Primary Purpose: New Hampshire has spoken. What has it said? What will it mean?

Politics Insight
The first of the presidential primaries of 2016 occurred yesterday in New Hampshire. What do the respective victories of Senator Bernie Sanders and Donald Trump mean for the rest of the contest?
Why New Hampshire matters
Since 1952, when Dwight Eisenhower entered the Republican Primary to demonstrate his broader appeal by defeating Senator Robert Taft, the favourite of the party establishment, while Senator Estes Kefauver upset incumbent President Harry Truman on the Democratic side of the ballot paper (thus extinguishing any thoughts that he might have had about seeking re-election), the battle for the allegiance of New Hampshire voters had had a massively disproportionate influence over the race for the White House. It has become so important to New Hampshire itself that its state law mandates that it hold its presidential primary before any other primary in the United States (but not in advance of any caucus state, hence Iowa’s competition last week).
Furthermore, New Hampshire has a stellar record of correctly anticipating the eventual nominees in each party having backed the ultimate Republican candidate in the contested elections of 1976, 1980, 1988, 1992, 2008 and 2012 and the victorious Democrat in the contested elections of 1976, 1980, 1988, 2000 and 2004. This is a consistently better record than the Iowa caucus whose victors often fall flat later in the competition. New Hampshire is, however, biased to those from adjacent states backing men from Massachusetts in 1988 (Michael Dukakis), 1992 (Paul Tsongas), 2004 (John Kerry) and then 2012 (Mitt Romney).
Yet in many respects, New Hampshire is a surreal state to award such a status to, especially for the Democrats. It is small (the fifth smallest by land area in the US), sparsely populated (the ninth least populous state) and very much rural and suburban with no major conurbation to speak of. It is highly disproportionately white (92.3% compared with 62.1% for the US as a whole), with minimal numbers of Hispanic/Latino citizens (2.8% compared with 17.4% nationwide) or African Americans (only 1.1% compared to 13.2% across the whole United States). Average income is high (the sixth largest in the US) and it has the lowest estimated poverty rate in the country. It also has a distinct age profile with older Americans overrepresented compared with younger ones. It has unusually large numbers of residents who have at least a college-level education. It also has a strikingly libertarian streak to its political culture (the state motto is ‘Live Free or Die’) demonstrated by high rates of gun ownership, the absence of either a state income tax or a state sales tax (unique in the US) and is the only state in the union which does not require adults to wear seat belts in their own vehicles. It is clearly atypical.
It is important to note, though, that it is far more atypical for Democrats than for the Republicans. The Republican electorate across the entire United States is whiter, more affluent and older, more likely to live in a rural or suburban settlement and more likely to have a college degree than normal.
The sole significant feature of New Hampshire Republicans that deviates from the national average for their party adherents is the character of religion in the state. The numbers of Protestants is low in relative terms and the fibre of that faith is Episcopalian, even Anglican, in tone rather than Baptist or Evangelical. The numbers of white Catholics is comparatively high and the proportion of residents who are willing to admit to not being particularly religious at all (at more than a quarter) is amongst the largest recorded in such surveys in the United States. This is very different from Iowa (or indeed South Carolina which holds the next primaries for the two parties) and this explains why somewhat unconventional Republicans often do well in the state (John McCain won here in 2000 and 2008) and why liberal Democrats who appeal to white upper income intellectual voters often perform well too.
The Democratic outcome
In the light of its previous history, Senator Bernie Sanders triumph over Hillary Clinton is far from the shock result that the media will undoubtedly present it to be. The Senator is from the neighbouring state of Vermont. His support base lies in precisely the kind of highly educated affluent white liberals found in New Hampshire. Those of his policy stances which buck his broad pattern (he has a spotty record in his votes on gun control for instance, a liability with Democrats nationally) did not do him harm here. If there was any state in the entire USA bar his own Vermont where he was better placed to outperform his overall potential it is New Hampshire, which is precisely what occurred yesterday. All this was confirmed by a set of opinion polls which have had him ahead in the state for some time.
