How can we finance entrepreneurial Britain?

How can we finance entrepreneurial Britain?'

CBI Access To Finance Conference

22.01.2009

It is a genuine pleasure to be here on a CBI platform again. In the 15 months since I have been in my present position, the CBI and the BVCA have co-operated very closely across a range of issues and long may that continue. 

There could be no more important question to address than "financing entrepreneurial Britain". Indeed in recent times it has seemed as if those three words should be followed by a question mark. Events since the collapse of Lehmann brothers last September have been truly extraordinary and continue to be so.

The second bite at the banking bailout in Britain earlier this week illustrates this spectacularly. If I had stood in front of you 12 months ago and predicted what has occurred you would not have believed me. If I had said it two years ago you would have had me sectioned under the Mental Health Act. 

Yet such is the moment that most media speculation today is about whether 2009 will "only" be another 1974/1975 or whether it has more of a 1929-1931 ring to it. I can offer an even older historical example from France, exactly 300 years ago. In 1709, ministers serving Louis XIV found that the short-term credit on which they depended to raise vast loans for the monarchy had suddenly dried up. The sale of public offices - their other nice little earner - had become saturated. Furthermore, their ability to manipulate interest rates and the exchange rate had been exhausted. Matters were made worse by an early example of stampede short-selling.

The French State had, in effect, to nationalize the banking system to save it. A deal was cut with the king's principal creditor, who was on his deathbed and thus not in much of a position to drive a hard bargain. Meanwhile an unprecedented early form of income tax was levied on all subjects. The good news is that these desperation measures actually worked and by 1710 the situation was stabilized. The bad news is that the banking network did, nonetheless, implode ten years later, triggering a recession which lasted for decades, sowing the seeds of the 1789 revolution and leaving financial institutions which were so weak that no national bank could be restored again in France until Napoleon in 1800. 

How are we to prevent such a disaster, or something perhaps a little less dramatic, occurring here and now? 

The mood of pessimism is profound and understandable. I am under no illusions about the scale of the downturn and the challenge it presents to my industry. Yet I believe there are grounds for optimism. Private equity and venture capital have been through a number of economic cycles and emerged stronger. They can be a powerful tool in helping the UK out of recession and moving us into the next phase of growth. My task in 2009 will be to ensure that the vital part private equity can play in kick-starting the recovery from recession we all want to see is understood by regulators, politicians and the media. 

How can private equity emerge as a pathfinder for prosperity? 

Firstly, private equity firms have cash available and are willing to spend. They have the hands-on experience necessary to help businesses through testing times. They want to invest in difficult situations and fix ailing and failing businesses.  We recently saw Whittard of Chelsea rescued by private equity. But we need more support from the banks. Private equity is being constrained in its ability to play a full part in economic recovery. With the right support, private equity can give these struggling businesses the tools to grow once the recession has cleared. 

Alongside more support from banks, private equity must not be encumbered by restrictive regulation. Last week Sir Michael Rake published his first report on the industry's compliance with the Walker Guidelines. I was encouraged by the progress the industry has made in such a short space of time. Compliance was sound and all firms understand their responsibilities to a wider stake holder base. However I am not complacent. I know that there are those who would regulate private equity out of existence. We cannot give them an excuse to do this. This is why we must continue to further transparency. It would be a tragedy if during the worst economic crisis of our lifetimes one of the few industries with the ability to kick-start the economy were prevented from doing so by black-letter law. I will be making it very clear to politicians, regulators and the media that private equity must remain free to do what it does best - invest with a long-term view and take difficult decisions to revive ailing companies.  

And private equity is proving its worth. New Look, which is owned by two private equity firms, bucked the retail trend by posting a 14.5% rise in total sales recently. Another private equity owned high-street store doing well is Poundland. Sales are up and it has recently announced plans to open 30 new stores and create 1,000 new jobs - a significant achievement in the current climate. Bank support is crucial if private equity firms are to continue to do what they do best, invest in businesses and create jobs where economic conditions allow.  

I came across a statistic the other day which I found heartening. Of the fifty private equity firms that raised the most money during the period 1991 to 2000 (so before the last downturn), no fewer than forty-six are still active today. This will come as a shock to the prophets of doom predicting the demise of the industry.  Private equity firms are resilient. This is due in large part to the fund structure, which aligns interests efficiently and ensures there are no rewards for failure.  

All this said private equity owned-businesses will feel the pressures of recession. Some may not survive a deep downturn and there will be a change in the way several operate. When the banks begin to lend at reasonable levels again, they will do so in a more conservative fashion than has been seen for some time. This will necessitate a greater focus on operational improvement and less reliance on debt to generate returns. But what I am confident of is that private equity will still be playing a major role when we move out of recession and a new economy emerges.   

