Select Committee on European Union Minutes of Evidence


Examination of Witnesses (Questions 120-130)

MONDAY 12 MAY 2003

MR ANDREW MARRATT AND MR STEVE BATEMAN

  120. Yes; as it is meant to.
  (Mr Bateman) I agree that the PR of it needs to be heightened so more and more people become aware of it, whether that be through business link, professional advisers or banks.
  (Mr Marratt) It is not well known enough by the student population, is it? If they saw this as a possible employment move, very, very often the companies who have had this placement person for a year or 18 months take them on full time. It is a fantastic extended job interview. It could be useful.

  Chairman: I am going to switch us away from the detail of TCS to a wider question.

Lord Cavendish of Furness

  121. This is rather challenging, because I do not quite know what you are about. You do not rely on assessing management for the success of a scheme, you do not want to take new risk, that is the way the banking system works, you do want new customers and you want these schemes to work and you are telling us about them, but you do not automatically have in-house, I venture to suggest, the qualifications which are saying how this entrepreneurial spirit works, because you have divorced yourself from it. I know from my own experience of taking over even a small business, I am shuffled off to accountants, minor merchant banks and so on. Is there a feeling—I am sorry to put it like this—that maybe the banking system like yourselves is not making the contribution they should to this entrepreneurial thing? You are obviously making a great effort here and you have taken a lot of trouble over your evidence and I know you are very high profile, but what are your qualifications for telling us how entrepreneurship should go? I am sure there is an answer to this.
  (Mr Marratt) We see the evidence on the ground, particularly with the university spin-out companies; we see the ones who are doing well and do our utmost to support them. I would stand by my earlier comment. It is not the place of bank finance to step in with loan finance ahead of the company being able to demonstrate its ability to meet those repayments. One lesson we learned from research work we have done with the US, where we compared the way in which UK banks and particularly one in Silicon Valley in the US operate, and in other areas as well, is that there is no one organisation which has the all the answers, there is no silver bullet, no magic formula. It is a question of everybody working together to support an entrepreneurial cluster of an entrepreneurial activity, be it in Oxford or Cambridge or London or York or Manchester. Almost at the end of it every party should say that they did not really do much, all they did was this little bit, 10 per cent. But if 90 or 100 people do 10 per cent, or 10 people do 10 per cent you get 100 per cent. The role for the bank as we see it is to identify those people early on who have the potential to take a company or an idea through to a successful high growth company, not to burden them with debt early on, which could just kill the idea, to have managers—this was a lesson from some of the US banks—who spend their time working with the network, so they know the entrepreneurs, they know the angel networks, they know the venture capital community, they know the particular stable from which that entrepreneurial idea has come, they will know the university chemistry department it has spun out of, or the entrepreneurship centre at the university. Informally and formally they can refer people to others who can support and then in a sense the bank can do what it is good at, which is to provide the appropriate financial services for those companies as and when they need them. Those services can be quite complex: it might be performance guarantees, international trade services, legal fees, intellectual property rights, insurance, all sorts of quite complex services which, if we deliver to them in a timely way, we are boosting that entrepreneurial spirit and in a sense feeling their pain by saying we know they are one who is going to go through this pain right through to the end result and we identify them as a high flying potential in a way.

