WHERE ARE THE BIG GORILLAS?
HIGH TECHNOLOGY ENTREPRENEURSHIP IN THE UK
AND THE ROLE OF PUBLIC POLICY
3 THE EMERGENCE OF ENTREPRENEURSHIP POLICY IN THE UK
Although small business has never carried the same political weight in Britain as in the US, the need to preserve a strong tier of small and medium-sized enterprises has long been a concern for public policy. As in the US, there has been a continuing debate over whether small firms are ill-served by the financial system. This was one of the issues highlighted by a government-appointed inquiry into banking and finance, the Macmillan Committee, in 1931. The committee found that public equity issues of less than £200,000 were too small to be of interest to existing financial institutions, and recommended that the gap should be filled by a new type of capital-raising agency, specialising in the small business sector.
There was no immediate response from the City of London, but at the end of the Second World War the commercial banks, under pressure from the Bank of England, reluctantly agreed to set up a new, jointly owned institution, the Industrial and Commercial Finance Corporation (ICFC), with a remit to supply risk capital to smaller firms. Although the government was instrumental in getting the ICFC off the ground, it was a private-sector institution, unlike the Small Business Administration in the US, and no government subsidy was involved.
Despite an uneasy relationship with its owners, ICFC made modest progress during the 1950s, and in the following decade it acquired an additional role as a backer of technology-based enterprises. This came about through the absorption of Technical Development Capital, which had been set up by the insurance companies and other financial institutions to help inventors commercialise new technology. Again this was a private-sector rather than a government initiative, but it came at a time of growing anxiety about the ‘technology gap’ with the US. The hope was that ICFC in its enlarged form would foster in Britain the kind of innovative small firm which was making such an impact in several American industries.
By 1970 Technical Development Capital had invested over £6m in more than 100 companies, including several American-style university spin-offs.[36] One example was Oxford Instruments, a manufacturer of low-temperature superconducting magnets, founded in 1959 by Martin Wood on the basis of work on superconductivity that he had been conducting at Oxford’s Clarendon Laboratory; the availability of ICFC funds in 1967 provided a lifeline at a crucial stage in the company’s development.[37]
Upgrading the technological capacity of British industry was a major preoccupation for the Labour government which held office from 1964 to 1970. However, the main thrust of government policy was to create larger companies which, it was hoped, would have the financial muscle to win a larger share of world markets. The Industrial Reorganisation Corporation was set up to promote mergers in fragmented industries, working closely with a new government department, the Ministry of Technology. The computer industry was an early target; most of the leading British-owned manufacturers were merged into a single group, International Computers Limited (ICL), which was supported by subsidies for research and development and preferential purchasing on the part of government departments. When a British entrepreneur, Iann Barron, developed a mini-computer in the early 1960s and set up a new company, Computer Technology Ltd, to exploit it, he received little encouragement from government departments. “The Ministry of Technology did not like us because we were too small... Government policy was being formulated by the big companies – they had the people to spare for lobbying and sitting on committees”.[38] Similarly, the Ministry of Defence relied for the most part on established suppliers such as Plessey and the various electrical firms that came together at the end of the decade to form General Electric Company (GEC). Unlike the US Department of Defence (whose procurement budget was very much larger), British officials did not deliberately seek to encourage innovative small firms.
Thus ICFC and TDC were to some extent rowing against the tide. Quite apart from the direct effect of government industrial policy, merger activity was running strongly during the 1960s. A buoyant stock market facilitated share-based acquisitions, and the government made little use of its power to prohibit anti-competitive mergers. Tax policy, too, tended to favour the larger firms. With capital gains tax at 30 per cent, compared to marginal income tax rates which could be as high as 90 per cent, entrepreneurs starting new businesses had little incentive to expand them. As one businessman wrote later, “most successful entrepreneurs tended to sell out to sleepy, poorly managed listed companies; these companies grew larger still, and increasingly complacent, via relatively cheap and easy acquisitions”.[39]
By the end of the decade there were fears that the process of concentration might be going too far; the share of the 100 largest enterprises in manufacturing employment had risen from 27 per cent in 1958 to 37 per cent in 1968.[40] Several of the big companies that had been created through merger (including ICL) were performing badly. It was clear that mergers were not a recipe for greater efficiency, and there were calls for a tougher regulatory stance on merger activity. A committee of inquiry set up towards the end of the Labour government’s term of office recommended a change in competition policy whereby proponents of a merger would have to demonstrate to the Monopolies Commission, not simply that their merger would not damage the public interest, but that it would be positively beneficial.[41] Although this proposal was not taken up, it was a sign of waning official enthusiasm for giant companies.
