Covid-19. 2020 it is notable that the concern about accessing the right finance to fuel their growth has risen sharply in The pandemic, combined with the global uncertainty, has importance, with double the number of scaleups seeking created a multiplier effect resulting in a £15bn yearly gap, finance in 2020 compared to 2019. which needs urgent action to address if we are to achieve our immediate recovery and long-term economic goals. The ability of the UK to enable businesses to start up and We need to double down across the public and private scale - and our scaling companies to scale even further sector and ‘level up’ across regions, localities and sectors. Access to appropriate Growth Capital is the fuel to maintain a vibrant, innovative economy. It is - is being stifled by an ever-widening gap between the Through creating a strong, regional infrastructure that is capital they need to grow and the capital available to based on a national framework that is geared towards one of the key foundations to building world beating global companies and a dynamic economy them. Scaleup businesses - those that are growing at that in every locality seizes opportunities and fosters jobs and sustainable growth for the long- growth, we believe that we can build back better, with greater than 20% in either turnover and/or employment an ecosystem that leverages what works, but draws upon each year - constitute a critical portion of the UK’s SME term. It is a key enabler of making the UK the best place to start and scale a business. other systems from around the world to provide the best population. Based upon ONS data 33,860 scaleup SMEs foundation for world beating UK companies. This approach alone represent £1 trillion to the UK economy. This is The Covid-19 crisis has placed unprecedented strain It is guided by the overriding principles of: can help to address both the supply-side and demand-side upon business and finance ecosystems around the world. 50% of all SME turnover. We know these companies are more productive and twice as likely to innovate, and have constraints that we identify in this report. Evidence shows There is a risk that this causes long-term scarring within • Build on what is in place: creating consistency and the drivers of local growth can be significantly addressed our economy through a lost generation of innovative confidence for the long term international businesses than their peers. For the purposes through access to high quality talent; cluster evolution businesses unable to access the right capital to scale of this report, we have looked at both Scaleup SMEs and in • Take short term, urgent actions: to accelerate and access to local growth capital: these are key factors to and go global, at a time where growth, domestically and some analysis both scaleups and those in the broader SME recovery from the crisis address for sustainable local recovery, exploiting growth abroad, is more crucial than ever. high potential growth population, who have already had an • Close key gaps: vis-à-vis best performing episode of growth and are on the pathway to future scale. opportunities. The current crisis has exacerbated our lack of capacity to international comparators provide Growth Capital funding. A long-term structural The growth gap issue should also not be seen purely issue for the UK, which has been recognised for decades • Public/private sector partnership: addressing the gap SIZING THE OPPORTUNITY: through a domestic lens. UK scaleups do not have the and arises from the interaction of both demand-side and is a joint endeavour with the private sector, which THE GAP IN GROWTH AND benefit of the targeted support that many of the UK’s supply-side constraints, has shown its fault lines in this the Government can catalyse international peers have developed. Countries surpassing current crisis. This has compounded regional disparities, • Prioritise re-levelling: address long term regional INNOVATION CAPITAL HAS the UK in scaleup growth have a much stronger federated sector fragilities, diversity challenges and weakness in the requirements and empowered local governance coupled often with depth and variety of capital pools. Closing this gap will DOUBLED SINCE COVID-19 regional development banks and /or sovereign wealth generate future growth and returns to the UK economy • Fix the demand side: close the information funds with in the US case greater pools of venture . as a whole, as well as boosting regional economies, asymmetry that limits demand for capital from high The Growth Gap is not static but represents a ‘flow’ on productivity, innovation and internationalism. growth firms an annual basis; unrealised opportunities within one year In addition they have a more liberal interpretation of the become unavailable in the next. Frascati Manual. This report explores the size of the Gap, the size of the Now is the time to make the quantum leap to ‘build Opportunity and the Solutions to address these. The Gap has arisen from long-term, not yet tackled, As the UK economy stutters in the wake of Covid-19, this is back better’, to seize the opportunities and lay to rest structural issues. This includes a deficit of institutional the moment to address the growth and innovation capital unresolved challenges. patient funds flowing into this market segment, gap with long-term policy solutions that can be practically information asymmetries and regional imbalances. It also implemented.

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RECOMMENDATIONS solutions at a commercially viable scale as scale will be vital for success. We accept that there is no silver bullet. No single policy or Expand the role and scale of Innovate UK - and regulatory change that can resolve what was already a complex, 4. its direct deployment of innovation and R&D long-running issue, now compounded by the extraordinary hit investment capital (via grants and loans) through the economy has taken due to Coronavirus. their Investor Partnership Model, to our most The £15bn growth capital gap is powerfully “ innovative, early stage and scaling businesses. That is why in this report we make five connected, though revealed in this report. It highlights the inadequacy of UK growth capital flows compared to other Expand Innovate UK’s high growth regional distinct recommendations that aim to close the gap for the countries and the rapid deterioration, due to Covid-19, of a long-standing market failure – one that is on relationship management infrastructure and long-term assessed through a lens of Accelerate, Expand, Align course to have a devastating impact on future growth, innovation and job creation. global innovation network, along with the critical and Create. They are: partnership opportunities it brings to our scaleups The 40 percent retraction in equity investment at the same time as a 43 percent increase in demand in collaborating with Government, corporates and puts in plain sight a deeply concerning trend. Urgent, practical action is needed. Key to unlocking this, as Universities. This should include expansion of the Create a ‘National Blueprint for Growth’ - that 1. role and use of SBRI, including its ability to drive the report asserts, is to create confidence for the long term by scaling up the investment vehicles that delivers a strategic joined up approach to support procurement with scaling firms and Government as already exist. There is a significant opportunity for collective growth if this widening gap is fixed, but and champion more consistent and effective growth an anchor ‘first’ client, strengthening the Catapult only if action is taken once and for all by major investors. across all regions and sectors of the economy. Centres to support regional clusters and further This should be through a tailored and segmented drive forward R&D investment via test beds and approach to scaling businesses that addresses Stephen Welton, Executive Chairman of BGF technology focused competitions. the UK’s scaleup systemic issues around talent, markets and infrastructure, with a core long-term Create a Future Opportunity Fund - A dedicated growth capital strategy tackling regulatory, legal and 5. Future Opportunity Fund should be developed to structural impediments in the short term. We must allow the UK to effectively engage with emerging also more effectively apply the Frascati Manual as we sectors and industries such as the carbon net- track our R&D expenditure to ensure we are applying zero challenge as well as drive forward on wider our institutional capabilities effectively. sustainable goals. This would be ‘purpose driven’ and have the right risk appetite to seed and Accelerate the unlocking of Institutional and 2. catalyse long term UK economic growth from Corporate Funding - through changes in legislation nascent and developing sectors and opportunities and organisation that crowds in the existing which are yet to emerge. This Fund would be significant private sector capital that can make designed to work actively with the overarching inroads into closing the Growth Gap. This should growth blueprint set out in Recommendation 1, entail developing an aggregator structure with and the broader enhancements described in wider relevant back office analytical and distribution Recommendations. It could sit as part of a number capability. Such a structure could be pursued by of existing bodies or be standalone and operate as transforming British Patient Capital into a joint- an entity with the dual role of not only supporting venture vehicle with the private sector. domestic companies but international opportunities

similar to a Sovereign Investment Fund. The Government would deploy further seed capital as necessary. Their role in this is to convene and We believe that the combination of these approaches will catalyse, with the private sector crowding in around “The UK has a broad universe of high-growth, scaling“ businesses and a diverse funding environment. finally solve what has been a long-running issue. We have great it. However, COVID-19 has highlighted the need for many of these businesses to have better access to a confidence in entrepreneurial UK businesses. Their ingenuity, broader source of funding options and, in particular, equity finance. We welcome the recommendations creativity and latent potential for fostering growth and Expand the scale and reach of our National set out in this report and look forward to working with the ScaleUp Institute, Government and 3. prosperity are considerable. We must give them the tools in the Development Banks - Expand and build upon the stakeholders across the finance community to develop further solutions to ensure the UK recovers from form of growth capital to unlock that potential. British Business Bank and continue the developments the pandemic and builds on the underlying strengths of the UK economy.” with Scottish Investment Bank, Development Bank of Wales and Invest NI to develop a network of STRUCTURE OF THIS DOCUMENT Marcus Stuttard, Head of UK Primary Markets & AIM at the Group ‘at scale’ National Development Banks. Further develop, through these entities, empowered regional This document provides a current assessment of the investor and devolved hubs with the ability to be agile business landscape (section 1). We then provide an assessment and deploy funding to sectors and opportunities of the market failures (section 2), both caused by the current at speed, through both national and bespoke Covid-19 crisis, as well as looking at the structural failures that regionally-designed schemes. Immediately enhance have become more pronounced because of the current crisis and expand existing schemes, such as the Angel Co- we face. This paper covers in some detail the growth funding Fund/ Regional Angel Programme, and gap (section 3) which cut across structural, regulatory and policy regional funds both to extend runways of existing barriers, regions, asset class constraints and market dislocation mechanisms and expand into areas not yet covered, and asymmetries. In the next section (section 4) we share e.g. West of England. The intent of this model is some comparative case studies of the types of instruments to combine local knowledge and insights with the that could also be implemented here in the UK. This is then British Business Bank’s expertise to deliver local followed by a set of recommendations (section 5). 8 9 THE FUTURE OF GROWTH CAPITAL REPORT

EIB and the European Commission has of the capital that has been pulled in the UK - the BBB’s Small business provided vital pools of capital and from other sectors such as leisure Equity Tracker 2020 shows that 1. INVESTOR AND GROWTH FINANCE LANDSCAPE research collaboration for life science and retail, which have been more London accounted for two thirds of businesses and other innovative impacted by the short-term scaling investment deals in the UK in sectors under the Horizon 2020 disruption. More established life 2019. This represents an increase since and COSME programmes. It is also science companies, especially 2018 of 37% (£1.5bn) in London, while The Covid-19 pandemic has placed severe pressure upon existing fault lines in the UK investor important to emphasise the wider those with Covid-19 products in the rest of the UK only increased by ecosystem. As liquidity and wealth capacity tightens in line with global market impacts, this is funding from structural funds such as development, have attracted record 6% (£160m). London also received causing an acute gap of investor engagement in innovating pre-revenue and R&D intensive firms ERDF, which provide funding to more sums of public and private capital, £51.5m of investment per 10,000 here in the UK. than 1 in 3 growth focused business which will fuel continued growth. SMEs and £213m per 100 High Growth support programmes at a local level. However, seed and early-stage Business in comparison with £6.1m and As matters evolve and the UK investment has been £28.4m in the rest of the UK. As our The nature of the current uncertainty that we face, and down across the year. Where capacity does exist in these relationship with the EU is clarified hit hard, with data published by analysis on business demand and in the disruption it continues to cause to both consumer asset classes, evidence suggests it will likely go to existing at the end of this year, the impact of the Bio Industry Association (BIA) chapter 2 shows this regional gap is demand and behaviour, is disrupting capital flows across portfolio firms to provide support through the crisis. changes for UK innovative businesses showing seed funding dropped from only set to widen. all asset classes. Stock market volatility - which is also Given some of the existing structural challenges that will need to be factored in to wider £11m in Q1 to £2m in Q2, and series A impacting valuations - is impacting upon liquidity and risk the UK faces both in terms of regional connectivity and growth capital considerations. The investment was down from £49m to appetite. investor knowledge and access to smaller growth firms, this INVESTMENT Government has noted that (R&D £9m. Compared to the same period pressure is falling in particular earlier stage scaling firms. It Roadmap) which is welcomed - last year, seed funding dropped from INSTRUMENTS Whilst there is some evidence of ongoing international is also falling upon smaller quoted companies that may be and this will also need to be taken £11m in Q2 2019 to £2m in Q2 2020, investment activity to UK companies, this international more dependent on individual shareholders both for daily account of in the Shared Prosperity and series A investments were down The importance of the Enterprise investment has primarily flowed towards specific sectors liquidity and further capital. Fund. from £79m to £9m. Investment Scheme (EIS) and Venture and more established companies. Wider instability may Capital Trusts (VCTs) are consistently also alter this picture further across Q3 and Q4 of 2020. Whilst there is investment activity being undertaken, As we look beyond Europe, The social business sector represents noted by many scaleups as a The importance of the international picture is illustrated wider data suggests that the capacity and risk appetite of international investment patterns an increasingly important sector cornerstone of early stage growth well in analysis by the British Business Bank (BBB) which existing pools of UK patient capital is also being stretched, into the UK are fragmented and of the UK economy and it is one capital and follow on funding. As notes that UK companies seeking larger rounds of equity with the majority of active investors during 2020 having fragile. Whilst in certain sectors, of the fastest growing investment seen in the ScaleUp Institute 2019 finance tend to be reliant on overseas investors to provide some form of Government backing whether tax incentive, such as technology-led businesses, opportunities. However it is also a Annual Business Survey, for those this capital, which could be a result of UK VC fund size co-investment models or development bank entities. investment may be holding up as sector in which access to finance was using equity we see that the majority lagging behind US VC funds1. noted in the Tech Nation June tech already seen as a greater challenge is from angel and VC investors. EUROPE AND THE INTERNATIONAL ecosystem update, other indicators before the Covid-19 crisis. The social Notably, approximately 80% of total Further, the global nature of the market volatility means suggest a potential decline of investment market is currently investment in angels’ investment that impacts and constraints are being felt by high net PERSPECTIVE international interest. This could be estimated to be worth approximately portfolios were made through these worth (HNW) individuals and larger investors alike. With exacerbated as a ‘second wave’ of £3.5 billion and has been growing at schemes in 20152 and the British exits dampened in the current climate, VC capacity is also Analysis from the British Business Bank shows that Covid-19 develops and stock markets around 17% per annum. The effects Business Bank’s Angel Market research challenged as is the capacity of existing Angel networks. significant amounts of regional equity funds are backed by remain volatile. of Covid and the UK’s exit from the report of 2018 revealed that 86% of EU money: the largest single investor class in the UK from European Union are yet to be seen total investment in angel investment As we emphasise in more detail in Section 3 of this report, 2010 - February 2019 was the European Investment Fund however, in order for this market to portfolios were made through these the Angel community has already estimated a gap of £200 (EIF) (23%). It is important that money has been identified SECTOR INVESTMENT reach its full potential all members of schemes in 2017 and the most recent million in unmet investment demand emerging during to fill any potential EIF shortfalls here for 2018/2021. The PERSPECTIVE the investment community, including Angel Market research report of 2019 the first two quarters of 2020. UKBAA’s poll of its own EIF has been an important provider of growth capital in the traditional players, must think reveals that 87% of angel investors members has shown that there has been a strong challenge the UK market and any gaps created by its absence will Whilst the majority of sectors are in harder about how to reach out more seek to use the tax reliefs not for tax to the angel market with a 45% decrease in the level of need ongoing assessment to ensure the finance ecosystem obtaining investment in the first half effectively to social scaleups and to advantage planning, but to mitigate angel investment compared with pre-Covid-19. There are is able to meet the needs of businesses with scaleup of 2020, across the board it is lower enable greater levels of investment. their risks when investing in small also indications that the number of new VCT deals is ambitions. Additionally, the joint initiative between the than in 2019 and acute in certain The impact investing landscape is early stage businesses and enabling growth industries such as the creative further discussed in an insight on them to invest more of their income sector. However, even in those page 17. on early stage innovators. The UK has a strong track record of finding ways to innovate in finance in order to deliver positive outcomes for sectors that have been very relevant people and planet alongside financial returns. This“ is increasingly what people expect to happen with their savings, to the Covid-19 response investment REGIONAL DISPARITY Continuous changes to EIS, the Seed pension and investments. There had never been a more urgent need for solutions that will release the full potential has been mixed. For example, in life Enterprise Investment Scheme (SEIS) sciences, the counter-cyclical nature and VCTs due to the constraints of untapped skills, entrepreneurialism and energy across the . Impact investing is a vital part of the Regional disparities across the UK answer, and is ready to play a key role in filling the growth capital gap. of the sector and biomedical interest imposed by State Aid rules creates of the pandemic has attracted some persist and London continues to be confusion and can increase the cost the focal point for equity finance Dame Elizabeth Corley, Board Chair, Impact Investing Institute

