Nurturing unicorn start-ups

Photo of a unicorn
By Martin Morris, The CA magazine

15 December 2017

Martin Morris discusses the logistics of turning a start-up into a billion-dollar ‘unicorn’ and government plans to help businesses scale up.

Unicorns are rare beasts: nurturing them takes patience. Investors must often be prepared to forego quick profits, keeping their eyes on the more long-term prize of taking a business from start-up to “unicorn” status, generally defined as a market capitalisation of $1bn (or equivalent).

The UK Government’s Patient Capital Review (PCR), which launched in January this year, aims to improve the long-term financing environment for business start-ups. Yet, as its first policy paper made clear, while the UK does well, by international standards, when it comes to launching business start-ups, it’s far less nimble regarding the provision of needed long-term finance for those businesses looking to eventually scale up their operations into so-called unicorns.

To put things in perspective, external equity finance is used by only about 1% of the UK small business sector, according to the BDRC Continental SME Finance Monitor Q4 2016 (published in March 2017). Fewer than one in 10 firms that receive seed funding in the UK go on to get fourth-round investment, compared to nearly a quarter in the US.

Although the UK (which accounts for an estimated 4% of the world’s “unicorns”) leads Europe, it lags behind the US and China, which boast 54% and 23% respectively.

The importance of external equity

For firms with ambitious growth plans, especially tech businesses in which revenues typically lag behind investment, external equity becomes a much more important factor.

But as Alice Telfer, ICAS Head of Business Policy and Public Sector, put it: “Our view is that the real funding gap applies not just to the best high-growth companies at the top of the investors’ attractiveness list but also those businesses which are a tier below; those that have struggled to get private investment in the current market but nonetheless have potential.

The Government’s overriding objective remains making the long-term financing environment more “investor friendly".

“Most businesses are not in the high-growth category yet they may be strong and reliable businesses which contribute to sustaining and growing employment in the UK economy. We would encourage Government not to overly focus on high-growth business.”

The PCR has also been tasked with identifying the root causes negatively affecting the existing financing environment. The Government’s overriding objective remains making the long-term financing environment more “investor friendly”, removing barriers and providing policy support for patient capital.

Addressing the appetites of investors

A key component of the PCR has been the proposed introduction of a National Investment Fund (NIF), outlined in the paper Financing growth in innovative firms. Consultation on this ended on 22 September.

UK businesses currently benefit from funding from the European Investment Fund (EIF). A new UK-based fund would, in theory, provide an alternative, assuming the existing relationship with the EIF ends when the UK leaves the EU.

The paper also looks at how businesses might benefit from investment by pension funds; at how to commercialise research from UK universities; and how to drive investment in firms across the UK.

Investors have different time horizons, risk appetites, and attitudes to liquidity and the wider market and regulatory environment.

A major part of the problem is that investors’ exposure to patient capital and other forms of long-term finance differ significantly according to the type of investor. Investors have different time horizons, risk appetites, and attitudes to liquidity and the wider market and regulatory environment.

In the meantime, the vacuum is rapidly being filled with new and innovative solutions, such as Edinburgh’s peer-to-peer LendingCrowd, for example.

What about tax relief?

Meanwhile, on the issue of extending tax reliefs, the Government argues that there has to be a trade-off between allocating resources used to extend tax relief for individuals investing in patient capital, and the additional support provided through a new fund.

EIS and VCT reliefs should not, however, be seen as a net cost to the Treasury, according to Robert Pattullo CA, member of the ICAS SME group and former chair of the ICAS Business Policy Panel.

He said: “These tax reliefs really do encourage investors to invest in early-stage innovative companies that are much more risky than normal stock market investments.”

The Treasury’s position is that focusing new resources on investment via the NIF may be more effective, and provide better value for money, than more generous reliefs for investors.

Calum Paterson CA, Managing Partner, Scottish Equity Partners, isn’t alone when he stated: “Access to adequate and appropriate long-term investment is… a critical factor for success.”

Yet, as a long-term objective, that may be easier said than done. Investor attitudes are all too often entrenched and the Government’s approach, when it comes to policy-making, is often glacial and invariably badly targeted.


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