In 1969 the government established a committee of inquiry into small firms under John Bolton, who was himself a successful electronics entrepreneur. The Bolton Report showed how far the small business sector had declined since the end of the war and underlined the importance of small firms as a competitive spur to established companies.[42] It was published in 1971, when a Conservative government was in power, and most of its recommendations, mainly aimed at removing impediments that were holding back the growth of small firms, were implemented.
This approach was taken further by the Labour government when it returned to office in 1974. The new government had a strong commitment to ‘regenerate’ British industry, and, when the National Enterprise Board was set up, part of its remit was to look for promising high-technology ventures which were difficult to finance through conventional sources.[43] Two of its most ambitious ‘greenfield’ ventures were the creation of new companies in biotechnology and semiconductors, which are discussed in Sections 4 and 5. The NEB also took stakes in smaller firms – many of them in computers and related sectors – in the hope of accelerating their growth.
Support for this shift of policy came from a study carried out by the American management consultants, Arthur D. Little.[44] Their report drew attention to the dearth of fast-growing, technology-based firms in Britain compared to the US. The number of new technology-based firms set up in Britain since 1950 and still in existence in the mid-1970s was estimated at about 200, compared to several thousand in the US. By far the largest of the British firms was Racal, a specialist in military electronics which employed about 4,000 people; most of the others had less than 500 employees.
The consultants highlighted a range of factors which made the US a more favourable environment for high-technology entrepreneurs: a large domestic market; the availability of private wealth as a source of seed capital for new ventures; a fiscal framework which encouraged the flow of private risk capital into a new ventures; the existence of an active market (through NASDAQ) for the trading of shares in new ventures; greater mobility of individuals between academic institutions and private industry; and a large government expenditure programme in high technology areas. The most important step the government could take, in the consultants’ view, would be to cut taxes.
These conclusions were entirely in line with the thinking of the Conservative government which entered office in 1979. One of the policy documents produced in the run-up to the election spoke of launching “a determined programme to remove every possible fiscal, legislative, social, planning and bureaucratic barrier in the way of starting up and growing small businesses”.[45]
In the short term, the new government’s small business policy was directed at countering unemployment, which had reached the unprecedented level of 2.5m in 1981. A new Enterprise Allowance Scheme enabled unemployed persons to draw £40 per week in benefit while working to establish a business, as long as they could contribute £1,000 of their own money; at its peak in 1987-88 some 600,000 people participated in this scheme.[46]
More important for the longer term was a range of financial measures aimed at boosting the small business sector. Under the Small Firm Loan Guarantee Scheme the government provided a guarantee of up to 80 per cent (later reduced to 70 per cent) for approved bank loans taken out by small firms. This was followed by the Business Start-up Scheme, later re-named the Business Expansion Scheme, which enabled private individuals to claim tax relief on their top slice of income on new equity investments of up to £40,000 a year in unquoted companies, provided the shares were held for five years. The 1984 Budget also provided more generous tax treatment for stock option schemes.
These changes gave a fillip to the growth of the venture capital industry. By the end of 1983 some 60 venture capital funds were operating in the UK, compared to fewer than 20 before 1979. One of the leading players was ICFC, which, under its new name of Investors in Industry, or 3i, had broken away from the tutelage of the clearing banks. By the early 1990s the British Venture Capital Association had more than 100 member firms, and the total amount of money invested or available for investment was estimated at about £7.5bn.[47]
As in the US, venture capitalists aimed to hold on to their investments for 3-5 years before seeking an exit through a stock market flotation or a trade sale. The London Stock Exchange, which had largely neglected the small company sector, responded to this demand by creating the Unlisted Securities Market, with simpler listing requirements than those imposed by the main exchange. The USM attracted smaller and younger companies, and by 1986 over 500 companies had listed on the new market, raising some £1bn.[48]
The government was not directly involved in the provision of venture capital; the National Enterprise Board was closed down and most of its investments were sold to the private sector. This non-interventionist stance did not preclude other forms of support for high-technology ventures, although the amounts of money involved were small. For example, the Small Firms Merit Award for Research and Technology (SMART) provided grants for companies with less than 250 employees to undertake feasibility studies and bring development projects up to prototype stage. Like SBIR and ATP in the US, these schemes helped recipients gain access to other sources of finance.