10 2 ERC (2015). A Nation of Angels. Assessing the impact of angel investing across the UK. https://www.enterpriseresearch.ac.uk/wp-content/ 11 1 British Business Bank Analysis of VC Financial Returns, October 2019 uploads/2015/01/ERC-Angels-Report..pdf THE FUTURE OF GROWTH CAPITAL REPORT

of implementation. At this time of For instance: acquisition of an older firm may More broadly, the ScaleUp Index EXPORTS AND R&D close to £1trn in capital. If invested political, EU and global economic • It is often assumed that also be deterred from doing so 2019 shows that equity investment into UK enterprises and scaling going into a company is more likely to businesses, the effect could be uncertainty, it is ever more important innovation and growth comes as they will lose tax benefits, It is also vital to recognise that in the facilitate continued scale up growth, enormous. to maintain business and investor only from young companies. causing them to delay or avoid first half of 2020 there remains clear and recent research has shown equity confidence by keeping key policy However, the 2019 ScaleUp growth. Artificial time limits also evidence of ongoing innovation, to be a significant driver of growth at Bold action to ensure that the measures stable and addressing the Index shows that many high- create a risk that businesses that research and development growth a local level, whereas access to debt investors are enabled through implications of State Aid Rules. Of growth and innovative firms are reach scale are sold prematurely activity across UK scaleups. As those using equity, 63% of scaleups does not have this same effect. regulation and appropriate much older than the seven year at exactly the point that highlighted on page 28, amongst Expanding the diversity of UK growth institutional structures, will help utilise angel funding. time horizon currently applied. scaling companies, Research and they are making the greatest funding options is important. Whilst to crowd in private sector money, Family firms or other firms Development, followed by Job contribution to employment traditional debt does not have a clear providing appropriate growth capital It is also important to note that many where a change in management Creation are the top two reasons and GDP. Addressing this gap correlation with high levels of growth, to innovative companies, as well as of these proven routes to finance are has occurred, and may spur for investment taking place by both also not able to provide capital to in UK based long-term patient the success of the Future Fund shows establishing a well curated, regionally growth, lose out under current volume and amount - although the capital that can ‘follow on’ is the importance of more flexible debt responsive ecosystem that can companies that are looking to grow, scale of these is down in 2020. Export rules. therefore also an imperative options such as Venture Debt. As an provide direct economic dividends and may be unable to source capital also remains a goal of the majority asset class this can bridge demand over the longer term. from elsewhere, because of the • Younger firms that may have to maintaining UK Intellectual of scaling businesses, if in some side challenges associated with equity, restrictions placed upon them. the opportunity to make an Property. sectors dampened as a result of the but provide a more manageable To address these ongoing investor Covid-19 crisis. To ensure we galvanise growth option for a business than constraints, for speed and efficiency further R&D investment and export Figure 1: Factors and their role in scaleup density growth 2013-2018 traditional debt. However, this is of execution, taking the ingredients opportunity as part of our overall currently an under-utilised asset class we have today in our financial Blueprint for Growth we should RELATIONSHIP WITH with less Venture Debt offerings in the infrastructures across the public and take the opportunity to review the FACTOR DESCRIPTION SCALEUP DENSITY UK compared to the US3, indicating private sector and, in partnership, GROWTH 2013-2018 UK adoption of the Frascati Manual; scope for increased additional dialling up their scale and reach, at a Proportion of 16-24 year olds with Level 4+ consider bringing forward R&D credits opportunities in the UK market local level would deliver the fastest qualifications. This comes from the most recent for a temporary period and ensure the SKILLS Census data (20110 and provides an appropriate Positive particularly for fast growing, pre-profit and most impactful results. This UKEF suite of services are expanded lag between the time that young people acquire and/or pre-revenue firms scaling approach also has the advantage for risk coverage and company reach. skills and when they enter the workforce. at the 5 to 20 percent per year rate. of building on the entities that The GEF is a welcome development There is appetite for this funding investors and businesses are familiar SECTORAL Proportion of companies from the most but needs effective deployment concentrated sector in a given Local Authority Positive up to from business, as seen with Barclays with, including leveraging existing CLUSTERING across multiples of businesses. There District (LAD), obtained using ONS IDBR data. saturation level Venture debt, backed by EU monies, resource pools. The importance of is also a potential case for UKEF to and Silicon Valley Bank who recognise optimising the scale of current proven align into the BBB, as in other markets, this gap. However, there are few providers cannot be underestimated. Visible SME equity funding per 100k population such as Germany, where the exports in 2013-2014, providing an appropriate period of players currently providing such International learnings show that it services sit under KfW. EQUITY time for funded SMEs to become scaleups. This Positive funding and awareness remains low. In is the long-term arm’s length nature data was obtained from Beauhurst’s high growth addition EU funding that supported of public entities such as KfW and company database. GROWTH BLUEPRINT SME lending per 100k population in 2013-2014, by some of these players is now SBA that has driven consistent and providing an appropriate period of time for stifled and needs replenishment sustainable impact as well as scaled LENDING No clear relationship funded SMEs to become scaleups. This was through alternative UK sources. This all points to the importance of interventions. Giving UK institutions obtained using UK Finance data. Consideration should be given to addressing the UK’s long standing sufficient runway and arm’s length using the Future Fund as a basis for patient capital gap as part of a empowerment with permanency greater expansion of UK Venture Debt comprehensive Growth policy and flexibility at a regional level Proportion of firms with 250+ employees in a No clear relationship LARGE FIRMS given LAD. This was obtained using ONS IDBR options that can operate at scale, with blueprint to prevent economic under clear national frameworks will data. greater founder and co-investor reach. scarring from Covid-19. Whilst there generate enhanced results and put are clear investment challenges us on a footing to our international Start-ups per 100k population in 2012. This time More broadly, greater transparency exacerbated by the crisis, solving long competitors. START-UP lag is necessary to give start-ups a suitable DENSITY No clear relationship around the potential returns available standing structural issues will unlock amount of time to become scaleups. This was from investing in UK VC could help previously untapped routes to growth. In the last decade we have developed obtained using ONS IDBR data. unlock more institutional investment a good basis upon which to build in the asset class, which could allow If we are to make significant and and we now need to accelerate their UK VC funds to increase in scale and meaningful progress, renewed efforts execution capacity at pace both in START-UP Proportion of start-ups from 2012 surviving after No clear relationship SURVIVAL RATE 5 years. This was obtained using ONS IDBR data. better meet the funding needs of by government and regulators to reach, and scale for the long-term. UK high-growth companies as they tackle the area of regulation identified . scaleup. by the Patient Capital Review’s • The British Business Bank and Pensions Taskforce must be made a Innovate UK have proven PUBLIC Time to get key services using public transport No clear relationship priority. By 2025, defined contribution multiplier effects. For example, TRANSPORT (England only data), obtained using Gov.uk data. pension schemes will have become in the last year, Innovate UK’s one of Britain’s largest reserves – with grant schemes enabled 642 scaling companies to realise their growth trajectory, unlocking an 12 Source: ONS IDBR 2010-2018, Beauhurst high-growth company database 13 3 British Business Bank Analysis of VC Returns, October 2019 (p35) THE FUTURE OF GROWTH CAPITAL REPORT

additional £3bn in private capital on top of the £205m demonstrate resilience - and a desire to grow and innovate. Figure 2: Future appitite for finance of grants provided. Whilst BBB in 2018/19 generated In June 2020, the innovation focus of our scaling businesses a 3.6 per cent adjusted return on capital employed4 in their products, services and business models, continued to to Government in its investments, scaling up these rise with 62% pivoting and evolving their business models, up 59 71 59 62 23 49 57 38 64 infrastructures and their work with the private sector from 53% at the beginning of the year. 56 51 48 50 23 56 63 44 58 55 46 59 61 is more efficient than standing up new entities that would drain time, resource and prove an unnecessary However, confidence is fragile, and we need to boost their distraction in such a critical period. aspirations by laying the right foundations for the recovery by taking bold steps in addressing their financing needs when • 2020 data already reflects some of the key players demand has risen across sectors and regions. 23 continuing to make scaleup investments (see Investor landscape) and they offer a starting point for those The June 2020 SUI SME ScaleUp Finance Monitor, based on 11 that can be a foundation to enhanced public/private 25 37 35 47 47 15 16 43 26 27 46 18 26 over 900 interviews with scaleup businesses, clearly highlights 11 sector partnerships in co-investment and potential 25 22 33 55 39 28 the ongoing regional and sector demand needs and from our joint venture vehicles that can be further leveraged/ analysis of Beauhurst data, the widening regional and sector co-invested through to operate at greater national and gaps in supply. regional scale. 19 11 17 3 30 29 21 13 17 18 8 23 13 31 5 19 5 22 12 16 40 26 The Government role in this should be to catalyse, convene, In all sectors demand is high and investment down but as England Scotland Wales Northern North/ Yorks/ NW West East Eastern SW London SE Agriculture Construction Wholesale/ Hotels/ Transport Business Health/ Other set the strategic blueprint and inject a modicum of capital detailed later in the report particularly acute in certain areas Ireland NE Humber Mids Mids Retail Restnts Activities, inc Social Work Community, to crowd in the private sector who are ready to step up in Real Estate Social & Personal such as creative, retail, and leisure. UK Nations English Regions addressing these long-term challenges. Service Activities Would be Seekers Plans to apply Happy non seekers Would be Seekers Plans to apply Happy non seekers EXPORT AND SUPPLY CHAIN DEMANDS Source: SUI/SME Finance Monitor BUSINESS LANDSCAPE AND DEMAND 10000 DYNAMICS Scaling businesses are strong exporters with aspirations to Figure 3: Future appitite for finance do more. As Covid-19 has hit these ambitions remain, but NET: Would be Seekers Have plans to borrow / renew Happy non seekers Having the right access to growth capital is a key pillar to confidence has been dampened due to concerns about 8000 scaling up a business. However, UK scaleups have consistently supply chains and prompt payment, reflecting the uncertainty pointed to the problems of finding56 the right51 growth48 finance50 23 56 63 44 58 55 46 59 61 59 71 59 62 23 49 57 38 64 of buyers behaviours. Potential for their needs. 6000

Data from the SUI Annual ScaleUp Business Survey has shown INFORMATION ASYMMETRY - Actual 2019 access to growth capital, across successive years, to be one of KNOWLEDGE AND DEMAND 4000 the top five challenges for scaling businesses, who particularly 23 wish to see easier access to locally rooted, patient funding. Whilst scaling businesses are much higher users of equity and finance than their SME counterparts, reservations about the 11 This is further corroborated in data25 from scaling37 businesses35 47 47 15 16 43 26 27 46 18 26 2000 use of equity finance do persist. There remains perceptions 11 responding to the SME Finance Monitor, which has equally of complexity and/or unsuitability and fears of having to “give 25 22 33 55 39 28 reflected that, across multiple years, scaleups perceive that up control” - all are still cited as reasons for not progressing they do not have all of the right finance for their future 0 such a finance option. growth and are uncertain of where to access the right forms East East of London North North Northern Scotland South South Wales West Yorkshire 19 11 17 30 31 5 19 5 22 12 16 40 26 of growth capital. Yet we also know from longitudinal data 3 29 21 13 17 18 8 23 13 Midlands England East West Ireland East West Midlands Increasing the provision of education about growth capital that access to growth capital at a local level is a key driver to England Scotland Wales Northern North/and myth-bustingYorks/ NWcommonWest misconceptionsEast Eastern is vital inSW order London SE Agriculture Manufacturing Construction Wholesale/ Hotels/ Transport Business Health/ Other a greater density of scaleups. Ireland NE Humber Mids Mids Retail Restnts Activities, inc Social Work Community, to ensure that scaleup leaders are fully aware of all the Real Estate Social & Personal UK Nations English Regions available finance options as they make choices about their Service Activities At the same time since the onset of the pandemic the latest Would be Seekersgrowth. FinancialPlans providers to apply working more closelyHappy withnon seekers local Would be Seekers Plans to apply Happy non seekers SUI/ SME Finance Monitor June 2020 data shows a significant communities are necessary in order to provide tailored increase in appetite for finance, with those planning to apply Source: SUI/SME Finance Monitor solutions for scaleups where they are based. doubling since start of the year (from10000 14% to 27% in June 2020) and only one third (33%) of scaleups now meeting the In recent work that the ScaleUp Institute has conducted definition of being a “permanent non-borrower”, down from with UKBAA and the British Business Bank network teams in NET: Would be Seekers Have plans to borrow / renew Happy non seekers almost half in 2019 (48%). 8000 The Growth Capital report gets to the very heart of the problem facing early stage and scaleup businesses in the UK regional roundtables, the following information asymmetry in the face of the coronavirus pandemic, namely the“ chronic lack of equity funding available to such businesses across themes have consistently been raised as needing resolution. These scaling businesses, who are our most productive, Potential all of the UK, but particularly in the region. The report zeroes in on why equity funding is so important and sets out a innovative and international SMEs, also continue to 6000 These issues and opportunities, highlighted below, can be coherent plan for expanding existing schemes alongside new, innovative funding ideas to help UK scaleups realise their addressed as part of a National Blueprint for Growth. Actual 2019 ambitions and deliver desperately needed growth to the UK economy.

4000 Mark Brownridge, Director General, EISA

14 4 https://www.british-business-bank.co.uk/supporting-over-89000-businesses-with-6-6bn-of-finance-an-increase-of-27-over-the-year/ 15 2000

0 East East of London North North Northern Scotland South South Wales West Yorkshire Midlands England East West Ireland East West Midlands THE FUTURE OF GROWTH CAPITAL REPORT

Better use of Data Referrals for businesses seeking growth results in Scotland, Denmark, Innovate capital - including follow on funding - is UK’s EEN, and the ScaleUp Directors IMPACT INVESTING - Insight Data remains fundamental to ensure currently very fragmented and often programme, which should continue to based upon informal networks. The be built upon, including the evolving investors and ecosystems at a national Prof Colin Mayer and the British Academy recently stated Social scaleups cite talent and skills alongside access to referral mechanism under the auspices relationship management approach in and regional level can engage on a that “the purpose of business should be to profitably markets as their principal issues. This is consistent with of the Small Business Act is appropriate LEPs and Growth Hubs. This relationship timely basis with companies that solve the problems of people and planet.” the views of the wider scaleup community. They also for debt. The finance sector in local management structure should be have the potential to scale and make highly value access to peer networks, local solutions and areas should consider what can be underpinned by strong CRM systems sure that our scaling businesses get A recent study conducted by the ScaleUp Institute and mentoring. further achieved for referrals between to enable better connectivity and the right support at the right time to Barclays focused on the challenges faced by scaleups in growth capital funders that is more customer cross referral. foster their continued growth. There the social business sector5. Notably, however, access to finance is seen to be a greater systemised. Developing a more is a need for the public and private challenge to social scaleups than for their fast growing streamlined approach in local areas sector to better harness data to Networks need extending and The social business sector is still developing but it peers in other sectors of the economy. would help to save companies time ensure better targeting of activities coordinating represents an increasingly important sector of the UK and effort and underpin wider work to and interventions. Open Banking can economy and it is one of the fastest growing investment While there has been growth in the scale and visibility improve ecosystem connectivity. Effort help in this regard as well as continuing Scaleup leaders acknowledge that opportunities. As the overall number of social businesses of the UK’s impact investing sector (see the Spectrum needs to be made in ensuring finance work in Government to harness HMRC advisers are generally well networked increases, so will the number of social scaleups. of Capital below), there is a clear need to ensure that networks; workshops; investment data, to identify and proactively engage but not necessarily aware of all Approximately 22% of all SMEs are socially oriented which the leaders of social scaleups can access finance and reaches all areas of a community and with scaling businesses, to fast track initiatives. Currently many business places the number of social scaleups in the region of understand the available options. A majority of social locality - city connectivity does not them to relevant solutions. As part of connections are informal and 8,000 businesses. Several factors have contributed to the scaleup businesses (62%) say they do not have the right mean regional connectivity. a Growth blueprint and renewed Data fragmented; business support providers growth of the social business sector including the Social amount of finance in place. In addition, significantly, social

Strategy the work the Government has need to identify these informal Value Act, which has added social impact considerations businesses are more likely to cite access to bank finance The British Business Bank’s Finance Hub underway in the DECA project should networks to make sure they have to public sector procurement procedures, and the and equity finance as vital/very important barriers to can play an important role here as can continue and Government should the right information on the finance establishment of new entities like Big Society Capital and growth (57% of social businesses, versus 43% across all learnings from the Future Fund which continue to assess future the ability to available to scaleups. Professional the Inclusive Economy Unit within DCMS. survey respondents, and 38% versus 24% respectively). has had much better reach into diverse further open up data channels via APIs service providers, such as legal and Given that only 26% of social businesses use equity geographies and founders than other to better link businesses to effective accountancy practices, and frontline Given the impact of social businesses, it is vital that finance currently, there is an opportunity to better serve financial providers. growth capital solutions. staff in high street banks have a key we understand the needs of social scaleups to support businesses that plan to use it in the near future (5%), don’t

role to play and need to also be up them to flourish and achieve the greatest possible know where to start in the process (9%) or don’t know Learnings should also be drawn from Building awareness across to date and connected to the wider impact especially in the context of recovery from social, enough about this type of finance (20%). the Basket Bond launched by ELITE the Advisory and Business finance options available to be able to economic and health crises, such as Covid-19. (part of LSEG/Borsa Italiana) in Italy. community share information with their clients. There is also the opportunity to expand 6 Effective advice needs tailoring, the role of peer to peer networks in The Spectrum of Capital Creating better understanding among segmenting and relationship tandem with the private sector and the the local business population and Government’s recent announcements in providing the right services at the right focus this area are welcomed. time is vital to ensure that growth can be encouraged. Physical Hubs Scaleups appreciate a relationship with structured briefings and Investor approach to finance and often a neutral Open up connections to non- Enablers such as those in and environment where they can go for executive directors in some LEPS/Growth Hubs, as well initial conversations about available as online resources can play a greater funds. Upskilling local ecosystem In many areas of the country scaleups role. The British Business Bank’s players is core to ensuring that the best are constrained by access to talent Finance Hub and Regional Network information is available, particularly with the right skills to help them is increasingly being recognised as an in relation to growth capital. More grow. NEDs and mentors can help to important source of impartial guidance, effort is needed to segment businesses provide expertise and guidance, as can playing an important role in breaking according to their growth life cycle temporary Finance Directors in place down knowledge barriers amongst and stage in the scaling journey. for a particular period of time with businesses and the wider ecosystem. Government should be adopting a a business. Better visibility of what These services should continue to be segmented and relationship driven and who are available and a trusted expanded upon as well as those of approach across all local and national source of information on quality is InnovateUK’s Enterprise Network and services. This will help address demand needed to unlock these resources for a Investor Partnership. barriers and information asymmetries greater number of businesses. Business stated above, and has the potential Schools can also play an important role Connectivity and referral to make significant inroads in enabling and provide resources to link scaleup systems need development - businesses to navigate interventions leaders with sources of expertise and and access the right service at the right ‘Coventry is not … should consider evolution of alumni time: simplifying the process, reducing Angel networks such as in Henley and Source: Bridges Fund Management and The Impact Management Project 2017 Oxford is not Oxfordshire’ friction and accelerating opportunities. Aston. Such an approach has had proven

