Bridge over troubled water will help startups make it through

This post first appeared as an Op-Ed in The Telegraph on 21st April 2020.

https://www.telegraph.co.uk/technology/2020/04/21/bridge-troubled-water-will-help-startups-make/

The torrents are raging, the river is rising and some will not get to the other side. However the Government’s Future Fund to help tech startups and innovative companies is the lifeline that will make a difference to many.

The £250m matched fund offers startup founders a bridge across the waters to dry ground and should be very warmly welcomed.

It works by matching private investment, rather than picking winners. Between £125,000 and £5m will be made to companies in convertible loans, as long as the company can demonstrate that it has private sector investment — whether from angels, the crowd or venture capital.

Companies need to have raised at least £250,000 in equity investment from third party investors in the last five years, and be registered in the UK to qualify.

The reason that I am excited and optimistic about this funding mechanism is that it relies on a convertible note — a well-established and well-understood tool, already widely used within the startup world, that can help young companies navigate through this crisis. It also challenges the fantastic foundations that successive governments have built in the shape of the British Business Bank, Innovate UK and R&D tax credits to seize the moment and become the long-term resilient infrastructure that the UK, now one of the world’s best innovation economies, deserves. Now is the time for our innovation infrastructure to be agile and fast-moving just like the startups and scaleups it is there to foster and develop.

Matched funding

It meets the criteria of simplicity and familiarity, as well as following the principle of co-investment with the private sector, which I have argued for. Ultimately I believe this means that the Government is less likely to end up investing in companies that would not have done well in more normal times (adverse selection).

There has been some initial concern in the media that a convertible loan will need to be repaid. This is not the case. In the startup world, convertible loans (or bridge loans) are widely used to facilitate fast-growing companies. These loans convert to equity at the next round of funding.

It is typically used by companies who are wanting to defer their next funding round in the belief that within 6–12 months their value will be greater than it is today. During the crisis, it makes sense to use this mechanism to give a startup more cash runway, thereby allowing them to stay in business for longer and raise their next round when the environment is recovering or is nearer to normal.

Vital lifeline

The result should be a vital lifeline to the company and an opportunity to the investors (including the Government) to gain ownership in normally fast growing companies — or at least companies expected to recover post- Covid.

We need it because the UK’s tech sector is one of our greatest successes of the last 20 years. The tech sector grew six times as fast as the rest of the economy in 2019 and nearly 3 million people are now employed in tech, with almost 1.5 million job vacancies in the sector — before the crisis hit. Last year we attracted just over £10bn in venture capital — that’s a third of total investment in Europe and more than France, Germany and Sweden combined.

The UK has produced 77 high-growth tech companies or unicorns — private businesses that are worth over $1bn. That’s 77 businesses that did not exist 10 years ago. We really have created a world-leading ecosystem, second only to the US and China.

We are also world leaders in basic research and science, with 15% of the world’s most highly cited research papers — despite just 2.7% of global spend. Every £1 we spend on public R&D delivers over £7 of economic benefit.

Strong foundations

Since 2010, when the Government first started backing the UK tech system with gusto, we have seen a maturing and productive ecosystem come together, with great foundations put in place by policy makers. Through the British Business Bank and British Patient Capital there has been £2.5bn of capital made available to startups and growing companies. Innovate UK now has £750m of new funds to make grants to research-based companies. Over the years R&D tax credits, as well as the EIS and SEIS schemes, have brought capital and experience to build the pipeline of next generation companies.

As most are aware, venture capital returns are delivered by the few outliers which produce outstanding results. The optimist in me believes that the Future Fund will allow those companies which would have thrived in normal times to attain the point where they are strong enough to survive this crisis and hopefully go on to become the UK’s next unicorns.

For the new Future Fund, and indeed the additional funds for Innovation to deliver their benefits, rapid deployment is essential. Reliance will be placed on BBB, BPC and Innovate UK to respond. In normal times, these organisations have been providing significant support to the eco-system. They will now need to do so at lightning speed. Anything less and the opportunity will be lost. This really is a case of ‘time is of the essence’

Today’s announcement is an opportunity for all the players who will deliver this lifeline to raise their game to the next level and become as agile and as fast-paced as the best investors of the private sector. That is how we will make sure that Europe’s best tech ecosystem continues to flourish, attracting capital from home and from overseas and allowing great ideas and innovation to be turned into market-leading businesses.

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Robin Klein

Entrepreneur, now active early stage tech investor. Portfolio includes/d: LoveFilm, Moo, Graze, Zoopla,CityMapper,Fizzback,Improbable,Transferwise+ others