This is almost certainly the high point of the Sanders campaign. Mrs Clinton will endure a somewhat uncomfortable two and a half weeks until the South Carolina Democratic Primary which will be held on Saturday 27 February (rather strangely it is a week later than the Republican ballot in the state). The electorate for that event will be dominated by comparatively poor African American voters with whom Mrs Clinton has a vast lead and highly educated rich white liberals will be thin on the ground.
Much will be true for the states taking part in the next wave of primaries on 1 March, the so-called ‘Super Tuesday’, where most of the action takes place in the South, with all of Alabama, Arkansas, Georgia, Oklahoma, Tennessee, Texas and Virginia voting. Mrs Clinton will probably sweep the lot. The most that Senator Sanders could realistically expect is to prevail in his Vermont and possibly Massachusetts and perhaps the Colorado caucus and the Minnesota caucus (where turnout will be very low indeed and the likely electorate will closely resemble those witnessed in New Hampshire). If Mrs Clinton’s bid for the White House is derailed it will not be by her current opponent but only by a dramatic event (such as the saga around her use of a private e-mail account to send material that should have been restricted to her official account becoming much more damaging) forcing her out.
The Republican result
The Republicans, by contrast, look set to endure a wild race that could last for some months yet. The big winner was Donald Trump not simply because he won with about 35% of the vote but because of the manner in which the ballots cast for his opponents ultimately divided. As noted in BVCA Insight three weeks ago, the only credible route for the populist billionaire to secure the nomination is one in which the non-Trump/anti-Trump electorate fails to unite around a single candidate swiftly and he can stockpile large numbers of delegates benefiting from the rules of the Republican contest which heavily reward whomever comes first in a primary or caucus. That is precisely what could now occur.
For none of Mr Trump’s rivals has a strong claim to be his principal rival. John Kasich came second in New Hampshire but not by a crushing margin and there are real doubts as to whether he can sustain his campaign in South Carolina on 20 February and then in the slew of mostly southern states that hold their contests on 1 March. Ted Cruz came in third, but with less than one vote in eight which is not what he needed to maintain his Iowa caucus momentum. Crucially, Jeb Bush seems to have just squeezed past Marco Rubio who might have hit the self-destruct button in the debate last weekend. The remaining contenders (Christie, Carson and Fiorina) must surely be on the verge of withdrawal.
All of which means that South Carolina becomes a primary within a primary for the Republicans. It is at one level a three-way battle between Cruz, Rubio and Bush as to who is the alternative to Trump with Kasich seeking to defy expectations with a better than anticipated showing in hostile territory. Cruz has a strong enough base to continue until 1 March. The real sub-contest is Rubio versus Bush.
Tim Hames, Director General, BVCA
Sector Insight
Cyber (In)Security: Threats and risks from the Internet of Things
As businesses continue to reap the benefits of online services and digital platforms – through greater accessibility to consumers and international markets – so too are they exposed to a variety of increasingly potent threats. So long as the internet remains a central component of future commercial growth, businesses and their private equity and venture capital-backed investors will need to adopt stringent and effective cyber security systems if they wish to not only protect their products or services, but to secure their capital and their position in hyper-competitive global markets.
The scale of criminal cyber activity cannot be underestimated. According to a Cost of Data Breach Study by IBM and the Ponemon Institute, the average cost of a cyber-attack in the UK was £2.37 million in 2015, an increase of 7.2% on the previous year. The study also revealed that the average per capita cost of a data breach rose from £95 in 2014 to £104 in 2015, with 49% of the breaches defined as malicious or criminal attacks. A similar study by the Department for Business, Innovation and Skills (BIS) found that 81% of large organisations had experienced a cyber security breach over the past year, with a subsequent cost of up to £1.5 million for each organisation. Perhaps unsurprisingly, lucrative industries such as financial services, pharmaceuticals, energy and technology were the principal targets of these attacks.