16 5 https://www.scaleupinstitute.org.uk/reports/social-scaleups-high-growth-businesses-with-impact/ 17 6 https://www.bvca.co.uk/Our-Industry/Impact-Investment/What-Is-Impact-Investment THE FUTURE OF GROWTH CAPITAL REPORT

Analysis of the impact investment market conducted by However, challenges remain including: data issues which the ScaleUp Institute and Barclays in 2019 identified that limit our ability to identify scaleup social businesses and at least £446m of equity investment has gone into 226 to understand the full breadth of the impact investment distinct UK social businesses since 2015, with average deal market; concerns from traditional investors around return size doubling from £0.81m (2015) to £1.58m (2018). profiles; and, a lack of infrastructure which supports collaboration between the range of investors and 2. THE MARKET FAILURES The UK is rightly seen as pioneer in this sector, the social intermediaries involved - evidence shows the variety of investment market is estimated to be worth approximately different types of investors engaged with social businesses, £3.5 billion7 and has seen an annual growth rate of 17 per some with an impact focus9 and some with a more cent, however some forecasts have suggested that social general focus (including bodies such as Innovate UK and investment could grow at 38 per cent a year. The BVCA has Funding London). The withdrawal of EIF funding from the identified a range of factors behind this rapid growth in the UK will also present challenges for impact funds, with sector8: indicative research in the sector shared with the authors of this report suggesting that fundraising has already been • The growing awareness that responsible business affected. behaviour and strong Environmental, Social and Governance (ESG) practices can not only reduce harm It is both a challenge and an opportunity for the financial to people and the planet but also create value and community, including the traditional players, to think actively contribute to solutions to societal challenges harder about how to reach out more effectively to social scaleups and to enable greater levels of investment. • The emergence of the United Nations Sustainable Development Goals (UN SDGs) as a framework to raise It is why as part of our recommendations we highlight awareness of and address these societal challenges the creation of a Future Opportunity Fund to set aside The evidence described above on the latest investor and growth finance landscape points to • The rise of a new generation of entrepreneurs, many funding for businesses rapidly growing across the 5 % to both longstanding (structural) and crisis-related (cyclical) challenges in delivering growth capital of them based in the UK, who believe commercial 20% spectrum serving new and emerging sectors. This to scaleups. High growth firms face accumulated pressures from the Covid-19 crisis against business can play a part in helping to solve these Fund would also have a remit to foster strategic Green challenges at scale – increasing the availability of economy ‘carbon net zero’ and sustainable development a backdrop of substantial institutional change as we exit the EU. But there is also reason for investable opportunities goals and be capable of execution through co-investment optimism. The evolution of public infrastructure to support the flow of growth capital can be and guarantee models. The Government could ringfence • The emergence of a new wave of customers linked to recent improvements, in particular during 2019. such a Fund within existing infrastructures, such as Big (particularly among the millennial generation) who Society Capital, British Business Bank, Innovate UK, or as a believe their buying choices should align with their In this context, it is vital to be clear on the potential these market failures below, distinguishing between the standalone investment vehicle, as was previously in place personal values, and as such are keen to support causes of the gap in growth funding, and in particular, why structural issues that existed pre-Covid-19 and have been with the Green Investment Bank. ‘profit with purpose’ businesses – creating a sizeable available capital is not reaching scaleup firms even though further exacerbated by the crisis, and the cyclical issues market opportunity those investments offer potentially higher risk-adjusted that arisen due to the Covid-19 crisis. These market failures returns to investors. These potential causes therefore then provide the basis for estimating the size of the gap (in • The growing body of evidence that by tapping into represent market failures, stopping the market from Section 3) and identifying the strategic solutions that are this market opportunity, impact investment can delivering funding to economic opportunities. We consider required to address them (in Section 4). achieve returns in line with (and sometimes in excess of) traditional investment.

It has been a privilege to contribute to this report. We“ need a step change in the flow of growth capital into UK businesses. To the well-known growth capital funding gap that has been around for as long as I can remember since working at ICFC in the 70s and 80s, there has now been added a further similar scale funding gap created by the pandemic and lockdown. Our challenge is to take the right steps immediately to fund businesses and protect It has never been more important to support the early“ stage, scale-up and high growth segments of the UK jobs but importantly to provide much more capital for investment, otherwise the UK economy will face a growing economy. The Growth Capital Report highlights the structural opportunities for strategic longer-term capital catastrophe and falter. Besides increasing the quantum of growth capital, there are three other critical factors: to support these ecosystems, as well as drive key aspects of the diversity and levelling-up agenda. speed – we need to act immediately to avoid more business failures and job losses as dries up; relax the rules – for a period, we should relax the rules that stifle rather than encourage investment, for example State Ben Davey, CEO, Barclays Ventures Aid; and greater financial support for the regions - building on the existing infrastructure to get funding to where it is needed fast.

I and my colleagues at Foresight look forward to playing our full part in funding the recovery and growth of UK business.

7 https://bigsocietycapital.com/latest/uk-social-investment-market-grows-by-30-in-one-year-now-worth-over-35-billion/ David Hughes, Chief Investment Officer, Foresight Group 8 https://www.bvca.co.uk/Our-Industry/Impact-Investment 18 9 Research by Beauhurst shows 29 social impact funds operating in the UK, however at present the scale of these investors is limited to small and earlier 19 stage investments. THE FUTURE OF GROWTH CAPITAL REPORT

STRUCTURAL MARKET FAILURES CYCLICAL MARKET FAILURES

The pre-Covid-19 gap in growth funding has been driven by longstanding structural market Past crises, such as the global financial crisis, have negatively impacted on the flow of growth failures, which have been exacerbated by the Covid-19 crisis. From the evidence presented in capital for a number of years beyond the economic recovery beginning, and again in this crisis this report, and our discussions with stakeholders and market participants, four key structural we observe a number of potential new cyclical challenges arising. Four cyclical market failures market failures have been identified. are set out below:

1. AN UNCOORDINATED APPROACH HAS CREATED the cost of capital being too high, deterring management 5. GROWTH CAPITAL FLOWS ARE NOT SUFFICIENTLY provided businesses with the liquidity that many require to REGULATORY AND POLICY BARRIERS WHICH IMPEDE and owners from using external capital sources. There exist RESILIENT AND FLEXIBLE THROUGH THIS CRISIS survive. There can be little doubt that this has been vital THE FLOW OF FUNDS considerable potential sources of finance, from pension for protecting the economy from the immediate negative Over the past ten years we have seen SME growth funds and corporate players, but successfully channelling impacts of the crisis. It has resulted in considerable The evolution of public infrastructure and various investment held back by the long-running impact of the those funds to fast-growing businesses can face many liquidity available to businesses, primarily through various initiatives has done much to support growth capital in Global Financial Crisis (GFC), then after a short period hurdles. Large institutional investors are not equipped with government supported lending schemes and grants. recent years, but the patchwork approach has resulted of recovery 2014-16 impacted by the decision, and the resources required to invest in small businesses, so in barriers to the flow of funds from different types of now, again after a short recovery, impacted by Covid-19. It is however also vital that this liquidity does not effective infrastructure (e.g., introduction of aggregators) is investors, ranging from pension funds, This has resulted in a volatile and uncertain environment, inadvertently crowd out investment to fast-growing required to support the channelling of funds. and angel investors. For example, VCTs can only invest in contributing significantly to the growth capital gap. The smaller companies. The rules around government support certain companies that are less than ten years old, and an 4. INFORMATION, COLLABORATION AND GFC saw a negative impact on the banking sector (not can penalise growth companies, for example, limiting array of requirements for pension funds limit their interest CONNECTIVITY ASYMMETRIES LIMITING THE USE as apparent in this crisis), but the Covid-19 crisis presents support to loss-making businesses, which may simply be in growth capital investments. Such regulatory barriers to OF EXTERNAL CAPITAL TO REALISE FULL GROWTH new challenges, for example, due to the restrictions on a reflection of a business being in a rapid growth phase. the flow funds represent a limitation on the effectiveness POTENTIAL social interactions and travel, which can create practical Government support may also tend to flow to existing of the market to deliver growth capital, particularly in the difficulties in dealing with investment needs. More businesses, which may prop-up uneconomic incumbents to Another longstanding challenge, explored in detail in context of the current crisis where the availability of funds specifically, the UK does not have deep pools of angel, VC the expense of new businesses with better opportunities. previous studies10, arises from the awareness, sophistication is restricted in general. or Venture Debt funds, or ‘follow on funds’, which means It is therefore vital that the needs of growth capital are and willingness of management to the use of external these challenges threaten the resilience and flexibility of carefully considered as part of the government response 2. LACK OF CAPACITY AND DEPTH IN THE REGIONS capital to drive growth. Studies identify challenges for capital flows that is required. Specific measures aimed at to the recovery. BEYOND LONDON AND THE SOUTH EAST TO SMEs, including a lack of resources and managerial systems, addressing these impacts on the resilience and flexibility of DELIVER GROWTH FUNDING the centrality of founders with a focus more on the 8. OVERSEAS INVESTMENT IS FRAGILE AND HIGHLY funding mechanisms are therefore required. customer and product than financing opportunities, and SECTOR SPECIFIC, SO MUST BE ADDRESSED The capacity of existing infrastructure to deliver funding a simple lack of experience of owners and managers in 6. INCREASED UNCERTAINTY AND REDUCED RISK ACCORDINGLY ACROSS THE UK GROWTH to scaling high-growth firms is often limited in terms of the use of external capital. External capital is expensive, TOLERANCE OF INVESTORS LIMITS INTEREST IN NEW LANDSCAPE scale and scope. This is driven by insufficient density of but a necessity for achieving scale. Addressing attitudes OPPORTUNITIES opportunities and funding pools, resulting in inefficiencies While the UK has made significant improvements in and information asymmetries is challenging, and a key and ultimately a high cost is overhead vs cost of The provision of long-term certainty to institutions, the flow of overseas investment before the crisis, this challenge for the various agencies that exist to foster capital. There are some success stories, such as with the individuals and companies that are looking to invest is key. success has been put at threat by the Covid-19 crisis, growth capital, including the BBB, IUK and BSC. Development Bank of Wales (Appendix B) and Northern One thing that the Covid-19 crisis has in common with bringing international travel largely to a halt and has largely Powerhouse, but much remains to be done. With the past crises is the negative impact on risk tolerance and depressed global trade and business interactions and importance of the levelling up agenda, ensuring inclusive longer-term certainty. We have seen investors channel enhanced stock market volatility. In such an environment, sustainable growth across the whole of the UK will be funds to help support existing businesses rather than foreign direct investment will be challenging. Once this vital. Forward-looking schemes must address diversity and take on new opportunities, which reflects this dynamic. crisis is over, these pressures should diminish, although regional disparities. It is a natural outcome of the market that an increase in there is a risk that longer-lasting damage may have been the rate of return required by investors, and a reduction caused, that needs to be addressed. 3. LACK OF SCALE AND DEPTH IN FOLLOW-ON Growing UK businesses don’t lack strategy, “ in the expected future returns of businesses, results in FUNDING DUE TO LIMITATIONS IN CURRENT RANGE ambition or talent, but even before the Covid-19 a reduction in the amount of investment. However, in OF FUNDING MECHANISMS crisis all too often, they were not getting the an environment of reduced risk tolerance, the impact of finance they need to take their business to the The UK has faced a longstanding challenge in delivering rigidities in market mechanisms are heightened and the the capital required by scaleup companies, in terms of cost next level. This report is a valuable contribution to need for flexibility and resilience increased. of deployment, reach and perceived return. Success in the debate about how to address the UK’s growth 7. GOVERNMENT SUPPORTED CRISIS LIQUIDITY funding start-ups has not translated into similar success in finance gap. We have an opportunity to make the SUPPORT (INADVERTENTLY) CROWDS OUT providing the larger amounts of funding required at later UK the best place in the world to start and grow GROWTH FUNDING stages of growth, resulting in limited access to capital, or a business as we build back better. By leveraging existing networks and frameworks, we can ensure The response of governments and central banks across businesses across every region and nation of the Europe and elsewhere has been striking, immediately UK can access the right funding to supercharge delivering a huge wave of support measures that have their business and power the recovery.

Rain Newton-Smith, Chief Economist, CBI

20 21 10 Said/Judge study, ‘Scale-up UK: Growing businesses, growing our economy’ THE FUTURE OF GROWTH CAPITAL REPORT

Figure 4: Key drivers and dimensions of the growth gap

Scotland: £0.6 bn Seed: £0.7bn Wales/NI: £0.2bn £ B Venture: £0.7bn Equity around SW: £0.5bn 3. THE GAP EXPLAINED Structural Broad range of £3.6 billion in comparison Key drivers gap SE: £1.3bn gaps across all sectors of the Scale up: £3.2bn with the US Pre-existing economy as NW: £2.0bn gap c.£5-10bn indicated by SUI per annum data Carbon net NE: £1.0bn Venture debt zero gap Established: and other asset Midlands/East: £3.0bn classes Diverse { £1.7bn Founders Impact Technology/IP: Angel: £0.2bn Investing £2.5bn VCTs: £0.3bn Brexit gap Cyclical Developing Business, Developing A range of pre-existing weaknesses have challenged the UK in its scale and depth of Growth impact impact gap Professional, Equity (other): spread across more severe for and Innovation Capital. These cut across structural, regulatory and policy barriers, sectors and COVID Fintech: £2.0bn c. £5-8bn gap all regions new businesses, regions, asset class constraints and market dislocation and asymmetries. The gap in growth c.£7.5bn Industrial: £0.5bn new projects and innovation capital, representing missed opportunities, has doubled since Covid-19. The per annum Leisure: £0.5bn Growth Gap is not static but represents a ‘flow’ on an annual basis with unrealised opportunities Other: £2.0bn Venture debt: within one year becoming unavailable in the next. This kind of structural gap means that the UK c. £2.0bn economy is not benefiting from the dynamic growth that scaleup companies can deliver across { 0 many sectors and areas of the UK economy. With the cyclical challenge presented by Covid-19 Growth Gap Regional Segment Growth Cycle Asset Class layered on top of this we face the risk of significant, long-term impact and going even further backwards in the OECD ranking of countries where a business can scale. 3.1. THE STRUCTURAL GROWTH We set out selected evidence on the structural gap below. This gap of around £5-£10bn per annum compares to Based upon contemporary analysis, and wider assessment the cyclical gap that has arisen due to Covid-19 - begins estimated investment by high growth small and medium of historical reports, we estimate the UK long-term first with understanding just how large this gap might be. CAPITAL GAP PRE-COVID-19 sized businesses of approximately £40 billion per annum, Structural gap to be equal £5- £10 billion every year. This is We have done this by drawing on the existing estimates Scotland: £0.6bn Seed: £0.7bn Wales/NI: £0.2bnand suggests that closing the gap could increase their not a new problem but it has been effectively doubled by (primarily of the structural gap) and then building on to Venture: £0.7bn SW: £0.5bninvestment by around 12.5-25%. The broad range of the impact of Covid-19, with a further £7.5 billion created them the changes in both the supply and demand for Our£ B estimates of the pre-existing Growth Capital gap, Equity around these estimates is driven in part by the gap having£3-6 million varied in by the current crisis. This pandemic, combined with the capital that we observe in the current crisis. This approach described in detail below, point to a gap of around £5- SE: £1.3bn significantly from year-to-year, as both the supplycomparison and global uncertainty, has created a multiplier effect resulting allows us to both assess the quantum and also link it to the £10bn per annum in the post GlobalStructural Financial Crisis period Broad range of with the US demand forgaps growth across all capital evolvedScale up: over time, including in a £15 billion yearly gap, which needs urgent action to potential causes - and hence potential solutions. We have (2011-19). gap £3.2bn NW: £2.0bnin responsesectors to developingof the events. Below we explore a address if we are to achieve our immediate recovery and explored a range of different drivers and dimensions of economy as Key drivers c.£5-10bn wide rangeindicated of approaches by for assessing the structural gap, long-term economic goals. the gap, producing a range of cross-cutting estimates that This structural growth capital gap has many layers and goes SUI data per annum exploring the drivers and dimensions set out in Figure 4 are summarised in Figure 4, and explored in further detail beyond the pre-existingPre-existing gap that we have observed in NE: £1.0bn gap above, including: Venture debt Our work on identifying the options for addressing this gap below. recent years. There may be additional demands for funding Established: and other asset Carbon net £3.0bn - both the structural gap that existed before Covid-19 and from future challenges, such as addressing the carbon netMidlands / classes zero gap East: £1.7bn • Selected estimates of the pre-Covid-19 gap, zero challenge, or there may be missed opportunities. Diverse developed by researchers in recent years In 2019 a further lensFounders was brought to bear with the Angel: £0.2bn Rose Review, and workImpact by the British Business Bank, for • The gap based on potential demand for capital, VCTs: £0.3bn example, showingInvesting that all female founder teams get less based on Beauhurst analysis developed with the Technology/ IP: than 1% of venture capital (VC) funding, and mixed teams ScaleUp£2.5bn Institute Brexit gap getting only 10%. Furthermore, the ongoing exit from the • The gap based on the potential supply of capital, UKBAA welcomes the Growth Capital Report presenting a five point plan for Funding to catalyse small business European Union is likely to create additional needs, both “ COVID gap considering what sources may exist to fillEquity the (other): gap Developing growth. These proposals are wide ranging and recognise the importance of addressing the existing regulatory and due to losses of sources of growthCyclical funding gap (such as fromDeveloping Business, c.£5-8bn impact impact more structural imbalances for access to capital and notably for regional businesses, as well as for women-led businesses the European Regional Development Fund (ERDF) and • MacroeconomicProfessional, indicatorssevere for of new the growth capital gap, spread across Fintech: £2.0bn businesses, and other under represented groups. We are especially pleased that the importance of further boosting Angel European Investment Bank / Fund (EIB / EIF)) as well as newall regions looking at SME investment trends c.£7.5bn new projects opportunities for funding that may arise. investment capacity across the UK and the role of the EIS scheme are identified as a core part of this segmented per annum • RegionalIndustrial: analysis £0.5bn of the growth capital gap, exploring strategy for funding future business growth. theLeisure: segmentation £0.5bn by region Venture debt: Other: £2bn c.£2bn 22 Jenny Tooth, CEO, UKBAA 23 0 Growth Gap Regional Segment Growth Cycle Asset Class THE FUTURE OF GROWTH CAPITAL REPORT

