The House of Lords’ Communications and Digital Committee is the cross-party group of peers that examines the opportunities and challenges of the sector for the British Parliament’s second chamber.
Its current inquiry, Scaling up: AI and Creative Tech, is looking at why the UK is adept at hothousing innovative start-ups, but struggles to scale them beyond a certain point. This growth-funding and opportunity gap forces many entrepreneurs to fly to the US, Europe, or the Middle East in search of more support and bigger investment.
As a result, brilliance, entrepreneurship, job opportunities, and money are lost to the economy – if and when those companies succeed. As I reported last month, the causes of this are legion, and the solutions often linked with countering Britian’s conservatism, parochialism, and risk-off mindset.
During one of November’s evidential sessions, Barney Hussey-Yeo, founder and CEO of Cleo AI, said of the British Business Bank, and efforts by the government to invest directly in start-ups, “it’s all fraud”.
Wisely, he did not specify how any alleged fraud might be committed. But he did say:
If you look at the returns and where the British Business Bank invests its money – I note the Future Fund – every time the government tries to do direct intervention into venture, it does not work.
Venture capital is about picking the outlier power law companies, so when the government tries to fund these companies directly, they pick the bad companies and, therefore, the returns are awful.
The returns for the British Business Bank are negative to dismal, and that is £12 billion of capital that could have gone into fixing the NHS, investing in infrastructure, or building supercomputers – you name it.
Direct intervention by the government into venture is a terrible idea. It is fraud, and we must stop it.
Strong words. So, it is no surprise that in its December sessions, the Committee has sought the views of, among others, Louis Taylor, CEO of the British Business Bank and Chair of British Patient Capital – organizations whose stated purpose, he said, is to help small businesses get the finance they need, to start and to scale.
He told the Committee:
We have a range of interventions, but they are intended to be catalytic to private market participants, to fill gaps in the market that need filling. Therefore, we are trying to crowd in private money and not crowd it out.
Some of our interventions have a subsidy element, and some are purely commercial. In that commercial venture capital market, the bank is a dynamic and critical player – the largest investor in venture and growth equity funds, and one of the most active later-stage investors in deep tech in the UK.
What of the claim that the returns are “abysmal?” Taylor said:
With our annual report and accounts this year we published an impact report for the calendar year 2023, and the £3.5 billion [$4.4 billion] of finance and guarantees that we put into the market will support around a quarter of a million existing jobs through the life of the finance, create around 40,000 new jobs, and generate about £8.4 billion [$10.6 billion].
So, £2.40 [$3] for every £1 we put out. The government should get the £3.5 billion back and a bit more.
Even so, does he recognize the criticism that funding early-stage start-ups is less of a problem for the UK at present? After all, it leads Europe, and is third behind the US and China in AI overall. The real challenge is scaling them and filling the growth-capital gap, which start-ups find is more often achieved in the US.
He replied:
I would dispute that we are done, that we have been catalytic enough and that there is no need to help start-ups. In relation to scale-ups, there is a gap, and that is universally acknowledged. But the way in which the Bank acts is intended to be catalytic, as I said earlier.
There are three models that you can employ. What we employ is putting a small slice of government money into a fund – sometimes to cornerstone it, sometimes at a later stage to fill it up – and we hope to magnetize private-sector money alongside government money. That is option 1, which is what we have been doing.
We have invested in 82 venture and growth equity funds through 44 fund managers in the UK, committing £2 billion to those. In doing that, we believe that we have not only increased the number of funds, but also the scale of those funds and their ability to finance later-stage companies. That is mode one.
Mode two would be for us to aggregate institutional money in a fund and actively invest third-party money into venture capital. That is what the Chancellor announced we will be doing at the Investment Summit: we are creating the British Growth Partnership, which is an attempt to aggregate some UK pension fund money to give a conduit to invest into venture and growth equity in a way that has not been found recently.
