«Research commissioned by the Intellectual Property Office, and carried out by: Martin Brassell, Kelvin King This is an independent report ...»
The FSE Group has also been responsible for management of innovative funding structures, including the Accelerator mezzanine debt fund (now winding down as it approaches the end of its 10 year life), which provided access to up to £200k of debt funding to growth businesses in two instalments, and the Proof of Commercialisation (‘PoCket’) fund, providing up to £50k of contingently repayable grant funding. The Accelerator Fund was funded by Small Business Service and Bank of Scotland (later Clydesdale Bank) and the PoCket Fund by the South East England Development Agency.
The Accelerator Fund was aimed at a market seeking additional non-dilutive funding to support growth and the achievement of business milestones. Typically priced at 7-11% above base rates to take account of the absence of security, it was used by 141 businesses over its lifetime.
Kevan Jones is Chief Executive of The FSE Group, with 30 years’ experience in SME funding via
traditional banking, acquisition finance, asset and invoice finance. He comments:
86 The role of intellectual property and intangible assets in facilitating business finance
Andrew Mullinger is co-founder of the largest peer-to-peer lending network to small businesses, Funding Circle, which at the time of interview had lent over £128m to more than 2,000 businesses since its inception. It operates an innovative, highly data-driven service, which is used to inform a manual assessment of each opportunity before it is promoted on the platform.
Funding Circle is one of the organisations which has already benefited from the Business Finance Partnership, and currently 20% of the total amount that approved businesses seek to raise will ultimately be government funded.
Funding Circle takes charges now over business assets and adopts a policy of taking personal
guarantees for loans of less than £100,000, though Mullinger would like to change this:
We take a charge over all assets as the first or second chargeholder: we can also buy assets and lease them back, or use hire purchase. Where we have any tensions with other lenders, they arise around priority of assets: we are pushing for greater speed and efficiency in the process.
One of my aspirations has been to lend without personal guarantees. We haven’t managed that yet – though in some cases we don’t take them on deals over £100k, because at that level, we have to find security in the business. I think IP could provide some of that ‘skin in the game’ element.
However, the current scoring models do not work well with intangibles-rich businesses:
We don’t have a policy that we won’t lend to you unless you have hard assets. However, companies get allocated a risk band. The issue with these [IP & intangibles-rich] businesses is that their balance sheet would be poorer. Like any other lender, we look at the balance sheet and we always strip out the intangible assets. The people with more intangibles than hard assets will always come out worst!
So anything we do around IP at the moment is pretty unstructured; it is just about having confidence that there are some assets which contribute to the cash flows.
Mullinger offers the following view on finding ways to finance IP in a more structured way:
My view on the future of this is that it will be massive. The capital resources needed to set up a business are reducing all the time, partly due to technology, and even if you use machinery, you generally make the money from the thinking behind it. So there is a lot of untapped IP on the market.
There is a huge opportunity for lenders who can lend against it in a smart way. I think it might be done by applying ratios to particular segments or ‘slithers’ across a whole portfolio, based on research into precedents where IP value has been tested, to determine what the implied IP value for that sector should be.
It needs some critical mass to work, and my view is that you would put in a structure at an industry sector level. But if you invest in this space, you will build up knowledge that could create a competitive advantage. Of course, you can do it now on bigger deals, on a one-off basis, but that doesn’t scale.
88 The role of intellectual property and intangible assets in facilitating business finance
One company which has made considerable use of pension-led funding to finance businesses is Clifton Asset Management, whose overall average loan size is around £125,000. The business has funded around 1,500 businesses to date.
The two limiting factors for how much can be raised by a business are the value that can be found in their IP and intangibles, and the value of the pension. The pension funds can belong to an individual or a group of participants. As a general guide, Clifton Asset Management discourages the use of these mechanisms where the total existing pension is worth under £50,000, as the process typically involves costs of around £7,000. Chairman Adam Tavener
explains that the process is “driven by pragmatism”:
Should a business be sold while the pension fund owns or controls the IP assets, there are a
number of options:
The deal can always be undone, and is always under the control of the business in any event. It can be rounded out by paying off the outstanding balance, and the IP transferred; or the pension fund can sell the IP, leaving the capital gain within the pension fund, which is a good way to defer tax liability; or, the agreement can be novated, though this isn’t usually the chosen route.
The tax treatment of the asset once transferred to a SIPP or SSAS is generally favourable, since pension investments do not attract capital gains tax. However, if the asset is being acquired
from a business, a liability may arise. Tavener explains:
The process is controlled by the FCA as well as HMRC. There are around 12 steps to go through behind the scenes. The asset then needs to be independently valued, and the accepted valuation practice needs to be followed. Robust valuation is critical.
The ongoing tax treatment depends on the structure of the deal. Currently, leaseback payments attract corporation tax relief at 100%, whereas a loan will only attract relief on the element that is interest.
90 The role of intellectual property and intangible assets in facilitating business finance
Equity funding is acknowledged as being better suited to certain types of companies, and certain stages of development, because of the greater flexibility it provides. The recently released Big Innovation Centre report53 highlighted the importance of equity investment to fund research and development activities (inferred from balance sheet activity in respect of intangible assets),
Crowdfunding is a generic term used to describe various different ways of raising finance by encouraging small contributions from a large number of people. This is, in a sense, the inverse of the traditional venture capital model, which involves approaching a small number of people for a large amount of money (which will generally only come from one or two participants – or maybe half a dozen in the case of angel investors).