It is thus vitally important that private equity and venture capital firms ensure that both existing and newly-acquired portfolio companies are protected against cyber-attacks and malicious online activity. A comprehensive strategy will of course include the implementation of appropriate IT security systems, but it should also require the extensive training of staff at all levels of the business (and private equity or venture capital house). Indeed, a recent survey of 200 IT security professionals by recruitment consultancy Harvey Nash found that 45% of those questioned believed that their board of directors had a “major gap” in their comprehension of cyber security risks. This worrying precedent is further compounded by the fact that just over half admitted that cyber-attacks had caused loss of revenue to their businesses, with 35% stating that subsequent damage had been caused to their company’s reputation.
Given that venture capital and private equity investors not only commit their capital to a portfolio company but also their commercial expertise and sectoral knowledge, it will be essential that those investors are aware of how to execute a robust cyber security strategy in order to guarantee a business’s profitability and, by extension, its viability in its market. A company with an online presence should not voluntarily remain exposed to cyber threats any more than one would expect a traditional high-street store to leave its doors wide open during closed hours. Indeed, the very vastness of the internet and the increasing complexity of malicious cyber activity mean that the risks to a business are potentially more severe yet more unpredictable.
For instance, the growing prevalence of ‘ransomware’ and ‘hacktivism’, attacks should be seen as a substantial threat to portfolio companies with online operations. Ransomware, a form of cyber-attack that involves hacking into a company’s system, encrypting data and then demanding a ransom as a condition for ending the attack, epitomises the growing sophistication of online criminal activity.
Investors ignore this threat at their peril. Concerns over the cost of implementing cyber security systems – reasonable though they are – should be viewed within the larger context of protecting a business’s assets and reputation. No investor will want to admit that their portfolio company’s profits were hit by a preventable cyber-attack because it was decided that funding could be more appropriately used elsewhere. If an attack were to be successful, such a decision would ultimately be embarrassing at the least, and considerably harmful at the most.
Fortunately, new methods to counter cyber-attacks are making a positive contribution to online security systems. So-called ‘honeytrap’ or ‘polymorphic’ technologies, whereby hackers are lured into a system that constantly changes the structure of applications on a computer – essentially outfoxing and catching the culprits – are being viewed with increasing interest. Although these technologies are still in their infancy, they do represent a welcome shift to more aggressive forms of cyber surveillance and protection. According to Daniel Ives, a senior technology analyst at FBR Capital Markets, these new deception technologies are set to become an increasingly valuable addition to the cyber security sector, with a forecast market value of US$3 billion over the next few years.
Whilst the United States and Israel continue to lead the field, the UK’s cyber security industry is witnessing strong growth and market expansion. Employing over 100,000 people, the UK sector has increased in value by over 70% since 2013 to £17.6 billion. More promising still, the venture capital and private equity industry has continued to take advantage of this growth trend, funding start-ups, supporting the development of new technologies and strengthening the UK’s competitiveness in this area. Notably, Paladin Capital Group recently established a new US$350 million fund to invest in British cyber security start-ups, with an aim to target investments of up to £30 million in early-stage businesses that sell to governments and commercial markets.
The UK Government’s recent policy proposals, as well as its acknowledgement of the need to develop effective cyber security systems have unquestionably created the necessary sense of certainty and stability required to allow the industry to flourish. The Chancellor’s announcement in the Autumn Statement that the Government is to almost double investment in cyber security to £1.9 billion by 2020 was viewed by many as a renewed commitment to not only improve sovereign capabilities but also to strengthen Britain’s market position in this field. The Early Stage Accelerator Programme, launched earlier this month, is a most welcome example of the Government’s commitment. The scheme, funded by the National Cyber Security Programme and managed by Cyber London and the Centre for Secure Information Technologies (CSIT) at Queen’s University Belfast, will aim to increase the rate of cyber security start-up development in the UK by supporting entrepreneurs and helping to gauge the commercial viability of new ideas and technologies. This should provide the necessary spill-over effects into the wider industry to encourage greater levels of investment from private equity and venture capital firms whilst underpinning innovation in the sector.