As I reported last month, the lack of pension fund investment in potentially high-growth, if speculative, AI start-ups is one of the claimed reasons for the dearth of growth capital.
He continued:
The third way we could go, which we are not doing yet, is more akin to in France, which mandates investors to invest in a set of funds that are focused on a sector of the economy.
Indeed, it is aimed at financing the Fourth Industrial Revolution. So, what of the criticism that Britain’s venture capital funds may appreciate the Bank’s presence more than the start-ups do? Taylor said:
We get very positive reactions from the companies that we support, whether it is by putting money into a fund, the businesses that they invest in, or the businesses that we invest in directly – because we subsequently do that with companies that have come through the funds and need more money at scale-up stage. We will invest directly.
The positivity stems from several things. But let me first just say that we get a lot of negativity from those we say no to. We understand that, but it is a discerning market, and we have a due diligence process.
When we invest in a fund – this is why fund managers are positive – there is a sense in the market that ‘here is a player who has done proper due diligence on a fund’. It is a kitemark of quality, to an extent.
Even so, the Inquiry pushed the point: are the funds that the Bank invests not money that would be available anyway? Would the commercial sector not want to invest without its help?
He responded:
The purpose of our investment is to catalyze private-sector investment, and to make it an asset class that is standard for the private sector in a way that it is not at the moment, because the asset class is critical to economic growth.
If you do not have a supply of strong and growing small companies, you cannot have them move up the escalator of scale, where they become more and more economically significant and productive. A vibrant economy needs that, particularly in a world where new technologies are arriving, and you need new companies to exploit those. That is a really important element.
No doubt, but the Inquiry is looking at why that scaling up rarely happens, at least not beyond a handful of companies reaching unicorn stage – which, we heard last month, tends to be seen as an endgame in the UK, yet merely as square one in the US.
Another criticism is that, by focusing on start-ups, the Bank has neglected investing in the bigger picture: the core infrastructure for AI that would enable start-ups to access world-class compute and energy resources. Would its funds not be better spent on datacenters, nuclear energy, and computing at exascale – as witnesses claimed last month?
Taylor appeared to sidestep the question, while suggesting that these matters were not in the Bank’s purview:
It will not be a surprise to you if I say that the choice of how much capital we get to invest is not made by us. It is made through a Spending Review where all the options for spending the money are taken into account.
On whether there are other priorities that the government might have, you need to ask Ministers about that.
The Inquiry also heard from Britain’s innovation agency, Innovate UK, this month. Esra Kasapoglu is Director of AI and the Data Economy for the organization, which is part of UK Research & Investment (UKRI).
She said:
Too much grant funding could be seen as an impediment to attracting private sector investment.
We are trying to create all the opportunities for these companies who have high-growth potential in order to benefit them and the economy. But, at the same time, we are really trying to push them to a stage where they can say, ‘OK, we are solid big companies now, and we will attract private investment.’
The customer and the scale also play a role here, so all these pathways are outside our control, but we very much recognize those challenges for the businesses.
Kasapoglu added:
We are also trying to provide them not only with grants, but also non-financial support so that they can get investor ready. They have the networks and the international connections to expand. This is the complexity that we always try to mask from businesses in everything we do.
Of course, we are a continuous learning organization, but the financial and non-financial pathways are important. We need to look at them and really get into the minds, the thoughts, and the hearts of those businesses in a way that means they will be incentivized to attract customers and commercial investments from outside the ecosystem for themselves.
A useful debate, which highlights the challenges the UK faces in bridging a funding and opportunity gap that has been obvious for the best part of three decades.
The good news is that the UK’s high-tech start-ups – not just in AI, but also in areas such as fintech, robotics, space tech, and quantum technologies – are booming. At least, in their early stages. But the critical growth stage remains Britain’s Achilles Heel.
But there are signs that the government is at last taking steps to address the problem – albeit in the context of a Brexit- and pandemic-shaped fiscal black hole.