SELECTED ESTIMATES OF THE GAP BASED ON THE given by the mid-point of our structural for DB pensions. This gap is linked to regulatory and that business investment in this community improved again gap range (£7.5bn) would be: commercial factors encouraging high liquidity and low asset somewhat in 2019, but any such recovery was short-lived THE PRE-COVID-19 GAP POTENTIAL DEMAND FOR management fees, even though high return, illiquid assets due to the impact of Covid-19 from Q1 2020. Throughout CAPITAL • Seed stage: £0.7bn would seem quite appropriate for the generally long-term the period, investment by SMEs has always been at a much Various reports have provided perspective of DC funds. DC pensions have a high level of lower level, relative to gross value-added, compared to larger • Venture stage: £0.7bn 16 estimates of the growth capital gap An alternative perspective of the contributions, of around £60 billion per annum , and if the companies. since the Global Financial Crisis. They growth capital gap considers the • Growth stage: £3.2bn proportion of this new money flowing in to support scaleup include estimates both of a ‘stock’ of companies was adjusted to close the current funding gap, it This persistent weakness of investment by SMEs since the last potential demand for funding from • Established: £3.0bn outstanding opportunities that are not scaling firms - representing scaleups and would point to an additional flow of around £6 billion per recession reflects the challenges that the UK has faced. The being funded, as well as estimates of a those growth firms with high potential annum. weakness of the banking sector constrained the availability lack of ‘flow’ of growth capital. The two that have not yet raised funding. THE GAP BASED ON THE of lending to scaleups for a long period following the global are of course related, and potentially Add to this further potential flows from (the much larger) financial crisis, and then the partial recovery in 2014-16 was interchangeable given assumptions In a recent analysis conducted with the POTENTIAL SUPPLY OF DB pension funds and also personal pension funds, it is clear knocked back again by events. This points to weakness in the for the longevity of unfunded ScaleUp Institute, Beauhurst estimated CAPITAL that additional funding of c.£10 billion per annum is feasible infrastructure that is required to ensure a consistent flow of opportunities. Selected numbers the potential demand for growth from UK pension funds alone. This suggests that the scale of capital to high growth companies. This is not only important include: capital from all of the fast-growing Another alternative perspective on the the gap being considered here is quite reasonable in terms of for rekindling economic growth following downturns, but • An earlier estimate of the ‘stock’ and potentially fast-growing firms that growth capital gap is whether there are what the wider asset management industry could be capable also because our scaling businesses are our sources of from Deloitte, which fed into it has identified to be in the order of clear gaps in the supply of capital that of delivering. innovation and technology that will help us address the the evidence behind the creation £118 billion. This is an estimate of the could be addressed, to ensure that the current and future crises. of the British Business Bank, stock of outstanding capital investment estimates of the gap could feasibly be suggested that the SME funding opportunities, which comprised of met without needing to increase the MACROECONOMIC INDICATORS OF THE It is also possible to estimate the gap based on official gap in 2013 was around £10 billion some £3 billion from ‘seed stage’ firms, overall volume of savings available - GROWTH CAPITAL GAP statistics for capital investment by businesses (which includes to £11 billion (central estimate), and £4bn from ‘venture stage’ firms, £45bn which ultimately constrains the amount investment in , and thereby includes by 2017 this figure was projected from ‘growth stage’ firms and £66bn of investment. The challenge in ensuring UK scaleup businesses have access R&D). While not all growth capital is required to fund capital to rise to about £22 billion11. from ‘established’ firms. to the funding they require to grow can also be observed in investment (some might be required for working capital, for • More recently, the growth capital For the UK economy, one major source macroeconomic data since the global financial crisis. Official example), and not all capital investment is linked to growth ‘flow’ gap was assessed by the In terms of an equivalent flow estimate, of potential funding is from private ONS data for the UK shows that after the global financial (some investment is required simply to maintain the capital Industry Panel reporting to the one might expect to ideally meet the pension funds, including both defined crisis, business investment by SMEs was suppressed until 2014, stock of the UK), there should be a broad correlation. The Patient Capital Review in 2017, demand for capital over a period of contribution (DC) and defined benefit long after the partial recovery in investment by larger firms analysis below, in Figure 5, suggests that investment by SMEs which estimated the annual UK time, with the amount of time being (DB) occupational schemes, as well as in 2011 - as illustrated in Figure 5 below. The recovery in SME over the period 2011-2018 was some £11.4bn per annum lower, flow gap as between £3-6bn. shorter for seed stage and longer for personal pensions. Total pension wealth business investment in 2014 - which we expect was driven in on average, than it would have been if the more buoyant established, for example. In addition, in the UK was estimated by the ONS investment levels of 2014-16 had been maintained. A higher • An estimate of the ‘stock’ a large part by scaleup companies - coincided with the long- some of the firms included would to be in excess of £6 trillion during the estimate of £24.3bn per annum would be implied by the rate prepared by BlackRock for this awaited recovery of the economy from the long-running perhaps never be ready for investment. April 2016 to March 2018 period13, and 17 of investment of larger companies observed in the UK during report suggests that equity recession . This recovery in SME investment was short-lived, If one assumes that the lifespan of is one of the largest components of however, falling again in 2017 due to the uncertainty created the full 2011-18 period - which is widely considered to have funding for scaleups has been 1920 opportunities varies from between UK financial wealth. A review of this 18 been a period of weak business investment in the UK. around US$40 billion lower than by the Brexit decision . There is some evidence to suggest two years (for seed) to ten years (for massive source of wealth indicates would be expected compared Business investment as % of gross value added established)12, this would suggest that that there is easily sufficient scale to Figure 5: Business investment as % of gross value added to the US, over a ten year period a flow of around £18bn per annum meet the estimates of the gap being (which equates to around UK£3- would be required if all firms sought considered in this report, as we outline 4bn per year. 100% 0% capital. So even with relatively prudent here. 90% There is a fair degree of consistency assumptions on the proportion likely -5% 80% amongst these estimates for a growth to do so, the estimate of the stock Starting with DC pensions, which have 70% capital gap of around £3-6 billion of outstanding opportunities would -10% significantly lower current assets under 60% appear consistent with a somewhat per annum, in terms of a flow. Each management than the more established 50% -15% higher estimate of an annual gap estimate is different, and arguably all of DB pensions (DC: £517 billion, compared 40% them have omissions compared to our (compared to the studies described to DB: £2,374 billion - neither figure -20% by size category 30% somewhat broader concept, but the above), perhaps circa £10bn per annum. including pensions in payment)14, there 20% -25% broad consistency - for a concept that is clear scope for increased investment 10% is undoubtedly with a wide degree of This approach also provides a basis for into scaleup high growth firms. As % of gross value added businesses 0% -30% uncertainty - is reassuring better. estimating demand for capital across detailed by Oliver Wyman in a report 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 1–9 EMPLOYEES 10–249 EMPLOYEES 250+ EMPLOYEES different stages of development, commissioned by the British Business -35% 15 suggesting that the annual Bank , DC pensions only invest 13% of UK business investment as a % of GDP: split by company size19 35000 -40% requirement for a total capital level their assets in alternative asset classes, es

e ations including VC funds, compared to 24% 16 ONS, ‘MQ5: Investment by insurance companies, pension funds and trusts: October to December 2018’ s l a

17 30000For a review of the timelines of the long-running global financial crisis recession in the UK, see ONS, ‘The 2008 recession 10 years on’: https://www.ons.gov. gy ator e and IP munic 11 See National Audit Office, ‘Improving access to finance for small and medium-sized enterprises’, 2014. uk/economy/grossdomesticproductgdp/articles/the2008recession10yearson/2018-04-30 essional Retai Medi Ener m

12 The specific assumptions for this thought experiment being: two years for seed; three years for venture, five years for growth and ten years for established 18 For a detailed exploration of UK business investment trends at that time, see chapter 2 of the IFS Green Budget 2019: https://www.ifs.org.uk/uploads/ of onal Servic adespeopl e Industrials Oper onstruction echnolog y/ Agricultur aft Industries ansportation Pr Leisur

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firms. GB2019-Chapter-2-Recent-trends-to-the-UK-economy.pdf Business and Tr Entertainment Tr Cr le

13 Source: ONS Pension Wealth: Wealth in Great Britain, July 2006 to June 2016 / April 2014 to March 2018 19 Source: Deloitte calculations based on data from the ONS Annual Business Survey, 2009-2018. The data is for the non-financial business economy. Pe

24 14 Source: ONS Pension Wealth: Wealth in Great Britain, July 2006 to June 2016 / April 2014 to March 2018 20 We note that there may well be reasons why investment by SMEs is systematically lower than that of larger companies, for example due to the most 25 Te 15 Oliver Wyman (2019), ‘The future of defined contribution pensions: enabling access to venture capital and growth equity’, September. capital20000 intensive production sectors being dominated by larger companies due to economies of scale. Scaleup Productivity Premium 15000 Construction 161%

Professional, Scientific & Tech 87% 10000 Creative / Arts 78% 5000 Other Service 71% Unfounded growth capital opportunities, £millions

0 Wholesale/Retail 67% East Midlands London North West South East Wales Yorkshire East of England North East Northern Ireland South West West Midlands Scotland Agri/Mining/Energy/Water 66%

Transport 55% Info & Communication 52% Education 22% 10% Real Water/ Accommodation/Food 16% Estate 0% Sewage Finance/Insurance Real Estate 15% -10% Agriculture and Mining Information and Communication Energy Manufacturing 15% -20% Manufacturing Professional, Scientific and Technical Health and Social Wholesale and Retail Health/Social Work 5% -30% Transport and Storage Administrative and Support Service Education Construction Admin & Support Services -1% -40% Other Service Activities UK Average -50% Creative/Arts 0 100 200 300 400 500 -60% Scaleups Turnover per employee (£ ’000) -70% -80% Change in GDP Q2 (compared to Q4 2019) Accommodation and Food -90% -100% 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 Number of Scaleups THE FUTURE OF GROWTH CAPITAL REPORT

REGIONAL ANALYSIS OF THE in which all high growth and potential high growth firms 3.2. THE CYCLICAL GROWTH Analysis conducted with ScaleUp Institute by Beauhurst seek growth capital funding to the same extent as firms in shows that external equity funding to fast-growing STRUCTURAL GAP London currently do. Some 25% of the ScaleUp Institute/ CAPITAL GAP DUE TO THE businesses fell by approximately 40% in Q2 2020 compared Beauhurst estimate of the potential demand for growth to Q2 2019. The impact is potentially even more severe Finally, we also consider the regional dimension of the capital was delivered to London companies in 2019, COVID-19 CRISIS in Q3 2020 as Q2 will have benefitted to some extent by Business investment as % of gross value added structural gap. The ScaleUp Institute with Beauhurst has according to the ScaleUp Institute/Beauhurst data on deals already put in place, and also flattered by additional assessed the potential outstanding demand for growth the level of funding in that year, by region. If one were to equity funding provided to existing businesses to support capital across the regions, as shown in Figure 6 below. apply this same rate to companies in other regions, the 0% We estimate that over the twelve months including Q2 recapitalisation, rather than growth. We expect reduced This provides100% a breakdown of the estimated £118 billion 90% increase in overall growth capital funding would be c.£13- 2020 to Q1 2021, the impact of Covid-19 on the availability equity funding throughout 2020, suggesting an overall drop -5% 21 of unfunded80% growth capital opportunities with scaleup 17bn in 2019 - with the range of estimates coming from of growth capital for scaleups is set to be in the order of of 40%, or £6 billion, is not unreasonable to assume . and potentially70% high growth firms, across different regions. whether one uses regional level funding averages or UK -10% an additional c.£7.5m, on top of the pre-existing structural The estimates60% are based on regional level estimates of the level funding averages (by firm type). This approach may gap of £5-£10bn per annum. This additional cyclical gap We believe the impact is primarily on growing businesses average amount50% of capital raised by seed, venture, growth over-state the true potential somewhat, as it is likely that -15% therefore represents a doubling of the growth capital that have not yet reached sufficient scale to use public and established40% firms. London attracts scaleup firms seeking capital, but it does -20% gap due to the impact of the Covid-19 crisis, and further equity markets, although there is still some evidence that by size category 30% provide another dimension to the potential split of the underlines the importance of addressing longstanding the availability of growth capital from the AIM market 20% -25% This data 10%can be used to consider a thought experiment structural gap. issues in delivering funding to fast growing businesses. has fallen significantly. Looking at AIM data, we see that

% of gross value added businesses 0% -30% Our estimate is based on an assessment of the impact of there was a significant amount of equity funding in Q2 Figure 6: Unfunded2009 opportunities2010 2011 2012 2013 2014 2015 2016 2017 2018 the crisis on both the supply of, and demand for, growth 2020, primarily aimed at recapitalising existing businesses. 1–9 EMPLOYEES 10–249 EMPLOYEES 250+ EMPLOYEES -35% capital - as summarised below. This comprises of the Compared to Q1 2020, the amount of equity capital raised 35000 -40% following elements: where there was some indication that the purpose was es for growth or acquisitions fell by around 45%, however, e ations s l • The impact of the Covid-19 crisis on the supply of between Q1 and Q2. A fall in 45% in growtha capital funding 30000 gy ator e and IP munic growth capital, including:essional is broadly consistent with the Beauhurst findings for a Retai