Another strand of policy, influenced by US experience, was to encourage universities to work more closely with industry. An important step was to change the intellectual property regime governing innovations resulting from government-funded research. Since 1948 the exclusive right to such property had rested with a government agency, the National Research Development Corporation. In 1985 the NRDC was converted, along with some residual activities of Labour’s National Enterprise Board, into a new body, the British Technology Group, and the universities were given the right to exploit their own innovations. The effect was similar to that of the Bayh-Dole Act in the US, and it prompted British universities to step up their technology transfer activities.
A much-discussed model for university-business collaboration was the cluster of science-based firms that had grown up around Cambridge University. Silicon Fen, as this region came to be called, was not the product of government policy but resulted from a series of initiatives taken by the university. In 1969 a committee chaired by Sir Neville Mott, head of the university’s Cavendish Laboratory, recommended that the city and the university should encourage the growth of science-based firms in and around Cambridge. The report was followed by the decision by Trinity College to establish the Cambridge Science Park on the outskirts of the town.[49] Several technology firms were already operating in the area (notably Cambridge Consultants, founded in 1960 and a prolific source of spin-out companies), but the creation of science park helped to accelerate the rate of new firm formation. St John’s College later set up an Innovation Centre, which became an important agency for technology transfer.
At Oxford, too, there had been some increase in entrepreneurial activity during the 1970s. Following the example of Martin Wood at Oxford Instruments, several university academics founded or helped to found new businesses to exploit their innovations. These included Research Machines, a supplier of information and communications technology to schools and universities, and Solid State Logic, a manufacturer of professional audio consoles for music, broadcasting and film.[50] A new body, Isis Innovation, was set up to market the university’s intellectual property.
By the end of the 1980s the UK had acquired some of the institutional support that had underpinned the growth of innovative high-technology firms in the US. The business environment was also more favourable to entrepreneurial activity, with lower taxes, less government intervention, and a stronger emphasis on promoting competition. The privatisation and de-regulation of sectors such as telecommunications encouraged new entrants, one of which - Vodafone, the mobile telephone company - was to become a major international player in its field (see below).
Not all the government’s initiatives were successful. The Enterprise Allowance Scheme had led to the establishment of many short-lived businesses – “a cycle of uncreative destruction”, as one commentator put it.[51] There were also still shortcomings in the supply of finance. Although the venture capital industry had grown at an impressive rate, it was increasingly concentrating on later-stage investments and management buy-outs or buy-ins, to the detriment of early-stage financing. The gap was partially filled by business angels, but more needed to be done to stimulate this type of investment.
Responding to these criticisms, the government replaced the Business Expansion Scheme, which had been widely abused for tax avoidance purposes, by the Enterprise Investment Scheme, which provided more generous tax reliefs for investment in start-up firms. This was followed by the introduction of Venture Capital Trusts, through which individuals could spread their risks with a range of investments in technology-based firms; shareholders in VCTs would qualify for income tax relief as long as they held their shares for five years.
The recession of the early 1990s had led to a dearth of new issues on the Unlisted Securities Market, and the Stock Exchange came near to closing it down; in 1991 only £11.6m was raised on the USM compared to £308m in 1988. (The decline was partly due to a change in the rules which made it easier to obtain a listing on the main exchange.) The Stock Exchange, under some government pressure, agreed that a separate market for smaller firms was still needed, and it set up the Alternative Investment Market (AIM) in 1995. It also agreed, at the request of the venture capital community, to introduce special rules for biotechnology firms, making it possible them to obtain a listing without the usual requirement of a five-year profit record.
By the time the Conservatives left office in 1997 the environment for small firms was far better than it had been twenty years earlier. This was a legacy on which the new government, having abandoned its old attachment to ‘national champions’, was determined to build. Echoing the rhetoric of Margaret Thatcher, the government declared that entrepreneurship and innovation were central to the creative process in the economy, and that fiscal and cultural barriers to entrepreneurial activity had to be removed.[52] The UK needed to move more quickly towards a knowledge-based economy, and high-technology entrepreneurs would play a central role in the transition.