In this I am not alone. A report published last week by the World Economic Forum in advance of its Davos conclave next week argued that private equity companies will be best positioned to attract fresh capital to invest in illiquid markets because they have established track records of aligning the interests of general and limited partners. On the possibility of more stringent regulation, the report said that unlike the hedge fund industry, private equity has not emerged as an amplifier of systemic risk and should not, logically, be a likely candidate for significant new controls. The report also foresaw attractive investment opportunities emerging as a result of the crisis. Private equity has in the past proven its ability to invest during a downturn and generate returns for its universe of investors, including, of course pension funds. With pension pots taking a hammering from the decline in public markets over the past year, private equity returns are going to be crucial for many pension funds struggling with growing deficits.  

I am continually working to dispel the myths around private equity, one of which claims that they make their money by selling the best parts of a business and pocketing the profit. A recent Ernst & Young study commissioned by the BVCA looking at the performance of 42 of the biggest private equity owned companies in the middle of this decade showed net organic growth in fixed assets of 6% - ie -'asset-strapping', not 'asset-stripping.' The report also showed that under private equity ownership organic job growth was 3%, EBITDA increased by 11% per annum and productivity grew 7.5%, compared to the UK average of 1.4% over the period 2003-2007.  

Private equity is only one half of the story.  Venture capital also has a crucial role to play in helping the UK re-align its economy and move into the next phase of growth. Politicians and commentators have focused on the evident need to broaden our economic base to allow the free enterprise economy to flourish over the long term. I couldn't agree more. As Gordon Brown has been saying over the past week or so, if 2008 was the year we confronted the global downturn, 2009 must be the year that the world comes together to invest in and build the economy of tomorrow.  So, as promised by the Prime Minister, we wait for the Government to set out its plans for: 

1. Smart investment in the industries of the future to give the UK global leadership by creating products and services we can sell to the world.

2.  A new programme of investment in green jobs and the environment.

3.  Investment in the digital economy, a market currently worth billions and expected to grow rapidly in the years ahead and a sector where Britain has the potential to be a world leader.  

And we wait with eager anticipation, because I know this plays to the strengths of venture capital investors. But it is also up to us as an industry to find a compelling argument to demonstrate that venture capital can make good returns by investing in the businesses of the future.  

Critical to our success is our ability to raise awareness of:  

1. why venture is good for Britain,

2. how it leads the way in Europe and

3. how it has the ability to propel new companies to the next stage of development in all sectors.  

So what are we doing? 

We recently launched our venture manifesto highlighting examples of where venture capital has spawned global leaders.  Our Venture Capital Committee's "Access to capital" team has been working to put return figures in a fuller and more comprehensive context and we shared exploratory numbers at our member-led launch event in early November.

In addition, our "Chairman's Research" exercise this year is entitled "Benchmarking UK Venture Capital to Israel and the US - What can be learned?" This will highlight some of the successful government interventions in other countries as well as the performance of funds in each of these countries and the specific drivers of performance in these funds.  

We want to demonstrate that venture capital is not only an attractive asset class for investors but also that it makes a positive economic and social impact. Thus, we are currently collecting data from a sample of UK venture capital firms that invest into early stage innovative intensive companies. And much of the information is very positive. In venture capital backed firms where information is readily available, preliminary analysis is already showing interesting trends in job creation. At one venture capital firm, companies that they have backed since August 2000 have grown their employment by more than 100% (1,777 highly skilled jobs have been created in this time period) and have increased aggregate sales by 500% (their portfolio companies have enjoyed a combined revenue growth of £455m).  

Preliminary results from another venture capital firm shows that they have created 1,505 jobs in 47 companies approximately 3 years after their initial investment. 100% of the companies that have supplied preliminary data spend a significant portion of their investment (more than a third) on R&D activities including on people and equipment. Over the 5 year period to 2006/2007, venture firms increased their worldwide employment by 8% p.a., a much higher rate than FTSE Mid-250 companies (at 3% p.a.). Their UK employment also grew by 6% compared to a national rise in employment of 1% p.a. Using this data, we have been working with the Department for Innovation, Universities and Skills to examine how the government can help venture firms make the fullest contribution to the economic recovery we all want to see.

Promoting these facts to Government will increase understanding of our business case and rally greater support.  This sort of robust data will also help promote the case for venture capital to those investors which have historically been reluctant to commit money because of the perceived 'hit and miss' nature of the companies venture invests in.  

Private equity and venture capital can be a weapon against recession and a resource for recovery. This will not happen, however, if politicians in Whitehall, or more pertinently perhaps, Brussels tie our hands and if the banks do not back those, like private equity investors, who want to back British business in its hour of need.

Financing Entrepreneurial Britain is absolutely vital because without that finance there will be no entrepreneurial Britain to speak of. It is as simple and as stark as that. I started with a reference to early eighteenth century France. I want to conclude with one from sixteenth century China. I have heard that in the Ming Dynasty there was a law that if any bank went bankrupt every employee from the chief executive to the office boy was beheaded. Consequently, there were no bank failures. I offer this example without charge of further comment to both the CBI and the Government. 

Thank you.