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25000 co rs T Supply Chain C Business and - The impact of operating losses (or, in some cases,Tr Entertainment Tr Cr le gains) on the resources of the business and its Pe In addition, market participantsTe indicate that the availability 20000 owners to fund growth of lending products suitable for high growth businesses has Scaleup Productivity Premium - The offsetting impact of government-supported been curtailed, in part due to the flood of state-backed 15000 Construction 161% lending and grants 23 plain vanilla lending during the crisis. This reduction in Professional, Scientific & Tech ‘venture debt’ inevitably adds to the loss of funding. 87% 10000 11 - The loss of external capital to fund growth, 25 37 35 47 47 15 16 43 26 27 46 18 26 including Crbotheative equity / Ar andts debt funding 11 78% 25 22 33 55 39 28 Angel investors have also seen a reduction in available 5000 • The impact of the Covid-19 crisis on the demand for supply of funding. The UK Business Angels Association Other Service 71% Unfounded growth capital opportunities, £millions growth capital, including: (UKBAA) surveyed their members in April 2020 and 0 Wholesale/Retail estimated that there is a current unmet demand for 67% 19 11East Midlands17 3 London30 29 North21 West13 South17 East18 8 Wale23s 13 Yorkshire 31 5 19 5 - 22 The loss of growth12 opportunities16 due40 to the 26 East of England North East Northern Ireland South West West Midlands Scotland crisis, both in the short term (e.g., due to social growth capital of £200 million. On average, the surveyed England Scotland Wales Northern North/ Yorks/ NW West East Eastern SW London SE Agriculture Manufacturing Construction Wholesale/ AgriHotels//Mining/TransportEnergy/WaterBusiness Health/ Other angel investors had seen a 45% reduction in funding, similar 66% Ireland NE Humber Mids Mids Retail Restntsdistancing measures)Activities, and in inc the Sociallonger Work termCommunity, (e.g., Source: Beauhurst Analysis - Unfunded growth capital opportunities across nations and regions to the estimates above for wider equity sources22. TransporReal tEstate Social & Personal 55% UK Nations English Regions due to changes in behaviour that persist) Service Activities Figure 7: 2019 equityWould be raising Seekers by region comparedPlans to apply to hypothetical potentialHappy non seekers– ‘if like London’ Would be Seekers - PlansNew toIn foapply opportunities & Communic ationdueHappy to the non crisis, seekers due to We also estimate a c.£300 million impact on venture 52% changes in behaviour and economic structures, capital, although this is quite uncertain at this time, and Education 22% 10000 as well as due to the failure of incumbent based on a patchwork of different estimates. 10% Real Water/ businessAccommodation/Food competitors 16% 0% Sewage Estate Overall, an assumption of a reduction in the supply of Finance/Insurance NET: Would be Seekers Have plans to borrow / renew Happy non seekers Real Estate external growth capital of around £5-10 billion would seem 15% 8000 -10% Agriculture and Mining The elements define the supply of and demand for growth Information and Communication capital, and the differenceManufac betweenturing them defines the relatively prudent for the next twelve months. Given that 15% Energy Manufacturing -20% Potential Professional, Scientific and Technical growth capital gap. crises have tended to negatively impact on the supply of Health/Social Work 6000 Health and Social Wholesale and Retail finance to SMEs for longer than expected in the past, this 5% -30% deficit could persist for quite some time. In addition, it is Transport and Storage Administrative and Support Service Admin & Support Services Education ConstructionActual 2019 IMPACT ON THE SUPPLY OF GROWTH likely that high growth businesses have seen a loss of own -1% -40% Other Service Activities resources for funding investment that has not been fully 4000 CAPITAL UK Average compensated by state-backed grants and lending. -50% Creative/Arts 0 100 200 300 400 500 Regarding the supplyScaleup ofs growth capital, the impact of the Turnover per employee (£ ’000) -60% This would therefore suggest that the additional impact 2000 Covid-19 crisis is gradually becoming clearer in the evolving -70% data available from market participants and official sources. of the Covid-19 crisis on the growth capital gap is at mid- But significant question marks continue to surround how point of the £5-£10 billion per annum range - which is £7.5 -80% the crisis may impact on markets and the economy going billion per annum. 0 Change in GDP Q2 (compared to Q4 2019) Accommodation and Food -90%East East of London North North Northern Scotland South South Wales West Yorkshire forward. Midlands England East West Ireland East West Midlands 26 Source: Beauhurst-100% analysis conducted with SUI for the Future of Finance group 21 Beauhurst estimate that the total amount of equity funding to fast growing businesses was £15.6bn in 2019. 40% of this figure is £6bn. 27 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 22 UKBAA, ‘Boosting Angel Investment for economic recovery’, June 2020. Number of Scaleups THE FUTURE OF GROWTH CAPITAL REPORT

IMPACT ON THE DEMAND seeking to cover the direct negative In addition, the ScaleUp Institute has ANNUALISED FUNDING impact of the Covid-19 crisis - which also reviewed the announced purpose AMOUNT RAISED PERCENT 2020 AMOUNT RAISED PERCENT 2019 FOR GROWTH CAPITAL we refer to as recapitalisation. of funding deals in 2019 and 2020 2020 2019 CHANGE SINCE PURPOSE 2019 so far, to shine some light on how Economic downturns inevitably RESEARCH AND It is perhaps too early to tell how demand has shifted due to Covid-19. DEVELOPMENT 1,811,348,826 62% 4,016,237,645 56% -16% result, at least in the short run, in much structural change there Of the 389 businesses that have some loss of opportunities, which in might be, and how the balance of announced what the funding is for JOB CREATION 575,315,394 20% 2,069,939,046 29% -48% turn results in some loss of demand opportunities will evolve. However, in 2020, we can see that the top two WORKING CAPITAL 415,260,311 14% 326,966,180 5% 136% from high growth firms for growth early indicators suggest that reasons for funding is job creation capital. But downturns also create considerable demand for growth and research, and this has flipped in PROPERTY 14,394,112 0% 340,275,740 5% -92% new opportunities, both due to the capital remains. The ScaleUp Institute 2020 with R&D the priority focus. The loss of incumbent businesses (creating has estimated that demand for proportion of funding for ‘working CAPITAL EQUIPMENT 75,088,473 3% 89,386,874 1% 56% opportunities for new entrants) finance from scaling businesses has capital’ has increased significantly in and due to structural change in the increased significantly, with 43% of 2020 as well, presumably reflecting PROJECT FINANCE 46,721,413 2% 383,215,282 5% -77% economy, which typically results from scaleups seeking capital for growth the need for runway capital. recessions. In the case of the current purposes in the three months to Source: ScaleUp Institute Analysis - Announced purpose of funding deals in 2019 and 2020 crisis, the potential for very significant May 2020, compared to 27% before Raising funds for property and structural change is particularly the crisis. This is almost double the capital equipment decreased most SECTOR IMPACTS This comparison provides an overview of the relative pronounced, due to the severe number of scaleups looking for significantly in 2020 compared to exposure of high-growth firms to the crisis. There are impacts on behaviour, which will likely finance seen in recent years23 and 2019, whilst property finance has scaleups in all sectors, including in some of the sectors The impact of the Covid-19 crisis on high growth scaling persist for some time. coincides with such businesses also also declined in deal value terms, that were largely closed down in Q2 2020. Some 70% firms continues to develop, and it is quite possible that having heightened concern over the even though the number of deals is of scaleups are in sectors that were hit hard, but either the reduction in available external capital worsens before So the impact of Covid-19 on challenge to access suitable patient relatively high. reopened fairly early (e.g., construction, manufacturing) it improves. The true impact of the Covid crisis is still high growth firms, and hence the funds. Cash runway is also a concern or could continue to operate through different business emerging, however we believe that our estimate of an growth capital that they seek, will in some of our most innovative firms. models (e.g., online retail, home-working by professionals). additional cyclical gap of around £7.5 billion per annum is a inevitably be a mix of lost and A recent survey of FinTech companies However, a significant number are active in the hardest relatively conservative and early estimate of the quantum new opportunities, and the overall by Innovate Finance show that nearly hit sectors (e.g. leisure, entertainment, media and craft of the gap at this time. To help shine some further light balance of impacts could be in either 70% of smaller UK FinTech companies industries), which have also experienced a downturn in on this uncertain Covid-19-related impact, it is useful to direction. This comes on top of the have a cash runway of 6 months or funding in the first half of 2020 as shown in Figure 9 below. consider the sectoral dimension. capital that many of them are also less24.

The economic impact of Covid on different sectors of Announced deals: the purpose of funding in 2020 vs. 2019 By number and value the economy has varied to a far greater extent than any previous downturn due to the nature of the blanket NUMBER OF ANNUALISED PURPOSE DEALS IN 2020 SO PERCENT 2020 NUMBER OF PERCENT 2019 CHANGE SINCE lockdown, shielding and social distancing interventions FAR DEALS IN 2019 2019 introduced to control the spread of the virus. Hospitality sectors were nearly entirely closed down, while other RESEARCH AND 220 46% 320 38% 28% DEVELOPMENT functions of the economy saw serious operational challenges requiring significant shifts to remote working, JOB CREATION 170 36% 362 43% -13% online sales models, supply chain disruption, etc., not WORKING CAPITAL 45 9% 48 6% 74% to mention increased human resource dynamics around sick-leave, furlough and work-life balance having a knock- This is an extremely“ important set of PROPERTY 15 3% 52 6% -46% on effect on productivity. However, underlying demand recommendations. for many services was not affected to anywhere near CAPITAL EQUIPMENT 13 3% 47 6% -49% the same degree across all sectors (e.g., financial services, As we emerge from the Covid crisis it will not be utilities, communication). This variation is starkly apparent enough to simply recapitalise companies, we will then PROJECT FINANCE 13 3% 12 6% 101% in estimates of sector GDP (economic output) in Q2 2020, need to properly support their growth so that they as shown in Figure 8, which compares this to the number of scaleup firms in each sector25. can propel the economic recovery. These proposals set out how government and industry can work together to drive growth and job creation and harness them to the benefit of communities across the whole of the UK.

Miles Celic, CEO TheCityUK

28 23 ScaleUp Sentiment Insight, June 2020 29 24 Innovate Finance, UK FinTech Covid-19 Impact Survey, June 2020 25 Data provided by the ScaleUp Institute for 2018. Business investment as % of gross value added

100% 0% 90% -5% 80% 70% -10% 60% 50% -15% 40% -20% by size category 30% 20% -25% 10%

% of gross value added businesses 0% 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 -30% 1–9 EMPLOYEES 10–249 EMPLOYEES 250+ EMPLOYEES -35% 35000 -40% es

e ations s l a

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Professional, Scientific & Tech THE FUTURE OF GROWTH CAPITAL87 REPORT% 10000 Creative / Arts 78% 5000 Other Service 71% Unfounded growth capital opportunities, £millions

0 Wholesale/Retail 67% East Midlands London North West South East Wales Yorkshire Figure 8: Covid-19East of England funding gap:North exposureEast Northern of scaleups Ireland Southto the West Covid-19West Midlandscrisis by sectorScotland Agri/Mining/Energy/Water UK EXIT FROM THE OPPORTUNITIES FROM MEETING THE66% CARBON Transport EUROPEAN UNION INCREASED DIVERSITY NET ZERO 55CHALLENGE% Over 70% of scaleup Info & Communication 52% The least impacted sectors tend to companies fall within The Brexit decision had an initial It is clear that female and BAME-led It has been clear for a while now the have relatively fewer scaleups these sectors hard hit Education 22% 10% Real significant impact on growth capital businesses are under-represented in massive scale of investment that Water/ in Q2 by lockdown Accommodation/Food 16% Estate funding with the uncertainty impacting the UK high growth firm ecosystem. is going to be required to reduce 0% Sewage Finance/Insurance Real Estate on funding in 2016-17 in particular. For example, the Rose Review, and carbon emissions15% to a stable level -10% Agriculture and Mining 27 Information and Communication There is now uncertainty surrounding work by the British Business Bank, both in the UK and across the world . Energy Manufacturing 15% -20% Manufacturing Professional, Scientific and Technical whether the forthcoming reduction showed that all female founder teams Recent estimates point to significant Health and Social Wholesale and Retail Health/Social Work in funds flowing from European get less than 1% of venture capital investment5% now being observed in low -30% Transport and Storage Administrative and Support Service Education Construction Admin & Support Services Union bodies such as the European (VC) funding, and mixed teams getting carbon-1% capital (particularly by electric -40% Other Service Activities Regional Development Fund (ERDF) only 10%26. This suggests that the utility companies) and research and UK Average and European Investment Bank / Fund UK economy is also missing out on development (particularly by transport -50% Creative/Arts 0 100 200 300 400 500 (EIB / EIF) and Horizon 2020 will be a huge pool of talent, and inspiring companies)28, summing to some €124 -60% Scaleups Turnover per employee (£ ’000) sufficiently offset by new funding future female and BAME founders billion in 2019. But this report also -70% Significant number from UK bodies. The impact of the and therefore an extensive missed concludes that at least double that -80% of scaleups are in the exit from the European Union is also opportunity for innovation and job amount of investment is required Change in GDP Q2 (compared to Q4 2019) Accommodation and Food hardest hit sectors likely to lead to some deep structural creation. across Europe to deliver net zero by -90% changes in the UK economy, requiring 2050. -100% 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 new investments in some areas and, To estimate the impact on the growth Number of Scaleups inevitably, lost opportunities in other capital gap requires an assessment Clearly the potential need for areas. of the potential rate of change in additional investment in the UK is very Source: ScaleUp Institute analysis, ONS data on sector GDP for April & May, extrapolated for June based on reopening policies. this current dynamic, which depends considerable, and includes high growth

Business investment as % of gross value added The overall impact on the growth on the choice of solutions, as well firms across many sectors. Again this is Figure 9: Covid-19 funding gap: sectoral perspective Loss of funding across all sectors capital gap is quite uncertain, due to as societal changes, and is beyond a key area for further research, outside both sides of the equation involving the scope of this report. But it is of the scope of this report, but an 0% 100% new and lost opportunities, for clearly potentially very significant in important element of the plan going 90% -5% 80% example: magnitude, and is a key part of our forward. 70% -10% considerations for the plan going 60% • The supply of growth capital may forward. 50% -15% 40% be impacted by the loss of funds -20% by size category 30% from European entities, but this 20% -25% 10% could be offset by changes in

% of gross value added businesses 0% flows from other markets or new 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 -30% 1–9 EMPLOYEES 10–249 EMPLOYEES 250+ EMPLOYEES infrastructure within the UK. -35% 35000 -40% • The demand for growth capital es

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m by some opportunities no longer of onal Servic adespeopl e Industrials Oper onstruction echnolog y/ Agricultur aft Industries ansportation Pr Leisur

25000 co rs T Supply Chain C Business and Tr

Entertainment being viable. Tr Cr le Pe Te 20000 It is clear, however, that the impact Source: ScaleUp Institute analysis Scaleupmust beProductivity considered Premium going forward, and 15000 Construction is a key part of our thinking for161% the Professional, Scientific & Tech is why we have not included it in our base estimate of a longer term solutions.87% 10000 3.3. NEW CHALLENGES AND Creative / Arts £5-10bn per annum pre-existing gap), we can explore what 78% 5000 OPPORTUNITIES GOING some of these issue may entail. In particular, three future Other Service 71% Entrepreneurs throughout the UK require an urgent solution to the Unfounded growth capital opportunities, £millions challenges that are clear at this time include: “ 0 FORWARD Wholesale/Retail 67% funding challenges facing the future prosperity of growth companies. East Midlands London North West South East Wales Yorkshire This report highlights that to deliver this support quickly we must build East of England North East Northern Ireland South West West Midlands Scotland Agri/Mining/Energy/Water • The structural changes given the UK’s exit from the 66% European Union. upon existing frameworks that can deliver regionally-focused, patient There will inevitably be new structural challengesTransport for the 55% capital – the VCT industry will fully support this vital work. • Addressing the opportunity of improving the UK economy to address whichIn fowill & Coaltermmunic theation required flow diversity of founders and leaders of businesses. 52% of growth capital, impacting on both the supply of and Education 22% Stuart Veale, Chairman, Association • Meeting the carbon net zero challenge. 10% Real demand for that capital. Water/ Accommodation/Food 16% Estate 0% Sewage Finance/Insurance We explore each of these structural challenges in turn These changes will therefore impact onReal the Estate growth capital 15% Agriculture and Mining below. -10% gap, and while the impact is challenging to estimate (which 26 See British Business Bank, ‘UK VC and Female Founders Report’ Information and Communication Manufacturing Energy 27 15For% example, in 2014 the Global Commission on the Economy and Climate estimated a global investment need of US$93 trillion to meet this challenge. -20% Manufacturing Professional,30 Scientific and Technical 31 Health and Social Wholesale and Retail Health/Social Work 285% For example see Oliver & Wyman, ‘Doubling down: Europe’s low carbon investment opportunity, February 2020. -30% Transport and Storage Administrative and Support Service Education Construction Admin & Support Services -1% -40% Other Service Activities UK Average -50% Creative/Arts 0 100 200 300 400 500 -60% Scaleups Turnover per employee (£ ’000) -70% -80% Change in GDP Q2 (compared to Q4 2019) Accommodation and Food -90% -100% 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 Number of Scaleups THE FUTURE OF GROWTH CAPITAL REPORT

