This is the fifth in a series of blogs on the UK Industrial Strategy Green Paper published recently by the UK Government. In Blog #4 we offered a new framework for how to understand technologies as distinct from market spaces alongside the importance of maintaining and developing our control over key technologies.
This blog addresses questions 7,8, 9, 21, 22, and 23 posed in the Green Paper:
7. What are the most significant barriers to investment? Do they vary across the growth-driving sectors? What evidence can you share to illustrate this?
8. Where you identified barriers in response to Question 7 which relate to people and skills (including issues such as delivery of employment support, careers, and skills provision), what UK government policy solutions could best address these?
9. What more could be done to achieve a step change in employer investment in training in the growth-driving sectors?
14. Where you identified barriers in response to Question 7 which relate to planning, infrastructure, and transport, what UK government policy solutions could best address these in addition to existing reforms? How can this best support regional growth?
15. How can investment into infrastructure support the Industrial Strategy? What can the UK government do to better support this and facilitate co-investment? How does this differ across infrastructure classes?
21. What are the main factors that influence businesses’ investment decisions? Do these differ for the growth-driving sectors and based on the nature of the investment (e.g. buildings, machinery & equipment, vehicles, software, RDI, workforce skills) and types of firms (large, small, domestic, international, across different regions)?
22. What are the main barriers faced by companies who are seeking finance to scale up in the UK or by investors who are seeking to deploy capital, and do those barriers vary for the growth-driving sectors? How can addressing these barriers enable more global players in the UK?
23. The UK government currently seeks to support growth through a range of financial instruments including grants, loans, guarantees and equity. Are there additional instruments of which you have experience in other jurisdictions, which could encourage strategic investment?
The questions posed here relate to a very wide range of perceived barriers to investment, ranging from government stance on infrastructure development to investment by companies in employee up-skilling. While these are all critical areas, the over-riding challenge in tackling growth is understanding how innovative companies are actually funded.
The research data underpinning the Triple Chasm Model shows that the most important driver for investment into all companies and organizations is their maturity along their own growth trajectory: the investment mix, reflecting different sources of investment, varies with maturity based on an explicit definition based on Commercialisation Readiness Level (CRL).
The relative contribution to the investment mix of 14 different sources includes government grant funding, venture capital, customer funding and public and private markets. The ability of companies to attract the right kind of funding ultimately drives their own ability to invest in, for example, market, technology and skills development.
This picture of investment mix is at odds with the conventional language favoured by financial markets, based on ‘definitions’ such as pre-seed, seed, Series A, B, C: while superficially attractive as labels, the problem is that these labels can mean very different things in different market spaces and geographies, and can indeed change over time. To take one example, in the life sciences market space, for investments in therapeutic companies in the USA, the quantum for Series A investment can range from $10m -$50m (and sometimes higher), where the equivalent numbers in Europe may be one order of magnitude lower. What this shows is that, when we are looking at investment mix, the actual maturity of any company is a better guide to understanding investment challenges.
The other critical thing that this data illustrates is that the common perception of Venture Capital as the key player in managing high risk growth opportunities is at variance with the reality: typically, VC contributes about 2-3% of the growth capital, and interestingly, only half of that at the critical Chasm II where most growth companies struggle. This has important implications for the role of the state. This attitude of VCs to risk management should not actually be a surprise given the typical VC model (perhaps only flexed for some ‘evergreen’ funds).
Funding Mix Changes with Maturity
This typical ‘average’ view of investment vs maturity shows a clear pattern, which the UK Industrial Strategy needs to incorporate-but the precise decision-making framework needs to reflect the variation in risk and overall commercialisation timescales, which can vary significantly across different market spaces: this of course is then reflected in different timeframes for return on investment (T-Max), in say, financial services vs the development of new infrastructure, or new therapies. We believe that UK Industrial Strategy needs to reflect this variation across all the high-priority market spaces discussed in Blog #3.
Typical Variation in T-max
This variation in T-max across different market spaces has significant implications for technology development, market development support and type and quantum of investment required from a national perspective. This also has implications for the new Green Agenda, discussed in Blog #7, which explained the need for a wider ‘green’ stance than just looking at carbon emissions.
The UK Government has already flagged up the need for ‘patient capital’ as a critical funding challenge, and launched a number of measures to tackle this, including encouraging pension funds to become less risk averse. There are however two challenges with this:
- Identifying the precise nature of this funding gap.
- Taking practical steps to help ‘pension funds’ to manage their exposure to risk.
The Funding Gap at Chasm II
Analysis based on the Triple Chasm Model has identified that the real funding challenge occurs around crossing Chasm II where companies develop ‘charter’ customers and validate their commercial models. This is precisely the area where Venture Capital is intended to focus but in reality, plays a relatively small role. Our analysis confirms that this is where the funding gap is located: grant-based funding is largely focused on Chasm I, and public markets and corporates are mostly active around Chasm III. There is an urgent need to tackle the investment gap at Chasm II, based on a more structured approach than simply urging ‘longer-term’ investors to take more risk. This is where ‘Crowding-in’ Funding can and should play a critical role.
Key takeaway from this Blog
We believe that a well-structured approach to crowding-in investment is required to tackle this challenge head-on. The main features of such an approach should be:
- Targeted interventions based on specific market spaces with a good understanding of the market-space-centric value chain, regulation, and growth constraints.
- Appropriate structures to manage how government holds investment and to balance potential and risk.
- Selection of the right commercial players and investment structures within the government (for example, the National Wealth Fund and the British Business Bank).
The recent plans for the National Centre for Commercialisation in Life-sciences as discussed in our “Blueprint for a UK Industrial Strategy” could serve as an exemplar for this type of intervention.