  122. Back to the text then and answering my own question in a way. In order to get the downstream business you are looking for you can steer your customers in the direction of these various schemes and interpret them, but you find that the map of government schemes is very, very complex and even you yourselves find them hard to understand. Have you voiced this opinion to government? Have you contributed to the DTI review of its schemes? If you were asked for your advice, what would you say?
  (Mr Marratt) One thing we would say on a positive note, which has come back after the response was made to the review, was that we feel the recently launched DTI business and support directory, which is now available on their website and also on the business link website, is an excellent move forward and we have promoted that, or are in the process of promoting that through our internal communication to our managers and for them to then communicate it out to our customers. It has an excellent search facility by region or type or business type, or, if you have vaguely heard of a scheme, you can tap in the name you have vaguely heard of, or if you are looking for particular types of support in different areas; many different search facilities. Then it comes up with a straightforward guide to what the SFLGS is, what a SMART award is, what a Teaching Company Scheme is, depending on which, what the Phoenix fund is, or the venture capital bridge fund or whatever. On that note, positive, yes. That has happened in the last month really, so we applaud that one. On the responses to the DTI survey, yes, we did make a response on that. One area we have highlighted was the need for public sector support, advisers, business links, whatever, to be constantly in contact with the private sector advisers around them, not to see them in competition, in a sense they are in competition, but not to see them as trying to replace the commercially-minded advisory market, not to expect us to refer all our customers who need business planning advice to a business link organiser. We will refer them to the most appropriate source of advice for the type of company they have. We do think it is very important that all of the local business link advisers are always targeted to meet all of their local banks, all their local accountancy firms and be linked into them. The other area we highlighted was whilst we would not in any way expect all government schemes to come under a single one-stop shop, because that is just not feasible . . . I can remember when I was doing my A level economics hearing about one-stop shops back in the 1970s as going to be the saviour of us all and I am still waiting. In a way, it is like innovation: as soon as you have something new, it does not always want to join the one-stop-shop, but you should maybe have one place where people can go, particularly with the internet now, to look at that website or go to that place and they can point you in the right direction of the appropriate advisers. It is now a lot better than it was even six months ago when we responded to that survey.

  123. In your written evidence in Section 6 (a) you identify the difficulty for small growing businesses in obtaining "second round" risk capital in the region of between £2 and £7 million. What market failure causes this? If it is a market failure, can the government help overcome it and how?
  (Mr Marratt) The failure, if it should be called that, the phenomenon really, is that finance in the region of £1 to £2 to £3 million, £2 to £7 million, whatever figure is always quoted as the equity value—the gap always moves depending on what size of equity the individual is looking for in a sense, but the £2 to 7 million area—is generally, with some notable exceptions, going to be beyond the amount individual private investors would put in. Obviously there will be cases where people do, but once you get into that figure, it is getting to the commercial market. In the commercial market there would always seem to be an upward drift in terms of size of deal that they will invest in. That is for very good reasons. It is partly sheer excitement—it is much more exciting to be working on a £10 million deal than it is on a £50,000 deal. It is partly simply economies of scale in that the legal fees, the hassle, the time and effort to do a £500,000 investment will be the same as doing—

  124. That can be factored into the price.
  (Mr Marratt) It can be, but, given that many venture capital firms are not large entities, they are often two or three people with a couple of support staff and an office in Oxford or Cambridge, if a lot of their time is spent on the legal fees and the legal costs of the smaller scale investment, whereas with the same legal costs they can do several larger scale investments, they do tend to drift up. Also, the individuals, simply through their career path, want to move onto the bigger deals, the bigger funds that are investing, doing the management buy-out for £50 million or whatever. It also tends to be a less risky end of the market: the more developed the company, the slightly less the risk.

  125. The reason I find great difficulty in the concept of venture capital for this sort of finance is that they for a start are only interested in money—there is nothing wrong with that—but a lot of businessmen are not, because they want to develop their businesses and they have regard for their employees and all sorts of things which are beyond pure finance. Venture capitalists, almost without exception it seems to me, unless I am out of date, want a controlling interest in the business, want to influence management and want to get out of it as quickly as possible. Is that a healthy entrepreneurial development?
  (Mr Marratt) I would disagree on the point that they always want a controlling interest. They will obviously always want a sizeable stake in the company and it is not for me to quote typical amounts, because it will vary so much for different types of firm, but they are likely to want 10, 15, 20, 30 per cent of the company.