British Business Bank and British Patient issues around access to finance. Three- such targeted support could be blended Capital. The Future Fund is encouraging quarters of the Innovate UK sample cited in a hybrid model with mainstream The Diversity Opportunity the investors applying to the fund to that having easier access to finance is the programmes to embed diversity sign up and will be monitoring investors’ most important support in helping to and inclusion and address multiple commitment to the Code as part of establish a business - let alone to scale disadvantages. The UK has a rich diversity of entrepreneurship. Supporting our female and black and ethnic minority the overall fund evaluation. So far, 465 one. Non-financial support was also entrepreneurs to scale their businesses is an immense opportunity for the UK economy. convertible loans have been approved highlighted as important by both surveys, Recent research from the US has shown worth £468.7m, 82% of funding to especially access to mentors. that diverse founders returned 30% more There have been a variety of reports Female Founders of deals whereas 89% of the £5.6bn of senior management teams of mixed Of the ethnic minority founders capital to their investors at exit - to laying out the challenges for our women venture capital invested in 2017 in the UK gender and 59% of funding to senior responding to the Extend Ventures and capitalise on this opportunity and address and black and ethnic minority led went to all-male founder teams. In the management teams of mixed ethnicity. YSYS survey, only 13% of the businesses the finance gap that exists for ethnically Recent studies and analyses, including businesses which we discuss further FinTech sector, female-led businesses However, only seven convertible loans had received an equity investment from diverse businesses, the UK should expand the Alison Rose Review of Female below. (CEOs and founders) received only 10% have been approved for all-female a business angel or VC, despite two-fifths remit of (or establish a similar standard Entrepreneurship for HM Treasury, have of the $4.9bn invested into UK FinTechs leadership teams and 23 for those with (39%) seeking this type of investment. A to) the Investing in Women Code to made recommendations designed to tap To compound these challenges, all in 2019, and secured only 11% of the 359 an all ethnic minority team. 30 additional further 32% were seeking grant funding. encourage representation of other the huge unrealised economic potential evidence points to the fact that the funding deals in the same year. venture capital firms and angel groups underrepresented groups in funding of female entrepreneurs by making the Covid crisis has had a more severe impact have become signatories to the Code In addition, the research found that decision making. Venture Capital firms in UK one of the best countries in the world on our female and black and ethnic As such, perceived bias within the UK which is encouraging. In addition, Natwest half (48%) of black and minority-owned particular should look to the ways they are for women to start and grow a new minority population and is therefore venture finance community is a concern: through Coutts, and in partnership with business owners surveyed were not operating to create greater transparency business. further exacerbating the challenges these only 13% of senior people on UK BGF, has launched the UK Enterprise Fund planning to access or did not expect and openness, through the publication of entrepreneurs face. investment teams are female, and almost focused on female-led businesses and to qualify for any government support investment data, establishing open office Data highlighted by the Rose Review half (48%) of investment teams have no increasing the diversity of management schemes. This is despite the fact that they hours to break down the barriers created suggests that up to £250bn of new value As we seek to build back bolder and women at all. Women were also less likely teams. Natwest has also pledged £1bn to were seeing impact from Covid-19 on their by closed networks or developing new could be added to the UK economy if better, the ‘levelling up’ agenda must to obtain funding from business angels, women-led start-ups, launched the “Back client and sales pipelines, cashflow and scouting systems to source more diverse women started and scaled new businesses focus on both regions, localities and only 1% of female founded businesses her Business” platform supply chains. businesses. at the same rate as UK men. Even if the diversity with a Blueprint for Growth reporting this as a source compared to for female founders, and a number of UK were to achieve the same average embracing our diverse culture. It should 10% of male entrepreneurs. “Family First” banking products. These However, there are a number of additional share of women entrepreneurs as best-in- Creating diversity in the build on the good work already underway private sector examples can be followed factors experienced by ethnic minority class peer countries, such as Canada and in HMT, British Business Bank and Innovate The Rose Review highlighted three major by others and encouraged by the founders that hinder their ability to start investment base the US, this would add £200bn of new UK. areas for action: increasing funding for Government. and scale a business, and in particular value to the UK economy. female entrepreneurs via development their resilience at times of economic Fewer than one in ten management jobs In enhancing the roles of the British of a new code for investing in female crisis. Research from the Enterprise in UK financial services is held by an The Review found that women do not Black and ethnic minority Business Bank as our National founded businesses, new investment Research Centre has shown that these individual from black or ethnic minority lack ability or ambition, but only 1 in 3 Development Bank, and Innovate UK as vehicles including those with ring fenced entrepreneurs factors include: access to start-up funding background. Furthermore, in 2019, the FCA UK entrepreneurs is female, representing our Innovation Agency, one of their core funds or targeted rounds; providing family and insurance, low adoption of ICT estimated that the banking and finance a gender gap equivalent to 1.1 million public objectives should be to promote care support for female entrepreneurs Diversity and inclusion is an important within ethnic minority-led businesses, sector won’t achieve gender equality for missing businesses. The ScaleUp Institute’s diversity and inclusion. The Innovate UK by designing new financial products and but often underrepresented aspect of a proliferation of sole traders and/or another 88 years. 2020 Female Founder Index revealed that Women In Innovation programme, as support aimed at entrepreneurs with the business and finance landscape. The businesses with lower turnover, and that the number of scaleups with at least well as the new IUK Investor Partnership family care responsibilities; and, making picture in Europe is stark - less than 1% they are less likely to access business Increasing the level of diversity in the one female founder is rising. In 2020 we Programme, should expand to include entrepreneurship more accessible for of founders across the continent are advisory and support services. equity investment base, including both identified 194 female-led/co-led visible all elements of diversity. There is also women through relatable and accessible black, less than 1% of VC funding goes to angels communities and VC funds, will be scaleups – an increase of 10% in one year opportunity to expand or establish a mentors and networks. This third element black men and less than 0.006% to black There is an opportunity to address core to closing the finance gaps that exist - who have raised a total of £857m in similar approach for diversity as for the was seen as a major way to break down women. the gaps that exist for founders from for female and ethnic minority founders investment. However, this remains only a new Investing in Women Code supported cultural barriers shared by many women, ethnically diverse backgrounds. Alongside and realising the potential of all UK small proportion of the total number of by HMT and BEIS. including greater risk awareness, lack of In the UK, there are around 250,000 addressing the social inequalities that businesses. This should include actions to 5,456 visible scaleups who raised £1.3bn in confidence in their entrepreneurial skills ethnic minority-led SMEs (5% of all SMEs) exist for black and ethnic minorities, for increase direct recruitment and integration 2018 alone. New models of engagement will also be and limited access to networks. contributing £25bn to the UK economy example improving access to further of more women and members of black necessary to reach into the networks, each year. Furthermore, a 2018 report from and higher education, the government and ethnic minority communities within Female-led businesses are only 44% of the forums and online channels with which The recommendations proposed by Randstad suggested that the UK economy should undertake an awareness campaign the existing angel and VC Investment size of male-led businesses on average, women and ethnic minorities engage. the Rose Review are currently being would be £24bn larger each year if to promote and showcase the black community. Actions should also support in terms of their contribution to the Learnings can be taken from the Future implemented through the Rose Review individuals from black and ethnic minority and ethnic minority entrepreneurial and highlight the growing number of economy. Furthermore, male-led SMEs Fund deployment to see how it can Board supported by HMT and BEIS and backgrounds progressed their careers at ecosystem. angel groups and VC funds that are being are five times more likely than female-led evolve to embrace gender and ethnic beginning with the establishment of the the same rate as their white colleagues. led and established by representatives SMEs to scale up to £1m turnover. diversity further and how it can work Investing in Women Code to which 67 Business support providers, financiers and of diverse communities and that are more closely with specialist private investors have now become signatories, Recent research from Extend Ventures other stakeholders should also seek to focusing specifically on investing in diverse There are significant differences between sector players engaged in these sectors. to enable both capturing of gender and YSYS, and Innovate UK has further enhancing their understanding of how founders, including enabling access to male and female founders when it Democratising the access to long term based data on pipeline and investment explored the impact of Covid-19 and they are engaging with ethnic minority-led BBB existing venture funding schemes and comes to access to finance. According to growth capital, embracing diversity, must outcomes, as well as the development increasing participation in business businesses by reviewing and publishing angel co-investment funds to reinforce research by the British Business Bank in be a key goal for a sustainable economic of a new best practice framework. This innovation in the UK. data on diversity which will enable gaps their investment capacity, as well as 2019, less than 1% of UK venture funding recovery. is complemented by increased focus on Both reports identified a number of in provision to be effectively identified access to the Innovate UK Investment goes to all-female teams and just 4% diversity in the products offered by the barriers for black and minority-led and targeted solutions developed. The Partnership programme. businesses highlighting their particular Innovate UK research suggested that

32 33 THE FUTURE OF GROWTH CAPITAL REPORT

In the longer term, the net economic impact of policy • Increasing the scaleup population would be action is likely to be driven more through overall consistent with driving incremental long-term productivity improvements, rather than gross amount of economic growth, as their productivity has been employment, investment etc. In terms of net impacts, we found to be systematically higher than other observe that close the growth capital gap would likely: companies across all sectors of the economy. The scaleup productivity premium was estimated to 3.4. SCALING THE ECONOMIC Business investment as % of gross value added • Assist the levelling-up objectives delivered be 54% in 2018 – meaning that scaleups are, on through strong growth across all regions, not just average, 54% more productive than similar firms in SIGNIFICANCE OF THE GROWTH 100% 0% 90% London and the small number of other regions the same sector. See Figure 10 below for further -5% CAPITAL GAP 80% that currently have a sufficient scale and depth analysis from the ScaleUp Institute. 70% -10% 60% in terms of growth capital funding. Our analysis 50% -15% The existing literature on growth capital investment and 40% above points to a large numbers of currently unmet -20% by size category 30% these estimates provide a compelling case for further 20% growth capital opportunities recorded across all There is a body of literature on how venture capital unemployment in coming months, the gross impacts are -25% supporting growth capital in the UK. Further analysis of 10% regions. % of gross value added businesses 0% -30% and business angels help to foster the investments of arguably2009 as2010 important2011 2012 as the2013 longer2014 term2015 net impacts,2016 2017 at this2018 the potential economic impact of supportive policies 1–9 EMPLOYEES 10–249 EMPLOYEES 250+ EMPLOYEES start-up and scaleup companies, and consequently drive time. -35% can be expected to show strongly supportive multipliers 35000 -40% es job creation and economic growth. For example, a 2015 for government intervention. e ations s l a

European Commission report assessed how tax incentives 30000 Regarding the gross economic impacts, we observe that gy ator e and IP munic essional Retai Medi Ener m

can support the important role of growth capital in this closing the growth capital gap would represent: of onal Servic adespeopl e Industrials Oper onstruction echnolog y/ Agricultur aft Industries

Figure 10: Scaleups are more productiveansportation than the UK average across almost every sector Pr Leisur

25000 co rs T Supply Chain C Business and Tr

29 Entertainment Tr Cr le regard , concluding that ‘Venture capital and business Pe Te 20000 angel investment has been shown to generate a number • A potential 10-20% boost to UK business investment Scaleup Productivity Premium 30 of positive macroeconomic effects, such as job creation 15000 (£200bn in 2019 ), which is a positive impact that is a Construction 161%

and productivity gains’. There is a wide acceptance that similar order of magnitude to the current consensus Professional, Scientific & Tech 87% 10000 investment in growth capital produces multiplier effects forecast on the potential negative impact of the Creative / Arts 78% 5000 31 that justify tax incentives. Covid-19 impact in 2020 . Other Service 71% Unfounded growth capital opportunities, £millions

0 Wholesale/Retail 67% East Midlands• IncreasingLondon growthNorth Wcapitalest Southfunding East to highWales growthYorkshi re To provide a further lens on the growth capital gap, it is also East of England North East Northern Ireland South West West Midlands Scotland companies by c.20% per annum leading to increasing Agri/Mining/Energy/Water 66% useful to consider the scale of the gap compared to other accumulation of high-growth firms over time, Transport 55% high level indicators of economic activity. This provides potentially doubling the number of scaleup firms over Info & Communication 52% insight into the potential economic impact of closing the a 5-10 year period. Education 22% growth capital gap, both in terms of a gross impact (e.g., job 10% Real Water/ Accommodation/Food 16% Estate creation) and also longer term net impacts (e.g., impact on 0%• Sewage Potentially creatingFinance/Insurance around 3 million new jobs over Real Estate 15% -10% Agriculturetime, during and Mining a period where unemployment is UK productivity). With the expectation of significant Information and Communication Energy Manufacturing 15% -20% expected to be sharply increased.Manufacturing Scaleups employedProfessional, Scientific and Technical some 3.5 million people in the UKHealth in and 2018. Social Wholesale and Retail Health/Social Work 5% -30% Transport and Storage Administrative and Support Service Education Construction Admin & Support Services -1% -40% Other Service Activities UK Average -50% Creative/Arts 0 100 200 300 400 500 -60% Scaleups Turnover per employee (£ ’000) -70% -80% Change in GDP Q2 (compared to Q4 2019) Accommodation and Food -90% -100% Productivity of scaleups relative to the sector average 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 Number of Scaleups Source: ONS IDBR 2015-2018, ScaleUp Institute analysis of ONS Business Population Estimates 2018. Notes: Financial sector excluded as the ONS do not publish financial sector productivity estimates Together with the Scaleup Institute, we’ve long been“ extolling the transformative effect of investment on business growth. The numbers in this report show how much investment is required to enable business growth across the UK – growth which is needed now more than ever. The amounts are not small but they are achievable. SMEs are an excellent asset class that deliver returns to investors, jobs to the economy and innovation to society.

Henry Whorwood, Head of Research & Consultancy, Beauhurst

29 European Commission, ‘Effectiveness of tax incentives for venture capital and business angels to foster the investment of SMEs and start-ups’, 2015 30 ONS data 34 31 The consensus forecast for fixed investment growth in 2020 was -15.5% in July 2020, as surveyed by HMT in ‘Forecasts for the UK economy: a comparison 35 of independent forecasts, July 2020’. THE FUTURE OF GROWTH CAPITAL REPORT

A DEVELOPMENT BANK - development projects, such as, AAA credit rating to pass on low initiatives supporting the reduction of interest rates to businesses. KFW, GERMANY the carbon footprint and care for the KfW has a wholly owned subsidiary, elderly, by refinancing the loans to the KfW Capital, that invests in German KfW Development Bank was formed local governments via regional banks. and European venture capital and 4. INTERNATIONAL LEARNINGS in 1948 to support the reconstruction There are some instances where loans venture debt funds, strengthening of Germany after WWII and it has may be provided directly by KfW, their capital base. Their stated aim continued to help the German Federal although this is not common. It mainly is to improve access to capital for Government to achieve its goals in relies on the regional network of local innovative technology-oriented development policy and international banks, cooperatives and commercial growth companies in Germany development cooperation ever since. banks that lend to SMEs and start-ups, through financially strong funds. KfW has evolved over time as the leveraging the relationship between development bank of Germany taking customers and their current banks KfW Development Bank also on responsibilities for finance for for the assessment and distribution promotes developments projects tackling climate change, international of loans. A public law institution, in Africa, Asia, Latin America and development and export finance. The UK is not the only economy considering the need for growth capital to drive the success it benefits from a federal republic South East Europe, with investments It is now a vital part of the German guarantee, and is majority owned by of €8.8bn in 2019. Domestically KfW of high growth firms and economic prosperity. In a dynamic global landscape, many countries economic model, with a balance sheet the Federal Republic of Germany, with finances SMEs, start-ups, private and regions are turning their attention to scaleups as a means of economic renewal such as the of €600bn. a 20% stake by the German states. customers and municipalities. Figure 11 recently announced start-up investment fund in France (see panel). KfW accesses most of its funds from below shows the types of investment KfW provides loans for major capital markets, relying on its strong products that the KfW offers. infrastructure projects and social Here we draw out lessons from three world-leading In 2019, France announced €5 billion of investment capital institutions to address these gaps in the supply of capital, being made available for French start-ups over the next 3 Figure 11: KfW Products and Platforms including: years, with the President setting a goal of France having 25 unicorn companies by 2025, and attracting more capital KfW Products • The French Tech Mission from overseas. • KfW, the German development bank; Innovation Products Business Start-ups and succession Energy and Environment investing Of the €5 billion announced, €2 billion will focus on late- • ERP-Mezzanine for Innovation • Erp start-up loan- startgeld programmes (up to €25m) • Canadian pension schemes; stage investments, whilst €3 billion will support global tech Up to 100% of the investment cost Loan with a term of 5-10 years. Up to • Climate protection offensive for funds managed by French-based managers. This investment eligible for financing, up to €5m, with €125k for capital expenditure and working medium-size businesses • Small Business Administration in the US; and capital, the share of working capital is a 10-year fixed rate • KfW Environmental Protection capital will be made up of two-thirds private companies limited to €50,000 • KfW Energy Efficiency - Production • ELITE in Italy, part of LSEG and one-third public institutions such as the pension • ERP-Digitalisierungs-und- • ERP start-up loan - universal Innovationskredit Facilities and Processes These short case studies highlight aspects of potential reserve fund and EDF. Loan term of up to 20 years, up to €25m Up to 100% of the investment costs for capital expenditure and working • KfW Energy Efficiency and Process Heat solutions that then feed into our key recommendations, eligible for financing, up to €25m, with from Renewable Energies As a consequence, the amount of investment capital capital explored in Section 5 below. a 10-year fixed rate • KfW Energy Efficiency - Energy-Efficient available to French tech companies has tripled over the last • ERP Capital for start-ups KfW subordinated load with a term of 15 Construction and Refurbishment four years, putting France ahead of Germany in terms of The French Tech Mission / La French Tech Business expansion and consolidation years and a maximum loan sum of €500k. • BMUB Environmental Innovation (no max start-ups collected by investors during this period. programmes - financing and equity However, the borrower must have a amount) minimum amount of equity. Investments • KfW Renewable Energies (up to €50m) Under the leadership of French President Emmanuel All this aligns with the French government’s mission to in eastern Germany and Berlin receive special support • KfW Offshore Wind Energy Programme Macron, the tech ecosystem in France continues to benefit provide French start-ups with global opportunities to scale International projects (up to €700m) from both public and private capital support. - known as The French Tech Mission, or La French Tech. KfW Platforms

KfW Capital DEG KfW IPEX Bank • Innovation Hub responsible for • Responsible for working with private • Responsible for export and project I am delighted that the Business Action Council have demonstrated the benefit of a collaborative sustainably improving the provision of enterprises that invest in emerging finance that supports companies in key “ venture and growth capital to innovative economies industrial sectors in global markets ecosystem by coming together with others to deliver such a valuable report. It’s vital that we work with technology companies government proactively on these issues and provide the consensus from enterprise that will help this • Offers tailored solutions, long-term • Medium to long term financing for • Attracts private capital to the venture financing, and business support services Germany and European exports administration deliver the right support at speed – so that it is effective, sustainable and instils confidence. capital asset class €1.85m invested in 2019 in developing • Infrastructure investments and secure €156m VC fund investments in 2019. Aims to countries raw materials supply Access to Growth Capital is crucial and this report provides important evidence and clear recommendations invest €2bn over ten years on German and • Financing environmental and climate on how this can be taken forward at a critical time for the UK economy. As an entrepreneur, I believe in the European venture capital funds protection projects worldwide importance of scale-ups, which are frequently our most innovative businesses and are thus essential for the Source: KfW Annual Report 2019 UK’s recovery from the crisis.

