How a co-investment fund can boost Northern tech: let’s look at the data

Data & research, funding

Henri Egle SorotosHenri Egle Sorotos, October 17, 2017

This article was originally posted on the Tech North website.

In summary:

  • Coinvestment funds in London and Scotland have participated in tech investment rounds worth over £130 million
  • Both schemes have directly resulted in jobs created, whilst in the long term the taxpayer receives a return on investments made
  • Consistency is key – both funds invest regularly in small amounts to stimulate the wider private tech investment space
  • The London co-investment fund is highly active, and is one of the largest seed investors in Europe
  • Tech firms in the North are failing due to lack of investment. A co-investment fund would mitigate this issue.

Access to finance and talent – the two most common issues facing the Northern tech firms. I rarely have a day at work where the investment and skills conundrums do not come across my desk. Neither can be solved with a silver bullet, but the proposed Northern Co-investment fund will certainly go a long-way to improve the dearth of capital raising opportunities in the region.

Insufficient local financial opportunities means some tech firms are either leaving or failing. The proposal provides 120 company investments including some additional follow-on, the creation of up to 1,500 new jobs, and a strong return on investment for the taxpayer. The North certainly doesn’t lack companies worthy of investment, but imperfect market conditions stop the right companies finding the right investor.

I love data and uncovering what makes the tech community tick. I relished the opportunity to explore how co-investment mechanisms are working in other parts of the UK, as well as abroad. Below are findings showing how similar funds work, and what this could mean for the North. Data has been sourced from the Beauhurst investment database and analysed using R and Tableau.

Learnings from the UK

Both Scotland and London currently have co-investment funds. The Scottish Co-investment Fund was highly innovative, and stretches back to 2008. Investment is not exclusively focussed on tech, but is heavily focussed on digital industries and advanced manufacturing. Such pedigree has resulted in more than 120 tech deals involving the fund alongside private venture firms and business angels. Administered by the Scottish Investment Bank, the fund can be used to match accredited investment partners up to a maximum of 50 percent of the total funding deal. Investments can range from £10,000 – £1.5 million, with a total deal size of £20,000 to £20 million.

In contrast, the London Co-Investment Fund (LCIF) has only been operational since 2015 and is managed by Funding London and Capital Enterprise. Despite this, the LCIF is more active in the tech space than its Scottish counterpart, having already invested in 65 separate rounds in just over two years. Capital is invested in seed rounds worth between £250,000 – £1 million. The figures listed in this article are all based on the size of the total investment round. In reality, LCIF and the Scottish fund contribute around 50 percent of the total value of the round. On occasion the proportion is far lower.

The existing funds and proposals for the Northern equivalent are all based on the same principles designed to stimulate the investment scene. However,  the specifics of each taxpayer-backed co-investment can be catered for the economic dynamics of the region.

London’s VC infrastructure is one of the best in the world, meaning the capital’s fund is best suited to participate as a minor investor alongside the heavyweight private investment scene. This is mainly in lower seed-stage rounds. There is less provision for follow-on investments from the LCIF public purse so the average deal size is lower. This means a high volume of low value (£250,000 – £1 million) deals form the bulk of LCIF activity to stimulate the investment market and business growth in the capital.

The relative infancy of the Northern investment scene means public co-investment must perform a different purpose in the £150,000 – £2 million space, much like the Scottish operation. Proposals for the Northern fund allow 50 percent of the fund to be used for follow-on investments to mitigate for the lack of private investment opportunities for organisations looking to raise over £500,000.

Figure 1 illustrates the size and variance of deals where the two funds are participating. In London the median deal size is only £697,000. This makes sense – the LCIF is limited to seed investments only, whilst the Scottish example has the flexibility to participate in larger rounds. North of the border, this flexibility now means there are so many angel syndicates that the VC sector tend to participate in deals over £3 million only.

Steady and constant investment is required over a lengthy period to reap the full rewards of a public fund. Figures 2 and 3 demonstrate just that – a steady flow of seed investments designed to nurture an ever-growing ecosystem. The cumulative growth of investment rounds from both funds is generally linear, and remains broadly constant over the period, although a single Scottish investment round in 2011 bucks the trend.

Scotland has now benefited from £89 million in tech investments which the co-investment fund has had some involvement in. Figure 2 also demonstrates that LCIF is investing at a quicker rate than its Scottish counterpart. This is not due to higher deal size, but the higher numbers of yearly rounds the fund participates in.

Geographically, both funds have been spent where the tech ecosystem continues to burgeon. Figure 4 reveals just how Edinburgh-centric the Scottish co-investment fund has been since its inception. Tech Nation 2017 put Edinburgh as one of the leading clusters of Scottish tech, however it’s thriving financial scene means co-investment fund activity is likely to be greater compared to Glasgow.

Similarly, figure 5 highlights high value London investments clustered around Zone 1, and in particular the Old Street and Liverpool Street areas, where the tech start-up scene is strong.