  126. As low as that.
  (Mr Marratt) It will vary a lot and like everything in life you will hear horror stories from different ends of the spectrum. Obviously it also depends on the amount of funding people are wanting as to the stake they will be expected to sell to the venture capital community. The venture capital community does obviously want an exit; that is how it gets its return. That does produce the issue of lifestyle companies which, colloquially, might well be a nice little earner, but are never going to go through to a public flotation, and it may still be a higher risk in starting up. So how does someone who has taken a stake in that company ever get their return, unless it is by some sort of participatory loans, some share in the revenues, some share in the profits? If it is done the traditional venture capital way, where they have to wait for a trade sale or wait for a flotation, then yes, particularly at the moment, flotations are not exactly happening as frequently as they were a couple of years ago and it may be a longer wait for the venture capitalists to get their money back. With this upward drift, it is almost like car manufacturers, making a small hatchback car and then the demand is for a bit more leg space and a bit more whatever, so the car gets a bit bigger. Eventually they have to have a new small hatchback which comes in underneath it. Then that one gets a bit bigger and you get the even smaller hatchback which comes in underneath it and in the end the original small hatchback is much bigger than the larger car which it used to replace. You get the same upward drift with venture capital firms and that is why we hope the regional development agency, the regional bench capital funds, as promoted and partly sponsored in a way by the RDAs, are good news. They have not been around long enough to make a judgment on yet. As long as they do not also have this upward drift, then you will probably have another one coming in underneath.

  Lord Cavendish of Furness: I find that very helpful; thank you.

Lord Shutt of Greetland

  127. You refer to this "second round" risk in section 6 (a) but in 6 (e) you then mention a continuing "equity gap" at early stages. You are a substantial bank and therefore several people come knocking at your door. For what percentage of the people who come with good ideas and whom you can assess well can you just not put a scheme together and just not get them away. What percentage of them that come to you can you not get away and really they have to be disappointed?
  (Mr Marratt) It does vary by geographical area. In the technology field in some areas of the country it could be as high as 80 per cent would come to us for SFLGS funding, but just cannot demonstrate any realistic hope of being able to meet the repayments. In Oxford, where there is a thriving business angel community, serial entrepreneurs, individuals willing to make investment, then yes, we can say we cannot help personally but here is an angel network which can, or that there are other people in the technology cluster who are able to provide that support. We do not regard it as a failure on the part of HSBC if we are able to refer somebody to an external source of funding which is more suitable for them, because that, to my mind, is still helping the customer, still helping the firm. If we are operating in an area of the country where there just is not so much suitable other investment, then yes, it is not a failure on our part but it is a shame.

  128. You are not able to have the cluster of the mind rather than the cluster of geography in terms of those who are not potential investors.
  (Mr Marratt) I have to declare an interest here as a sponsor and director of National Business Angels Network. Nearly all the banks are sponsors of that and they do have an interchange system, Best Match, for trying to get potential investors in one area of the country in touch with potential investee firms in other areas. There are all sorts of issues over that because investors generally do not want to invest too far away from their base point because of the distance to travel to see how the investment is going. That is one area we are keen to support for that very reason. You will have meetings in Oxford with angel investors and you will have people coming from Southampton and Bristol and all over the place just to come to Oxford to meet the angel investors there.
  (Mr Bateman) There is an emerging signal that people are looking on a wider geographical base. In Oxford Hartwell PLC are owned by a Middle Eastern family called the Jamils. They are doing a £5 million seed stage investment fund per annum now and, whilst they are based in Oxford, they say they want me and my colleagues round the UK to tell them if there is something in Edinburgh we want them to look at and when the technology is right they will look at it. There is an increasing emergence of smaller earlier stage funds looking to invest on a wider geographical basis.