Labour’s entrepreneurship policy had two main strands – improving the supply of finance for start-up and early-stage firms, and promoting the transfer of technology from universities to business; the latter was linked to regional policy, influenced by the belief that universities should be more involved in upgrading the technological base of the regions in which they were located. At the same time government ministers, led by Gordon Brown, the Chancellor, launched an energetic campaign to promote an ‘enterprise culture’, urging schools to take a greater interest in the subject and encouraging universities to include entrepreneurship in their curriculum.
In his first budget Mr Brown announced a package of reforms to increase the flow of funds into small business, including a reduction in capital gains tax on long-term investment and a new version of the Enterprise Investment Scheme, providing more tax incentives for angel investors. This was followed by the launch of an Enterprise Fund, combining public support and private finance to increase the flow of funds to smaller enterprises; some of this funding would go to a network of Regional Venture Capital Funds.
High technology was a particular target of attention – hence the appointment of a committee under Sir Peter Williams, chairman of Oxford Instruments, to identify financing barriers experienced by high-technology firms.[53] The committee recommended further reform of the capital gains tax regime, more generous tax treatment of stock options, and more encouragement for pension funds to invest in venture capital. On pension funds, the government accepted the conclusion of a subsequent report that existing rules for pension fund investment unduly restricted their ability to invest in venture capital.[54]
At the start-up stage the government sought to increase the supply of funds both by direct intervention – it sponsored a number of Early Growth Funds which made investments of up to £100,000 in innovative and knowledge-intensive businesses – and by stimulating activity by business angels. The financial promotion rules were altered to make it easier for start-ups and other small firms to offer their shares to business angels without having to be subject to regulation under the Financial Services Act. The government also helped to set up the National Business Angels Network.[55]
Even after these initiatives the government continued to worry about the existence of an ‘equity gap’ facing businesses seeking modest amounts of growth capital – principally in the range of £250,000 to £1m, below the level likely to interest venture capitalists and too large for most business angels.[56] At the end of 2004 the government was considering the introduction of Enterprise Capital Funds, loosely modelled on the Small Business Investment Companies in the US. The government would offer debt at favourable interest rates to privately owned and managed funds, the funds would defer repayment until they had generated the necessary cash flow, and profits would be shared between the government and the private investors.[57]
Independent evaluation of the Enterprise Investment Scheme and the Venture Capital Trusts indicated that both schemes had achieved their immediate objectives, to the extent that most of the investments they supported would not have gone ahead in the absence of the schemes.[58] However, there was rather more doubt about the Regional Venture Capital Funds. Given that these trusts would focus on small-scale, early-stage ventures, requiring hands-on monitoring and support, it was not clear whether there was a sufficient supply of skills to manage them. There was also the ‘crowding out’ problem. According to one critical assessment, “the likely effect of creating an additional supply of early stage capital, operating on a less than fully commercial basis as a result of government financial support, in a situation where there is a restricted supply of viable, high potential businesses, will be to create distortions in the market which over the longer term could drive out existing private sector venture investors”.[59]
Despite these criticisms there was not much doubt that the changes made by the Labour government since 1997 had improved the availability of finance for high-technology entrepreneurs. The venture capital industry was the largest and most active in Europe, and AIM had established itself as the preferred European market for Initial Public Offerings; in 2004 it attracted over 60 per cent of all European IPOs. Some commentators suggested that the task for entrepreneurship policy was no longer to increase the supply of finance but rather to increase the number of investment-ready proposals from entrepreneurs.[60]
The other strand of government policy was to improve the transfer of technology from universities to business. From the start of its term of office the government sought to reward universities for activities that enhanced interaction with business to promote technology transfer.[61] It set up a third stream of funding for universities (alongside funding for teaching and research) through the Higher Education Innovation Fund, which was designed to encourage universities to devote more resources to contract research, licensing and the formation of spin-out companies.
The Lambert Review of business-university collaboration, published in 2003, found that the commercialisation of university intellectual property was hindered by a lack of clarity over ownership of IP, and by the variable quality of technology transfer offices; a new protocol for the ownership of IP was recommended.[62] The Review also suggested that the ready availability of public and private funds for high-technology start-ups during the 1990s had caused universities to put too much emphasis on spin-outs and not enough on licensing. In the US 4,058 new licenses were agreed in 2001 and 494 spin-outs were formed; the corresponding figures in the UK were 648 and 158. Too many of the UK spin-outs were of doubtful quality.