For the North, a co-investment fund would likely mean high levels of investment in the already thriving tech hubs of Manchester and Cheshire. However, it also makes finance readily available for tech startups across the region, so a successful organisation in Hull would also receive finance for instance. It will “level the playing field” across the Northern region.

The benefits of a co-investment fund

The beauty of the co-investment mechanism means jobs are created in the short term as more deals are completed, whilst in the long term the taxpayer receives a return on investments made. This is a highly efficient cooperative model working in tandem with the private investment sector. In contrast, a traditional publicly funded investment pot fails to retain 85% of finance invested on average in the UK.

The correlation with growth is clear – since 2011 Edinburgh has enjoyed 85% turnover growth in digital tech firms, fifth highest in the UK. Turnover growth in London has increased 106 percent over the same period – second highest behind Dundee. LCIF is a key driver of growth. The fund has encouraged £6 of private investment for every £1 of their own public finance across their portfolio, whilst their work can be attributed to the creation of 675 jobs.

Tech Nation 2017 also highlighted Edinburgh as the most opinion positive tech cluster in the UK, with 92 percent relishing the opportunities for growth in the future. Is it likely that the availability of finance through the co-investment fund has aided this. In contrast, the North is cited as a region lacking tech investment – something Tech North regularly writes about.

Figure 6 lists all tech investment rounds the two funds have participated in.

Learnings from abroad

Outside the UK, prominent private and public co-investment funds exist in Canada, Germany and Israel. Canadian examples include the Co-operative Investment Fund created in “response to a critical challenge facing co‑operatives and mutuals: accessing capital without compromising their autonomy”.

In addition, the 2015 Canadian Government’s VC Action Plan was created to revive investment opportunities in the country. At the time, those working on the programme said: “we see VCAP playing a critical role in revitalising the Canadian venture capital landscape and while still early, the investment program is off to a great start”.

German equity investment was bolstered in 2016 with the launch of the Growth Co-investment Facility. A total of £500 million has been made available to high-growth startups across the country. Fund rules state that VC partners will be selected if they match the following criteria:

  • Are active in Germany and invest into SMEs and mid-caps based in Germany
  • Have an established EIF relationship
  • Can demonstrate an excellent track record
  • Have investment opportunities in their existing portfolio with the potential to meet the investment criteria set for a growth-stage portfolio company

Whilst the fund is not specifically available for tech firms, a large proportion of recipients are digital tech firms. The facility is administered by the European Investment Fund, an organisation that co-invests in funds more widely across the whole of Europe and Turkey.

A Northern fund

Despite significant wealth in the North of England, there are far fewer investment funds and investors than can satisfy the great investment opportunities available. Northern tech entrepreneurs struggle to find the right investors, take longer to raise, and are disadvantaged by the under-developed investment ecosystem here.

Some tech companies are failing due to lack of investment, others are moving from the North to raise investment, with almost all the graduating startups from accelerator programmes such as Ignite and Dotforge moving to London. Both issues could be solved if the North had a more coordinated, dynamic and competitive investor ecosystem. James Bedford summarises:

“The principle of the co-investment fund is to utilise the public funds to corral the tech investors, offering a critical mass of deal flow from investment ready companies. Angels will be supported to replicate the success, particularly in Scotland, of syndicate building seen in other co-investment funds. Tech entrepreneurs will be able to engage with investors more easily and competition will be sufficient to enable the best companies to find the capital they need.”

The above examples demonstrate how a similar initiative in the North of England could significantly alleviate this issue. The Tech North Co-Investment Fund will coordinate investors, building a new pan-Northern network which can access more investment opportunities across the North.

Leveraging additional capital, more rounds will close more quickly and an open network will enable more competitive negotiations. Tech companies can access the fund via the investment partners or can come directly to the fund and then be directed to appropriate investment partners, thus making it much easier to find investors.

Tech North’s co-investment fund would attract more tech companies to set up in the North, stop entrepreneurs leaving and would support companies and new angels to become investment-ready. Northern tech entrepreneurs would cease highlighting raising finance as an issue and would instead focus on creating the new jobs and GVA the Northern economy needs.

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Data was sourced from Beauhurst and other manual web scraping tools. It is intended to offer a guide on trends in the digital technology sector, and is for general information only. This may not include every digital technology deal in the region during the period.

Data was cleansed to remove any companies not classed by Tech North as a digital tech company. The data includes all VC stages, private equity growth/expansion, and ‘corporate’ deals. It does not include M&A deals, IPOs, liquidity or buyout deals.

This report is published for general information only. Although high standards have been used in the data sourcing, analysis, views and projections presented in this report, no responsibility or liability can be accepted by Tech North for any loss or damage resultant from any use of, reliance on or reference to the content of this document.

Past figures may fluctuate as further information is published and sourced.