It is fitting that the taxpaying public gets to hear a candid appraisal of the government’s pandemic venture capital fund by accident.
What limited information there is about the £1.1bn portfolio of 1,190 start-up companies in the Future Fund has been published somewhat reluctantly, in dribs and drabs.
But minutes from the audit committee of the state-owned British Business Bank, which manages the fund, included comments from non-executive director Dharmash Mistry: “most” companies in the portfolio had “limited chance of growth to a sufficient scale of success” and would become “zombie businesses”, he said.
The comments were marked for redaction as part of a freedom of information request but the text was never removed. They suggest that concerns that the scheme would attract second-rate companies unable to access funds elsewhere may have been well-founded.
Patchy disclosure around this scheme is not a new problem. The BBB has now published the names of the 400 companies where the government’s convertible loans have flipped to an equity stake — a disclosure it previously said could not be made because of commercial confidentiality. But the government has said little about the two-thirds of companies where loans have not yet been converted. There is no performance data.
Nor is adverse selection in the fund’s investments a new concern. Then-BBB chief executive Keith Morgan in 2020 flagged that whether the fund would ultimately deliver value for money was “highly uncertain”. “The best companies will not use this funding route” he wrote when explaining one worry, which could “reduce very considerably the average expected return”.
The fund has suffered — then and now — from confusion over whether it was simply trying to prevent an entire cohort of fast-growing start-up businesses from collapsing as Covid-19 hit, or to achieve something more. Is success just covering its costs? Or does it aim to generate a decent return?
There has been rationale drift over time. The BBB has pointed out that write-offs tend to be high with early-stage venture investing: one set of data showed more than half making a loss, with 60 per cent of returns coming from just 6 per cent of investments.
But the fund was not originally pitched as a classic venture punt in pursuit of a handful of stars generating huge returns. It was meant to “protect” already-promising businesses, with a structure designed to de-risk investments with the government piggybacking on third-party investors’ expertise. It was designed to require limited, if any, due diligence.
If that has resulted in what Mistry calls “a significant tail of dormant companies” — more so than expected — then the government needs to come clean about how it will handle that, and whether it has the genuine outperformers to compensate. Where are its “unicorns of tomorrow”, to quote then-digital secretary Oliver Dowden at its launch?
Some in the market are increasingly frustrated by the lack of a clear framework for dealing with the bottom or top of the portfolio. One looming issue, as private valuations deteriorate, is what happens to unconverted loans that hit their 36-month maturity date from mid-2023.
A BBB official last year said the group did not want equity stakes in companies that had not managed to raise private funding in those three years. Will it really demand repayment of loans, potentially forcing some viable companies into insolvency?
There is also uncertainty over whether the government has the capacity to get the best from its star performers. In general, the strategy around the government ending up a minority investor in hundreds of small private companies has always been slightly mysterious.
But what is its investment approach and time horizon at Tomorrow’s Unicorn Inc? Does it even have money to participate? Morgan in 2020 pointed out that the lack of funding for follow-on investments in future capital raisings could hurt returns. Given limited due diligence on the way in, the BBB may need to set similarly light-touch ground rules for what it does next, rather than making case-by-case decisions.
The government needs to be clearer about how it intends to handle its venture capital book — both the failures and the successes.