Businesses, as well as their private investors, must be prepared for any perceived threats that arise from operating services online. The commercial opportunities are of course considerable, but unless action is taken to protect company assets and equip employees at all levels with the relevant education and training, then cyber threats could ultimately prove to be devastating especially when considering the growing audacity and sophistication of criminal hackers. From an investment perspective however, UK cyber security start-ups appear to be as increasingly competitive and sector-disruptive as their American and Israeli counterparts, suggesting as always that where there are significant risks there are also substantial rewards.
Research Insight
Small is beautiful
A recent publication by the British Business Bank, Small Business Finance Markets 2015/16, has outlined the continued importance of smaller businesses to UK economic growth and productivity, as well as the transition of finance markets that support those businesses. The report also highlights the challenges SMEs face in terms of access to finance and their role in improving the UK’s sluggish productivity.
According to the report, there is clear evidence that entrepreneurial activity in the UK is high. Recent figures from BIS show there were a record 5.4 million private sector businesses at the start of 2015, up 146,000 from 2014. The ONS also recorded 351,000 total business births in 2014 – the highest documented since records began. A report from the Enterprise Research Centre further highlighted the fact that SMEs’ contribution to the UK economy is becoming increasingly substantial, with SMEs now accounting for 60% of all private sector jobs and 47% of revenue.
With this in mind, it is no surprise that there is an increasing volume of finance sourced for SMEs, mainly in the form of bank loans. Bank lending data from the Bank of England (BoE) below illustrates the gross flow of loans, excluding overdrafts, to SMEs reached almost £58 billion in 2015.
Source: Bank of England, Bankstats 2015
However, a survey conducted by the British Business Bank in 2014 found that a significant proportion of businesses were discouraged from seeking finance for fear of rejection, with 28% of those surveyed not knowing where to access finance at all. Furthermore, there was relatively low awareness of the alternative sources of finance available if the business had difficulty accessing finance from a bank. Moving on from the demand side, there is also room for improvement with regards to the supply of finance for SMEs, as stressed in the British Business Bank’s report. There is concern that, despite the fact that £2.2 billion was invested annually in smaller businesses by equity providers in 2014, only 1% of small businesses have accessed equity finance in the last three years.
The UK’s productivity challenge
The UK has had a persistent productivity problem, as demonstrated in the chart below looking at constant price productivity. Using ONS estimates indexed to 2007=100, it displays the evolution of labour productivity for the UK against the rest of the G7 and includes simple projections based on average productivity growth from 1997 to 2007 (before the financial crisis). Using the projections, it is clear that the UK has a greater productivity gap (18%) relative to the projections of the rest of the G7 (7%). Economists use the productivity to measure how effectively businesses use labour and capital to generate products and services. As such, productivity is an important indicator in the wider context of the UK’s international competitiveness and future investment prospects.
Source: ONS, International Comparisons of Productivity 2014
The significant contribution of SMEs to the UK economy suggests that boosting SME productivity can have a real impact on the UK’s overall productivity. There is strong evidence that the role of internationalisation and innovation has had a positive effect in boosting SME productivity growth. It is estimated that between 9-12% of non-exporting UK firms have the capacity to become exporters.
Additionally, research from the Enterprise Research Centre claims that the limited engagement of SMEs in internationalisation and innovation is rooted in the low growth ambitions of SMEs. They propose that the drivers of change in this regard lie in business innovation education for SMEs and improving access to capital in the form of debt and equity financing to stimulate demand and support supply.
There is still limited diversity in the supply of smaller business finance. Real diversity and choice in supply would be accelerated by increased awareness and confident demand for financial alternatives. This is imperative as smaller businesses are essential to addressing the UK’s productivity challenge.
Bibliography
British Business Bank., “2014 SME Journey Towards Raising Finance Survey”, 2014
British Business Bank., “Small Business Finance Markets 2015/16”, February 2016
Department for Business Innovation & Skills, “Business Population Estimates for the UK and Regions 2015”, October 2015
Enterprise Research Centre, Goldman Sachs and British Business Bank., “Unlocking UK Productivity – Internationalisation and Innovation in SMEs”, 2015
Office for National Statistics., “Business Demography, 2014”, November 2015
Office for National Statistics., “International Comparisons of Productivity, 2014”, September 2015