Maurice Ostro, Chair of the Business Action Council

36 37 THE FUTURE OF GROWTH CAPITAL REPORT

We draw a number of key learnings from the success of Over the past three decades, a ‘Canadian model’ of SMALL BUSINESS ADMINISTRATION ELITE, LSEG ITALY KfW as a development bank, which informs our thinking public pension has emerged that combines independent on key recommendations. These include: governance, professional in-house investment (SBA), USA management, scale and extensive geographic and asset- ELITE is LSEG’s private market, connecting private • Leveraging a strong regional network, deployed class diversification. It primarily focuses on diversifying The SBA is a US government federal agency that provides companies to diverse sources of capital to drive their under a national framework, allows KfW to work funds in illiquid, alternative asset classes, such as, support to entrepreneurs and small businesses. It was growth. ELITE’s network and platform provide companies locally with banks to offer more favourable loan infrastructure and real estate, with a preference for direct created in 1953 as an independent agency of the federal with simplified access to a range of funding options, help schemes for local investment, whilst benefiting investment. Some schemes, such as OTPP, have actively government to assist and protect the interests of small intermediaries and brokers expand their reach, and direct from the existing relationships. While creating such entered into venture capital, for example with the launch business concerns. It has a network of offices across the US the impact of institutional and professional investors to a network in the UK would likely take considerable of the Teachers’ Innovation Platform, which makes late- that process loans, provide disaster assistance and business the real economy. time and effort, this example points to benefits in stage venture capital and growth equity investments. The development services. developing a national framework to make best use main distinction for the purposes of the report is the In addition to facilitating single company transactions, of what we have, and potentially moving to address much greater extent to which Canadian pension schemes Like the KfW, the functions and role of the SBA is ELITE has the flexibility to support clusters of companies some of the most pressing gaps. have brought on board highly competent in-house governed by law, with its three main functions being, the through its Basket Bond product, which was launched investment professionals to directly make investment provision of capital to small business, provide business • KfW shows that state-supported development in 2017. The Basket Bond provides an opportunity for decisions. Roughly three-quarters of the assets of the top counsel or entrepreneurial development services, and banks can make a major impact, which points to institutional investors to support growing companies while ten Canadian pension funds, across a range of asset classes, supporting the awarding of government contracts to a further bolstering the development banks that the maintaining a portfolio approach and gives companies are internally managed rather than managed by external defined statutory target level, 23% of federal contracts by UK already has in place: the British Business Bank, the access to a larger pool of institutional funds. Participating asset managers. While the pension funds compete for value awarded to small businesses. forthcoming Scottish National Investment Bank, the companies issue bonds with some common characteristics talent, they do also commonly co-invest in businesses and Development Bank of Wales and Invest NI. but for different amounts. The individual bonds are projects, to help share investment risk on deals. The SBA has total assets of $12.7bn and an outstanding loan grouped together under a securitisation transaction • The success of KfW Capital in providing state- portfolio of $124bn. The main tool for supporting SMEs structured by an independent financial institution with a supported capital bolstering venture capital We draw a number of key learnings from the success of is the 7(a) loan guarantee programme, which accounts for Special Purpose Vehicle issuing the Basket security through investments for early stage financing, points to the Canadian pension schemes, which informs our thinking 63% of the SBAs loan portfolio. These loans are targeted at ELITE to institutional investors. another aspect of the model that may be relevant to on key recommendations. These include: small businesses which are unable to apply for commercial the BBB and Innovate UK. The key challenge here is in loans and are provided by lenders that have partnered Over the years, ELITE has launched several Basket Bonds in providing the infrastructure to support high growth • While changes in legislation are clearly required to with the SBA, which include most major American banks as Italy each with a specific focus (for example regional such businesses throughout all growth phases, including help unlock institutional and corporate funding well as local and state banks. The SBA guarantees up to of as those launched in Lombardia and Campania, or exports from start-up to scaleup and beyond - although in some areas, particularly regarding DC pension 85% of loans up to $150k and up to 75% on loans up to $5 etc). Creating a specific theme for the Bond generates we also understand the KfW also faces its own schemes, to help increase the impact of major DB million, providing loans with long maturities, ranging from targeted interest from both companies and investors challenges in ensuring the delivery of capital for scale pension schemes on the supply of growth capital seven to ten years, reaching a maximum of 25 years when and provides the opportunity to seek government or up. is likely to require longer-term cultural change as the investment is used to purchase fixed assets or real institutional support. For example the ELITE Export Basket well. The Canadian pension model has evolved over estate with a long-term useful life33. Clearly it is not possible to simply copy and paste the KfW Bond launched in 2019 was guaranteed by SACE (the Italian time, particularly with regard to developing highly concept into the UK, given wider structural differences in Export Credit Agency). Additionally, there is flexiblity professional in-house investment decision-making, Governmental interest in the SBA’s loan, venture capital, the 2 economies, but we believe the national framework to create a Basket Bond programme which can then be and this would take time to replicate. training, and contracting programs has increased in recent of regional ecosystems is a key learning for the UK, and years, as small businesses are viewed as a means to accessed in tranches by smaller groups of companies over feeds into our recommendations below. • But even with the focus on competing for the best stimulate economic activity and create jobs, particularly in a number of years. talent in terms of asset management, the Canadian the context of Covid-1934. CANADIAN PENSION SCHEMES pension funds continue to cooperate with one In light of the challenges faced by smaller Italian banks another in terms of co-investments, due to the We draw a number of key learnings from the success particularly during the Covid-19 crisis, ELITE has also significant benefits of doing so. This helps them of the SBA, which informs our thinking on key launched a Basket Loan programme supporting smaller manage their exposure to individual projects or banks with standard procedures and tools to help them Like the UK, the Canadian occupational pension system recommendations. These include: businesses, which is a key risk for all DB pension provide and aggregate SME loans. Similar to the Basket includes a mixture of (mainly public sector) defined benefit schemes in particular, Canadian or UK alike. Bond, for the Basket Loan individual company loans are schemes and (mainly private sector) defined contribution • There are benefits from the long-running state- aggregated through a securitisation process with the schemes. Among the DB schemes, there are a number of supported lending programme for the smallest guarantee of the Central Guarantee Fund of the Italian large provincial schemes that are widely considered to be This highlights both the potential benefits of the Canadian businesses, including its adaptability for times of Government. This initiative is with a small number of banks global ‘best practice’ organisations, including, for example: model as well as the considerable challenges to unlock the crisis. that have the balance sheet capabilities but not necessarily the Canada Pension Plan Investment Board (CPPIB), the vast sums, particularly on the DB side. In the shorter term, • Like the KfW, the system benefits from a central the tools and risk appetite to lend to a larger number of Caisse de dépôt et placement du Québec (Caisse) and unlocking the DC funds may be a more attainable goal. body with a network of regional delivery models, in individual SMEs. the Ontario Teachers’ Pension Plan Board (OTPP), along this case primarily through the banks. with various other provincial mainly public sector pension The ELITE Basket products could be a relevant solution schemes. The country’s top 10 public pension organisations for UK SMEs which should be investigated further with manage over $1.2 trillion in net assets, employing thousands The SBA provides another example of a national companies and investors. In the UK context, Baskets of highly qualified professionals, and competing for framework for addressing capital issues for small businesses could be themed around innovation, sectors such as investment opportunities around the globe on behalf of at a local level, which is a key requirement this report seeks manufacturing, regions etc. Additionally, there may be Canadian pension beneficiaries32. to address. opportunity to explore baskets for other underlying securities (for example equity).

38 33 Closing the Financing Gap, Justin Protts 39 32 The evolution of the Canadian Pension Model, World Bank Group 34 Congressional Research Service, ‘Small Business Administration’, June 2020. THE FUTURE OF GROWTH CAPITAL REPORT

exports and internationalisation to include: 2. ACCELERATE THE UNLOCKING OF INSTITUTIONAL opportunities to expand dedicated trade missions AND CORPORATE FUNDING for scaleups across the UK and dedicated cross Through changes in legislation and organisation that government scaleup procurement channels crowds in the existing significant private sector capital 5. RECOMMENDATIONS IN DEPTH • Scaleup finance and infrastructure requirements that can make inroads into closing the Growth Gap. (including local space to scale and grow) This should entail developing an aggregator structure with relevant back office analytical and distribution ii. Realignment of the regulatory and policy environment capability. Such a structure could be pursued by towards growth by reassessing the legislative and transforming British Patient Capital (BPC) into a joint- regulatory impediments to growth removing barriers and venture vehicle with the private Sector. The Government championing innovation, in particular addressing the long A number of solutions have been evaluated across the The UK’s lies 13th in the world for ‘scaleups’ and when would deploy further seed capital as necessary. Their term impediments to Growth Capital. This realignment market failures - see grid below - and these have been compared to our international counterparts that lay ahead role in this is to convene and catalyse, with the private should focus on: assessed across four classifications of: of us, including France, Germany, US and Canada, it is clear sector crowding in around it. that common features they share are: a more federated • Driving up the R&D opportunities by taking a bolder • Accelerate the pillars that already exist ‘regionalised’ governance model; long term ‘arms length’ Institutional entities such as pension funds, insurance approach to the Frascati Manual and assessing the national agencies driving their finance, innovation and companies and corporate entities are key to closing the • Expand to meet the key challenges R&D tax credits to encompass all sectors. This could business support interventions; deeper pools of capital Growth Capital Gap and their resource pools must be include a temporary bringing forward of R&D tax • Realign in response to the changing opportunities drawn from the institutional private sector, across varying unlocked in order to do so. credits as we kick start the recovery post-Covid-19 asset classes, including in a number a . • An enhanced AIA for scaling firms to support capital • Create new long-term infrastructure to drive growth The annual flow gap of £15bn identified in this report is investment equivalent to only a fraction of a per cent of total UK Overall those varying solutions and levels theme into 5 As we head further into a new decade, which has brought . With the right • Broadening of Sandbox opportunities across key actions which will materially affect the structural and with it an unprecedented global pandemic, and seek to structures in place this is well within the grasp of the UK regulated sectors cyclical growth gap: recover and build back better, the UK must definitively private sector to close with relevant regulatory support tackle the long term structural deficiencies in scaleup • Growth Boards established at regional level to drive and impetus from Government which needs to double growth and the key impediments to it which include forward local initiatives down and accelerate key measures underway and drive KEY RECOMMENDATIONS access to long term patient capital. • Reassessing State Aid rules and UK legislation forward heightened collaboration with the private sector. hindering growth opportunities and growth capital A new National Blueprint for Growth should have 3 key flows - see Recommendation 2 below. The Patient Capital Review (PCR) clearly laid out the Five key actions will materially affect the structural and underpinning elements: analysis of the issues surrounding release of such capital cyclical growth gap. iii. Open Data: pools and it also laid down a pathway of action to begin to i. High Growth Segmentation: developing and embedding The power of data to better understand and boost tackle this which remain even more valid today. 1. CREATE A ‘NATIONAL BLUEPRINT FOR GROWTH’ a joined up strategy across business growth life cycles with economic growth is significant. Understanding our economic health demands frequent taking readings at Create a ‘National Blueprint for Growth’ that delivers a tailored solutions across national and local government. The key now is to significantly dial up at scale the many levels with existing and new data, and better ways strategic joined up approach to support and champion This should place scaling business, new and established, progression of these initiatives as well as deal with the of combining it. Harnessing public and private sector more consistent and effective growth across all regions across sectors, at its core. It should break down silos and regulatory impediments including revisiting Solvency II. data is key as we seek to refine and target initiatives and and sectors of the economy. Using a strategic, tailored departmental barriers to ensure there is a clear cross engagement towards scaling businesses in a timely and and segmented approach to scaling businesses that government scaleup strategy with dedicated resources and As reflected below there has been action taken on the effective manner. Government should make sure that addresses the UK’s systemic issues around scaling up relationship management structures at local and national majority of the PCR recommendations e.g establishing legislation supports data sharing across departments and across talent, markets and infrastructure, develop a core level to back delivery to address: British Patient Capital (BPC), re-focusing EIS and VCTs on localities, including that held by HMRC that has the most long term growth capital strategy to tackle regulatory, knowledge intensive firms and implementing a regional up to date data points. Open data sources such as Open legal and structural impediments and identify related • Scaleup talent needs across sectors and geographies, Angel programme through the British Business Bank. Banking should be leveraged along with APIs and the short-term tactical opportunities. including fast track visas. continuation of the Government DECA project. Better However, most initiatives are only part way to being • Scaleup market needs: procurement, collaboration use of data held will support the levelling up agenda, fulfilled and currently sub-scale to meet the full structural makes the ecosystem more efficient in their assessments challenges in play - yet alone the now significant Covid-19 and solutions and enable prioritisation of those areas of cyclical challenge. the country where the scaleup gap is increasing as well as target bespoke engagement with our scaleup high For example, the £2.5bn British Patient Capital programme, The creative industries’ sector has grown at twice the rate of the economy over the last two decades, potential growth firms. and the additional £5bn it is looking to unlock from the “ private sector, is in year two of a 10 year investment yet many creative businesses still struggle to access growth capital. This timely and important report demonstrates the growth potential of the UK’s innovative business base, and the scale of the potential programme, with so far only £334m in new BPC funded missed investment opportunity all over the UK. As we now look towards economic recovery Government commitments in 2018/19. On a regional level, the £100m Regional Angel Programme that was announced as part must ensure that high growth potential businesses, like those in the creative sector, can access the finance of the same package of measures is at an early stage of they need to grow, innovate and export, wherever they are based. deployment and has only deployed 30% of the funds in the first 2 years. VCTs are still hampered by rules that Caroline Norbury MBE, CEO, Creative England and Creative Industries Federation