To the extent that British universities were now more aware of industry’s needs, and more actively involved in technology transfer, this was an advance on the situation which prevailed ten or twenty years earlier. Here, as in the provision of capital for entrepreneurial firms, the Labour government had moved the UK nearer to the US model. Yet one element was still missing. The UK continued to lag behind the US in its ability to foster ‘big gorillas’ – technology-based firms that grow very quickly from the start-up stage into major international enterprises.[63] This was particularly true in electronics and biotechnology, two industries that are discussed in the next two sections
NOTES
[36] Richard Cooper and Donald Clarke 3i: fifty years of investing in industry Oxford 1995
[37] Audrey Wood Magnetic Venture, the story of Oxford Instruments Oxford 2001, p.51
[38] Author’s interview with Iann Barron, July 22, 1991. See also John Hendry Innovating for failure: government policy and the early British computer industry MIT Press, 1989.
[39] John Hoskyns Just in time: inside the Thatcher revolution Aurum Press, 2000, p.7.
[40] S.J.Prais The evolution of giant firms in Britain Cambridge, 1976, p.8
[41] A review of monopolies and mergers policy, a consultative document Cmnd 7198, HMSO 1978.
[42] Report of the Committee of Inquiry on Small Firms Cmnd 4811, HMSO 1971.
[43] W.B.Willott Industrial innovation and the role of bodies like the National Enterprise Board in Charles Carter (ed) Industrial policy and innovation Heinemann, 1981.
[44] Arthur D. Little New technology-based firms in the UK and the Federal Republic of Germany, a report for the Anglo-German Foundation for the study of industrial society London 1977.
[45] Hoskyns Just in time p.68
[46] David J. Storey Understanding the small business sector Routledge, 1994
[47] Steven Abbott and Michael Hay Investing for the future: new firm funding in Germany, Japan, the UK and the USA Financial Times/Pitman Publishing 1995.
[48] Ranald Michie The London Stock Exchange, a history Oxford 1999, p.573.
[49] Segal Quince Wicksteed The Cambridge Phenomenon, The growth of high technology industry in a university town published by Segal Quince Wicksteed, Cambridge, 1985. See also Suma Athreye Agglomeration and growth: a study of the Cambridge high-tech cluster in Bresnahan and Gambardella (eds) Building high-tech clusters.
[50] Helen Lawton Smith and others Enterprising Oxford, the growth of the Oxfordshire high-tech economy Oxfordshire Economic Observatory, 2003.
[51] F.J.Greene, Kevin F. Mole and D.J.Storey Does more mean worse? Three decades of enterprise policy in the Tees Valley Urban Studies, Vol 41 No 7, June 2004
[52] Our competitive future: building the knowledge-driven economy Department of Trade and Industry, Cmnd 4176, HMSO 1998.
[53] Financing of high technology businesses, a report to the Paymaster General November 1998.
[54] Institutional investment in the United Kingdom: a review by Paul Myners HM Treasury 2001.
[55] Colin M. Mason and Richard T. Harrison Business Angel Networks and the development of an informal venture capital market in the UK: is there still a role for the public sector? Small Business Economics, Vol 9, pp. 111-123, 1997.
[56] Gunseli Baygan Venture capital policy review: United Kingdom STI Working paper 2003/1, OECD Paris 2003.
[57] Bridging the finance gap: next steps in improving access to growth capital for small businesses HM Treasury, Small Business Service, December 2003.
[58] Research into the Enterprise Investment Scheme and Venture Capital Trusts, a report prepared for the Inland Revenue by Nic Boyns, Mark Cox and Rod Spires of PACEC and Professor Alan Hughes of the Centre for Business Research, Cambridge University, April 2003.
[59] Colin M. Mason and Richard T. Harrison Closing the regional equity gap? A critique of the Department of Trade and Industry’s Regional Venture Capital Funds Initiative Regional Studies, Vol 37 No 8, pp.855-868, November 2003.
[60] Colin M. Mason and Richard T. Harrison ‘Investment readiness’: a critique of government proposals to increase the supply of venture capital Regional Studies Vol 35 No 7, October 2001.
[61] Our competitive future: building the knowledge-driven economy.
[62] Lambert Review of Business-University Collaboration, Final Report HM Treasury, December 2003.
[63] This was part of the ‘enterprise challenge’ identified by the government in 2002: Enterprise Britain: a modern approach to meeting the enterprise challenge HM Treasury and Small Business Service, November 2002.
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