Chairman

  129. We have minus two minutes to achieve the impossible. The impression for the layman in these matters is that there is already an enormous amount of support for venture capital. Our excuse is that does not leave the taxpayer to subsidise these things. So a lot of people, particularly taxpayers, who are not involved in small businesses and venture capital, might say an awful lot is already being done. I think you are suggesting that more could be done still further. What more could be done to bridge the gap, or is it simply that gaps exist and that is because some businesses just are not going to be profitable, or the risk is too great?
  (Mr Marratt) To answer the second part of your question first, it has to be accepted that there will always be some businesses which do not get funded and people whose ideas do not get off the ground. It could just be that the world does not want that product and you have to accept that people will fail along the way, and the fact that people fail should not be seen as a failure of the economy. A number of people who fail do then go on to do a more successful business and they may have failed in the closed business, but they have not actually lost money on it. You are quite right, it is a lot of state support, taxpayers' money in some respects, but the trick is that where that is seen as a match funding exercise, that it is the government almost priming the pump and knowing when to step back, then funding breeds funding. If, for example, the SMART scheme is never 100 per cent funded, you always have to put something into it yourself or find other investors to put funds in. With the regional development agency regional venture capital funds, there is an element of government support and they have accepted that they will be paid out last in the event of a fund being wound up, which encourages the private sector to come in and invest in a case where it might otherwise not have done.

Lord Shutt of Greetland

  130. Your Innovation and Technology Unit has produced detailed reports on technology funding in the United States and Germany. What lessons can be learned from these two particular studies for government policies to assist small and growing businesses in the United Kingdom and indeed beyond in the European Union.
  (Mr Marratt) First of all, the report on Germany is still at the draft stage. It is almost about to go to the printers and there is still a bit of checking and evaluation on that. Any comment on that is still the indicative conclusions. The report on the US was done at the end of 1999 so we have been through the dot com boom and bust cycle since then. Three or four key points from the US report which I shall just speed through. One is that you really cannot have a top-down approach and say this is the way innovation has to happen, because almost by definition you cannot tell people how to innovate. The US does benefit from very diverse equity and business angel markets and an easier regulation of business angel markets in the US. It is much easier for a group of individuals to get together and say they would like to view some proposals for potential investment, would you like to come along to meet us. If you do that in the UK you have FSA regulations, whether you are for profit, are not for profit, whether the people sitting in on the meeting are high net worth individuals, or whether you are from a regulated organisation and all sorts of things which make people frightened of going to gaol if they turn up just to make the tea. There is that issue. For a while the US certainly had a more favourable capital gains tax regime and a lot of that has been addressed since the report. Small business investment companies, SBICs, something they have in the US. In the recent budget that was proposed as a good idea for the UK which we welcome and would like to work on those proposals. A thing called the Bye-Dole Act which required all university research projects which have benefited from federal funding to do their utmost to commercialise that research, that is by spin-out company or by licensing. If you got money from the government you were duty bound to commercialise it if there was a commercial benefit from that research. Germany, still a draft, but early indications suggest that in Germany technology is valued an awful lot but the management skills not so much. It comes back to what we discussed earlier. So an awful lot of technology is promoted and gets off the ground but then is without the management skills. There was a lot of political pressure on the German regional banks to finance technology which really was not at the stage of being able to give evidence that it could meet the repayments and now there are problems because companies cannot afford to repay the banks and the banks are calling in the debts and so on. That has led to more failures than is good for the market. Certainly in Germany, with some very, very notable exceptions, many German universities could learn lessons from their UK counterparts as to the spirit of entrepreneurialism within universities and the recognition now being given to university entrepreneurship centres, the importance of considering the commercialisation of the research and the esteem given to the equivalent of Imperial College's IC Innovations, or Isis at Oxford or whatever. There is not yet that culture in Germany which values those people within the universities doing that work. Although yes, there are angel networks, the Munich angel network is a success story, but there is less business angel activity, so they do not have anything like the chance of a best match service like we have here in the UK, where you can swop deals between different areas of the country. There just is not that critical mass of activity. They are facing the same issue of companies getting through the early support stage, but not getting the second round funding.

  Chairman: You have been generous with your time. I apologise for overrunning, but it is a sign that you have interested us. Thank you for your evidence and your attendance. If there were anything arising, I hope we might be able to raise it with you in correspondence. Thank you very much.


 
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