40 41 THE FUTURE OF GROWTH CAPITAL REPORT

limit their follow on funding ability with existing portfolio Collaboration will be key going forward. Fully implementing regional centres/hubs, similar to the private sector, holding companies which necessarily impedes the ability for the PCR at pace is essential. We have the ingredients - they delegated authority to approve investors fitting the criteria In time the BBB and devolved nations development businesses to scale with their existing investor base. need to come together, be fully implemented and be set for participating in schemes set at national level. entities could also be a means through which to deliver supported by regulatory channels. This enhanced regional network could also be allocated the Shared Prosperity Fund at a local level. There is also a Blockers also remain to fully unlock institutional a portion of funding as a Local Opportunity Budget potential case for UKEF to align into the BBB and Devolved investment, particularly from Pension Funds. Whilst some The Government has a role to catalyse that collaboration for use on new local initiatives pertinent to the region entities as in other markets, such as Germany, where changes have been made following recommendations by and the private sector a role now to step up and work and matching pertinent criteria set at the outset. BBB export services sit under KfW. the Pensions Taskforce, further progress still needs to be together across finance players to address the significant regional offices could be firstly established in significant made on both the technical assessment of changes to fee issues growth capital issues Covid-19 has exacerbated if we regional clusters whilst at the same time, exploration of 4. EXPAND THE SCALE AND ROLE OF INNOVATE UK structures, as recommended in the DC Pensions review are to harness our entrepreneurial strengths and scaleup technological solutions to increase local reach should be AS OUR NATIONAL INNOVATION AGENCY which reported in September 2019, and to develop better films for the next generation. made. Relevant learnings from the Future Fund should be Expand the role and scale of Innovate UK and its direct vehicle that enable the industry to access high growth leveraged. deployment of innovation & R&D investment capital business asset class. 3. EXPAND AND BUILD UPON THE BRITISH BUSINESS (via grants and loans through their Investor Partnership BANK (BBB) AND OUR DEVOLVED NATION Expansion / Acceleration of existing products Model), to our most innovative, early stage and scaling The current acute challenges created by covid-19 mean it is DEVELOPMENT ENTITIES businesses. Expand Innovate UK’s (IUK) high growth even more important to take bold action to address both In addition to this expanded local presence with delegated Expand and build upon the British Business Bank regional relationship management infrastructure and the structural and cyclical challenges that the UK economy powers, the BBB should assess the suite of products now (BBB) by creating greater regional presence, with global innovation network, along with the critical faces. With the gap now doubling, a heightened impetus in its armoury and seek to scale up, accelerate and expand regional decision making, of the BBB deployed under partnership opportunities it brings to our scaleups and focus is required to allow the UK economy to move those with proven results. This would include expanding a national framework and continue the developments in collaborating with Government, corporates and forward to recovery. the Angel Co-Fund; accelerating deployment of the with Scottish Investment Bank, Development Bank of Universities. This should include expansion of the Regional Angel programme, expand the ECF programme Wales and Invest NI. Develop, through this presence, role and use of SBRI including its ability to drive The Government needs to rapidly accelerate the delivery and expansion of the activity of Regional Investment Funds empowered regional and devolved hubs with the procurement with scaling firms and Government as an of the suite of PCR initiatives with injection of both both to extend runways of existing mechanisms such ability to be agile and deploy funding to sectors and anchor ‘first’ client, strengthening the Catapult Centres further seed capital as well as impetus to deliver the as the Northern Powerhouse Investment Fund, Midland opportunities at speed, through both national and to support regional clusters and further drive forward required regulatory changes. Engine Investment Fund and expand into areas not yet bespoke, regionally designed schemes. Increase the BBB R&D investment via Test beds and technology focused covered, e.g. West of England/South West. It should also and devolved development entities capacity and runway competitions. To catalyse action, Government should in the forthcoming assess models working elsewhere and adopt them where to respond to the economic changes Covid-19 and the CSR invest further through the BPC structure and at proven and relevant including the Scottish Angel Co- exit from the EU bring. Expand existing programmes and Innovative businesses are a key part of growing the UK the same time seek to accelerate its partnership (move investment Fund model to widen access to co-investment develop new ones as economic and sector needs evolve. economy. Innovate UK has an important role to play towards) with the private sector by forming a much more opportunities. in driving this agenda and ensuring more innovative UK structured relationship between the BPC and the private Regional Presence - learning from others businesses go on to grow and scale in the UK and globally. sector, in a more formal Joint Venture type arrangement In particular the capacity for UK Venture Debt should be with private sector institutional and scalable funds, where fostered working with the private sector. In this regard, The intent of this model is to combine local knowledge However, there are a number of challenges which must be it can leverage both institutional monies, analytical and HMT should work with BBB to build on the success of the and insights with the British Business Bank’s expertise to addressed to ensure a strong recovery and future economy distribution power. Lessons can be drawn from the Future Fund to expand its life span and reach. deliver local solutions at a commercially viable scale - as which enables the UK to compete with other countries. Canadian models on such an arrangement which fosters scale will be vital for success. Firstly, the need to increase the level of R&D investment collaboration and cooperation, please cross reference with Tackling Information Asymmetries and Diversity from the public and private sectors - the Government’s page 38, Canadian Pension Schemes. Taking learnings from international players, the BBB’s role as intention to increase public investment in R&D to £22bn A key role for an enhanced BBB regional presence would a National Development Bank should retain an arm’s length per year by 2024/25 is an important statement of intent. Such a Joint Venture arrangement would provide the be to develop ecosystem cohesion through outreach relationship with Government, allowing it to focus on day It is also essential that the UK takes steps to maximise aggregator structure desired by the institutional players activities with the investor, bank, advisory and business to day operations and allocating resources where it sees the opportunity to have a recovery that supports green at the same time as delivering at scale regional funds with communities, building on the current role of the BBB market needs, while working to a clear and defined set of growth. Furthermore, in order to support our innovative, more ready access to investor pools. There are a range UK network team. This will also aid in addressing the long-term objectives that are agreed with government, scaling businesses to grow globally we need to maintain of UK private sector Funds that could be harnessed to information asymmetries through structured education with devolved entities operating on the same basis. access to, and develop new links with, programmes in form part of the Venture such as Foresight, BGF, Mercia, activities; investor briefings and intelligence gathering. It Europe and beyond that enable international collaboration Minerva etc. Leveraging also the structures that have should also facilitate a stronger cluster effect, which is The BBB would continue to act primarily as a wholesale and supply chain access, for example Horizon Europe. evolved through e.g. NPIF/Midlands/Wdb/SNIB and that beneficial to local growth, and be a driver of connectivity funder and ecosystem developer. To be seen as a global leader in innovation, the UK has to require evolution in other regions. From an institutional between regions and national private sector players. develop unique capabilities and facilities that are world standpoint the BPC with such a formation would provide Similar to the private sector, alongside the existing leading and therefore an attractor of global research the aggregator vehicle desired by institutional players The offices should also have a specific Diversity objective National HQ, going forward the BBB would strengthen its talent and businesses to come to the UK. It is important and at scale distribution. Whilst regulatory measures can and role to work with Diverse community leaders in network presence in regions which could include the set to anchor these in a strong and effective innovation be developed to encourage investment through such a extending the reach of finance to women and EMB up of formal regional offices. These could have ring fenced agency. Building on what works and taking action to vehicle in parallel relevant co investment and guarantee entrepreneurs. resources operating to defined parameters and budgets strengthen Innovate UK’s ability to deliver tailored support, structures should be deployed to support institutional and set at BBB national level. An enhanced regional presence programmes and funding to businesses that maximises corporate engagement with BPC. This should include the The BBB Finance Hub should be expanded to include would bring it closer to the market place, and to the their growth is vital. Increased partnership with the private immediate progression of the Small Business Investment greater levels of localised information, and potentially play end customer and will enable it to respond more rapidly sector is also important, both for leveraging private Company model identified in the PCR. a role in an equity referral mechanism working with the to emerging regional needs and themes. Such presence investment, but also to maximise the knowledge and private sector, such as the ELITE platform (see International would also reduce the friction of local investors’ ability expertise that exists and bringing them together for the Learnings). to access schemes in a timely manner with these BBB benefit of the business. 42 43 THE FUTURE OF GROWTH CAPITAL REPORT

businesses each year, bringing together a coherent package ADDRESSING THE ‘STRUCTURAL’ GAP: PROPOSED SOLUTION A range of key opportunities emerge for Innovate UK to of support including 250 Innovation and Growth Advisers expand its remit to boost growth: these include: across England, Northern Ireland and Wales (with Scottish Enterprise covering Scotland). A Scaleup programme Future Opportunity Fund InnovateUK National Development Banks A broader interpretation of the Frascati Manual: As using a novel delivery model provides high end intensive Institutional and Corporate Funding National Blueprint for Growth we move forward with the R&D roadmap, as laid out in support to a select group of c.40 companies with the the Government’s recent publication, we should take the highest growth potential each year. This should continue MARKET ACCELERATE EXPAND REALIGN CREATE opportunity, as part of a National Blueprint for Growth as to be enhanced and developed including its peer to peer FAILURES outlined in recommendation 1, to reassess the manner in activity. which we are implementing the Frascati Manual to ensure it optimises growth and R&D opportunities. 5. CREATION OF A ‘FUTURE OPPORTUNITY FUND’ 1. Uncoordinated Accelerate the Expansion of FCA regulation and digital Sandbox, Review tax incentives for EIS/SEIS, VCTA approach has implementation of in addition to Open Banking, to include an new state-aided funds to invest in later A dedicated Future Opportunity Fund should be Funding and finance – extending the investor Partnership created regulatory the Patient Capital investment component and ensure participation stages companies with lower tax relief to developed to allow the UK to effectively engage with barriers which recommendations incl. in the sandbox addresses key challenges around attract institutional funding Programme – Innovate UK funding is often seen by emerging sectors and industries such as the carbon impede the flow enacting of regulatory support for customers affected by Covid-19; the investor community as a “quality badge” and helps of funds changen needed in better access to finance for SMEs, and solutions net-zero challenge as well as drive forward on wider crowd in private finance where R&D is deemed too risky relation DC Pensions to help prevent fraud. Advance R&D tax credits and implement sustainable goals. alongside exploration of EMI reform or early stage for private investment alone. To ensure expanding VCT funding more private investment is crowded in, Innovate UK’s (e.g. company age, This would be ‘purpose driven’ and have the right risk Develop a kitemark that firms could use to attract Investor Partnerships model could be expanded, offering a investment thresholds) investment, e.g. Singapore’s APIX platform, a appetite to seed and catalyse long term UK economic package of public sector grant funding and private equity cross-border, open architecture API marketplace growth from nascent and developing sectors, and and sandbox platform, allows firms to drive investment to support early stage R&D and accelerate opportunities which are yet to emerge. collaboration between financial institutions and the process of commercialisation. Evidence shows that FinTechs. businesses that secure both grants and equity tend to This Fund would be designed to work actively with the raise more money and achieve higher valuations than their overarching growth blueprint set out in Recommendation Build on the Future Fund to create an equity counterparts who secured either grants or equity. As at 1, and the broader enhancements described in wider model that ensures diversity and inclusion, July 2020, £25.8m in grant funding has been committed to and addresses barriers to entry for EIS backed recommendations. 121 SMEs alongside £68m in aligned equity investment from businesses and other excluded growth businesses 21 investor partners. 37 projects have completed. Over It could sit as part of a number of existing bodies such as £118m in follow-on investment has been raised by SMEs Innovate UK and the British Business Bank. International Expanding VCT funding thresholds (e.g. company involved in these programmes (excluding one outlier raising age, investment thresholds) should be explored models often have such a ‘mission led’ under the wing of a further £67m). the Innovation Agency or National Development Bank.

Alternatively, it could be standalone and operate as an 2. Insufficient Accelerate deployment Address the levelling-up agenda by replicating Central Government resources to regions Better/more diverse Innovate UK’s wider portfolio of grants, loans and SBRI entity with the dual role of not only supporting domestic depth of funding and widen access to the success of the Midlands Engine and Northern distribution channels procurement contracts is also vital for many businesses and capacity, BBI Regional Angel Powerhouse Funds to other regions to ensure funds can be companies but international opportunities similar to a and the level of funding needs to be increased as well including scale programme Re-examine sectorial differences between accessed across the UK Sovereign Investment Fund. This would allow it to have and resource pool regional divides encouraging greater use of SBRI by other Government key hubs around the UK, and encourage both a domestic and international role taking significant in the regions Build further Angel capacity across the regions funding or support that targets Departments and public bodies. beyond London positions in sectors addressing global challenges. outside the Golden triangle as pipeline to scale-up specialities or industries and encourage a and the South East funding clustering effect Regional BBB physical To be effective, this Fund must also be flexible enough Testbeds – Large scale testbeds should be funded in areas offices aligned to key to account for the evolving nature of these future regional hubs, with to enhance the internationally recognised local strengths opportunities and actively work to engage with the data to devolved powers to tweak to raise the profile of R&D and innovation and drive core initiatives to regional find them. forward UK industry and new sectors of the economy; needs and take learnings from ICFC level up regional economies; attract inward investment and Innovative and new industries have significant risk profiles talent and drive the scaleups of tomorrow. and can be challenging for investors to engage with, even 3. Lack of scale Patient Capital Investment Company (PCIC) Address the imbalance on tax approach VCT Growth Fund and when the development of such industries will have long Catapult centres – there is the potential to strengthen and depth in programme of debt versus equity sector specific co- term material benefits for the UK and global economy as a follow-on funding investment funds, e.g. the existing network of Catapult centres and create new whole. due to limitations creative; life science; carbon centres in areas where the UK has the potential to take a in current range Replace the age limit with a gross assets test to net zero global lead and to support UK industry to do so. Given the of funding determine eligibility of State and Risk finance Building upon previous examples the purpose driven nature mechanisms centres are located in different parts of the UK there is also (EISA 2) of such a Fund will be key in enabling wider investment to the opportunity create more of a ‘cluster’ effect around industries of fundamental significance, and in line with UK them and collaborative opportunities as a route to anchor economy wide goals of job creation, levelling up and local 4. Information, Accelerate the Develop regional funding ecosystems to build on Central Government resources to regions Equity referral mechanism clients in the public and private sector. Collaboration deployment of work of BBB regional network, BoE and IUK EEN taking learning from SBA economic growth. and Connectivity Government High networks, alongside growth hubs: regional clusters credit sharing/debt referral Asymmetry Growth teams in every have a positive impact on growth processes ScaleUp Network – It is important to build on the success Segmentation and relationship The Future Opportunity Fund would represent an active department, with key management to enable businessess to of the existing Enterprise Europe Network and create a account managers tool that takes measured and recognised risks, as well navigate interventions and access the new network focused on innovation and global growth targeted by growth right service at the right time: simplifying Growth vouchers for as facilitating the mobilisation of private sector capital sectors, regions, product accessing advisory services to support innovative high growth and scaling businesses the process, reduce friction and into key emerging global industries that are of strategic accelerating opportunities. - which will be further in the UK. Currently the network supports over 3,000 clarified importance to the UK. 44 45 THE FUTURE OF GROWTH CAPITAL REPORT

ADDRESSING THE ‘CYCLICAL’ GAP: PROPOSED SOLUTION NEXT STEPS

Future Opportunity Fund InnovateUK National Development Banks This report has sought to bring together a range of data, investors, sectors and businesses, across the expanse of the Institutional and Corporate Funding National Blueprint for Growth finance and business landscape to home in on how the private and public sector can further collaborate to address our scaling businesses growth capital needs. MARKET ACCELERATE EXPAND REALIGN CREATE FAILURES Addressing access to talent and markets, along with this widening finance gap, remains vital if we are to close our scaleup gap. As we assess international models, we further reflect the need for the UK to be even more focussed on regionally empowered models, operating at scale, with regional clusters and heightened connectivity. Building on the foundations 5. Growth capital Expand scale of BBB, IUK and Enshrine BBB/IUK and Growth hubs Creation of sovereign wealth funds we have today, leveraging and scaling these up, will be key, along with reassessing regulatory policy to unleash private flows are not products therein in legislation for long term with with long term scaled funding sufficiently resilient agreed minimum 10 year funding that focuses on the domestic and capital flows. and flexible cycle international agenda through this crisis Scale of Venture Debt/Mezz We hope this report provides evidence for policy makers and businesses across the private and public sector as we seek Solutions to advance economic recovery and build back better. We hope that it informs further strategic projects underway, as Government to directly subsidise investments in midsized firms that well as the upcoming Comprehensive Spending Review with its focus on ‘levelling up’ and tackling long standing growth otherwise will struggle to raise capital and regional disparities. It is clear that this can only be done by close co-operation between the private and public equity or that support specific sector. The private sector stands ready to assist and looks forward to working with Government at national and local strategic objectives levels, to take this important agenda forward.

6. Increased Review State Aid risk finance Protect against macro-economic uncertainty and guidelines to enable relevant tail risk - get some offset through reduced risk time-bound EIS/SEIS adjustments insurance premiums in advance tolerance of to stimulate additional Angel and investors limits HNW investment interest in new Incentives for pooled investment opportunities vehicles; including corporate venturing

7. Government Boost role and capacity of private Expand InnovateUK grants and Establish London Stock Exchange as supported crisis investors to provide support and innovation loans which are a the leading pan-European market liquidity support capital through EIS/ISA incentives cornerstone to scaling growth for scaleups [inadvertently] for which the UK is in a strong and ‘crowding in’ private sector crowds out growth position investment funding or working New capitalisation vehicles to capital sources support the economy and clean up Expand and further develop banks’ balance sheets by setting up co-investment models to ensure a ‘bad bank’, to facilitate with other shared risk and increased leverage government initiatives of private investment

8. Supporting Accelerate initiatives that GotoGrow bespoke scaleup trade Re-examine sectoral differences Enterprise Landing Zones to further overseas encourage and attract overseas missions a la London/ between key hubs around the assist overseas investment into investment in UK capital into existing and new UK models to be deployed across all UK, and encourage funding or the UK growth companies equity growth funds, including role regions and take learning from support that specifically targets of BPC as cornerstone SVC2UK to develop a reverse certain specialitites or industries to model and build on successful help them grow and encourage a international investment models of clustering effect SIB; DoW and INI

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CONTRIBUTORS

We thank all the parties with which we have had the opportunity to engage and discuss this report:

• Agathos • London Stock Exchange Group • B-Lab UK • Make UK • • ScaleUp Institute • Barclays • The ScaleUp Institute Finance Committee • Beauhurst • Silicon Valley Bank • Beringea • Tech Nation • BGF • TheCityUK • Bio Industry Association (BIA) • The Entrepreneurs Network • BlackRock • The Industrial Strategy Council • British Chambers of Commerce • United Nations Global Compact • Business in the Community (BITC) • University of Oxford, Said Business School • BVCA • UKBAA • Can Do Scotland • UK Finance • Centre for Entrepreneurs • VCTA • Confederation of British Industry (CBI) • YPO UK Leadership Council • Deloitte • Business Action Council (A collaboration of 31 business organisations) • E2Exchange • EIS Association • Entrepreneurial Giving • Enterprise Trust • Entrepreneurial Scotland • Entrepreneurs’ Organization (EO) • Enterprise Nation • Federation of Small Businesses (FSB) • Foresight Group • Herbert Smith Freehills • ICAEW • Impact Investing Institute • Independent Professionals and the Self-Employed (IPSE) • Innovate Finance • (IoD) • KPMG

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