China overtook the UK as the world’s second-biggest destination for venture capital investments in 2007, in spite of a 27% rise in British early-stage company funding to about £1.4bn, a survey published on Tuesday.
Library House, the Cambridge-based entrepreneurship research centre, said India was also due to overtake the UK by 2009 if Indian venture capital investments continued to grow at the 90% rate seen in 2006.
The report, UBS UK Venture Backed Report 2007 (free download following brief registration process) commissioned by UBS Wealth Management, forecast that UK venture capital could fall to £1bn-£1.2bn this year, equivalent to 2003 levels.
As of May 2007 there are 1,668 venture capital backed companies in the United Kingdom. In 2006 these companies raised a total of just under £1.4bn, an increase of 27% from 2005. This dramatic rise was driven by significant increases in activity in both information technology and services and retail. The top investor by syndicated deal amount was 3i Group while, in terms of activity, the venture capital funds managed by Scottish Enterprise topped the investor league.
The report says that activity of Scottish Enterprise has presaged a dramatic growth in the number of venture backed companies in Scotland. Since 1999, when the Scottish Parliament first sat, Scotland’s venture backed portfolio has grown much faster than England’s, off the back of one of the UK’s most favourable environments in terms of public sector support. However, for a given quantity of public money, less private money follows in Scotland than in England.
The fastest growing sector for investors, with investments up 91% by value from 2005 to 2006, was services and retail. This increase, which makes the sector the largest in the UK venture capital market, clearly demonstrates the opportunities available for venture capitalists outside the technology sector. According to an analysis of exits during 2006, services and retail companies also delivered the highest company returns of any sector, estimated at an IRR (Internal Rate of Return) of 66%.
Investment in the IT sector grew by 42% between 2005 and 2006, the second largest increase across all sectors. Within IT, the last few years have seen a sharp rise in the number of companies targeting the media sector. The report says that this is evidence of the emergence of a ‘mediatech’ phenomenon in which communications, information technology and media are converging. As media content delivery increasingly switches to internet protocol (IP), opportunities are emerging to provide the underlying technologies needed to support this. Several IT companies targeting this space are highlighted in the report.
The report says that persistent gap between the vibrancy of venture capital in the UK and Europe versus the US suggests the existence of structural problems on this side of the Atlantic. The rise of China and India poses a growing challenge. Although the UK attracts over twice the amount of venture capital per capita than the rest of Europe, on the same basis, it attracts approximately a third of the amount of the US. China has already overtaken the UK in terms of absolute size and India is likely to do the same by 2009. Policy must be framed to address these challenges and resolve the structural problems that limit both UK and European venture capital. A key objective must be to foster the development of a pool of companies able to deliver returns to venture capitalists on a par with those obtainable from other classes of private equity. Library House says that only if this is achieved will the vitality of UK and European venture capital stand a chance of matching that in the US.
According to the analysis, the UK public sector already supports its start-up companies more than any other country in Europe. The analysis suggests that this has helped to make the UK Europe’s most vibrant venture capital market. However, the performance of Israel and the US suggest that this support could be configured in a more effective way. Most importantly, stimulating the demand for venture capital (i.e. growing the pool of investable companies) should be considered as important as directly stimulating the supply of capital. Emulating the highly successful SBIR scheme in the US or the Israeli Incubator Programme would go some way towards achieving this.
The Small Business Innovation Research (SBIR) programme forces US government agencies to spend at least 2.5% of their R&D budgets with small companies. Over $2bn per annum is spent on the programme and the related STTR (Small Business Technology Transfer) scheme.