Crowdfunding is highly technology-driven, using the internet to communicate propositions seeking funding to a broad audience, usually by setting up a mini-prospectus of their project, initiative or company on a website. This lends itself well to further online promotion through social media, as well as providing a mechanism and a focal point to generate support amongst friends and family or other supporters.
There is now a UK Crowdfunding Association (UKCFA) aimed at raising awareness of the various platforms which exist. Its website54 characterises crowdfunding as falling into three main
• Donation-based crowdfunding, which attracts participants who believe in a particular cause. Donors may receive rewards such as credits, tickets, samples or other free gifts, mostly items which are intangible. This is generally not the route used to fund SMEs, though it can work well in the creative industries, and is used by artists among others
• Debt crowdfunding, more commonly called peer-to-peer lending, and covered in Chapter 3 of this report
• Equity crowdfunding, where small stakes are purchased in a business, project or venture, dealt with in more detail in this chapter
Bill Morrow of Angels Den comments:
Crowdfunding is interesting because it allows people to fund deals that don’t meet an angel’s criteria, so it provides a means of monetising things like your Facebook likes and website traffic. It’s never been easier to raise capital – Crowdcube can help you raise over £1m in four hours – but you need help to spend it. If you look at Kickstarter for example, you’ll conclude that a lot of crowdfunding is donation, not investment.
Angel networks and syndicates
In terms of transaction volume and value, the largest single form of equity investment in SMEs is thought to be business angel investment. A business angel is a high net worth individual acting as a private investor in unquoted companies, either singly or in groups typically referred to as ‘syndicates’. An angel purchases shares, often providing a company with contacts, sector knowledge and specific skills and expertise as well as capital.
The ‘formal’ venture capital market is reasonably well understood because it is organised around partnerships which have reporting obligations. However, because ‘informal’ angel investments are often made by individuals putting their own money into businesses, many of the transactions that occur may be invisible. The relevant official sources of data on private investment activities are Enterprise Investment Scheme55 returns. These have a potentially lengthy time delay associated with them56, and are in any event not comprehensive as some private investments are not EIS qualifying. Based on the available data it has previously been estimated57 that in 54 See www.ukcfa.org.uk 55 See following section.
56 EIS forms can be returned up to 36 months after qualifying shares are issued. See further detail following.
57 The Race to the Top: A Review of Government’s Science and Innovation Policies, Lord Sainsbury of Turville, TSO, 2007.
92 The role of intellectual property and intangible assets in facilitating business finance 2000, the market accounted for up to £1bn of investment, distributed between 4,000 – 6,000 angels.
The industry association representing the interests of the private investor community, the recently renamed UK Business Angels Association (UKBAA), believes the market for angel investment is currently around £850m per annum (about 2.5x the amount being invested by venture capital companies). This figure is derived from the £600m regularly shown in returns relating to EIS, and the knowledge that about 30% of the deals in which investors participate are not done under EIS.
Whilst there have been some distortions in EIS activity in the past (relating to schemes qualifying for EIS relief but not primarily aimed at assisting business investment), most of those interviewed for this report suggested that the majority of these have disappeared. Interest in EIS has recently been boosted by enhanced reliefs and the even more generous tax treatment provided by Seed
EIS, explained in Chapter 2.
Venture capital is a particular subset of private equity. As understood across Europe, the term is used to describe equity investments made by organisations in unquoted companies (though it may also include loans and other capital that has an equity-type risk).
In practice, however, private equity and venture capital are taken to mean different things.
Private equity is the term generally associated with a range of refinancing activities undertaken by more mature companies (such as buyouts and rescue packages), whilst venture capital is associated with providing start-up to expansion investment. Both activities are undertaken with an expectation of a profitable exit in due course.
The trade body representing UK venture capital and private equity firms is the British Venture Capital Association (BVCA), which also has a European equivalent (EVCA). Amongst its activities, it compiles industry statistics to track investment and fundraising activity58.
For statistical purposes, BVCA divides up member investment activities into five principal headings: venture capital (comprising seed, start-up, early stage and later stage VC funding), expansion capital (including bridge financing), replacement capital (including secondary buyouts), Management Buy-Out (MBO) and Buy-In (MBI) and other late stage financing. The trend over the past three years for each of these areas in terms of UK investments is shown in volume (number of companies) and value (amount invested)59.
On the fundraising side, there was a significant upturn in 2012 to £5.9bn compared with £4.2bn in 2011. Whilst banks and academic institutions reduced their investments, the amounts of capital provided by sovereign wealth funds, pensions, fund of funds, insurance companies, corporate investors and capital markets all increased.
This report is not the place to explore the workings of venture capital in detail. However, a few
observations are pertinent when considering SME access to finance:
• Venture capital companies are responsible to their investors for making a return, and because their investments involve a high level of risk (and unlike many lending mechanisms, a high risk of losing all the money invested), a high level of return is also required. VC funds can mitigate this risk to some degree by investing in a portfolio of businesses, but still need to exercise great care when investing, involving detailed and lengthy due diligence enquiries