I have followed Professor Colin Mason’s research into early stage finance and Business Angel investing for many years. I have a great deal of respect for his opinions and agree with much of what he writes.
I have just read a Working Paper co-authored by Colin which has been published by www.nesta.org. The conclusion of this Working Paper is that public sector intervention should perhaps be targeted more towards older and “old economy” companies rather than innovative new technology companies. As the paper has been produced as a Working Paper rather than a final report I hope he will not mind if I add some reflections of my own. I cannot claim to have read the extensive Bibliography annexed to the Working Paper and my comments are based simply on my own experience of working with high growth firms and their investors over the past twenty five years.
- High Growth Firms
The paper quite properly asks what constitutes a high growth firm. It states that university spin-outs all too frequently disappoint and that older companies might better lend themselves to periods of accelerated growth. Perhaps Nokia is the best possible example of such a company which started life in the timber industry over 100 years ago and grew to become one of the most successful technology companies in Europe.
It has, however, been knocked off its perch by Apple which has become the world’s most valuable company through its superior products largely designed by an Englishman. What might have been achieved here if Johnny Ives had been given the opportunity to develop his unique creative talent and given the financial backing to do so in the UK?
Mitie Group has grown very quickly to become one of the largest private sector employers in the UK and might be regarded by the authors of the Working Paper as an exemplar of a high growth firm. However, that growth has come largely from outsourced low wage hourly paid workers, many of whom worked in the public sector, and contracting them back to the public sector. G4S has the same business model.
The care home sector is another good example of a sector which enjoyed a period of enormous growth, driven partly by demographics but partly by the eagerness of the banks to lend at inflated valuations against the security of bricks and mortar. It was also supported by private equity houses who saw an opportunity to take advantage of the opportunity of leveraged buy-outs and financial engineering, sometimes with disastrous consequences, as has been widely reported in the press.
Care homes have many places sponsored by local authorities and many outsourced contracts have to be paid for by local authorities. These businesses are therefore largely supported by the taxpayer. While they may enjoy high growth by one yard stick they mainly employ low paid workers who pay little in payroll taxes, they create little, if any, net new employment and are largely supported by the public purse. Policy makers looking at this area should be primarily concerned to ensure that the minimum wage is a living wage rather than creating more “breadline” jobs.
- Life beyond the Minimum Wage
Half of our young people now go to university and they are looking for a bit more from life than an hourly paid minimum wage job. Ohio Tech Angels recently surveyed the average wage for all of the employees in their portfolio companies and discovered that it was exactly double the average wage in the State of Ohio. While I would be the first to agree that we must do all we can to get rid of the scourge of joblessness, we must ensure that we create plenty of taxpaying jobs if we are to continue financing the ever rising burden of the State.
- Growth by Acquisition
For those who know how to “play the game”, a “buy and build” strategy in a consolidating market is a good way to build a business. However, in order for acquisitions to be successful, “efficiencies” must be achieved. This comes about through a process of rationalisation which usually means reducing headcount. How many jobs were created when Lloyds Banking Group took over HBoS? The authors do not contradict the much quoted research paper in www.kauffman.org suggesting that all net new employment comes from companies under five years old. Jobless growth is the “holy grail” of big business.
- Management Buy-outs
Management buy-outs/buy-ins are also cited as another potential area of opportunity to accelerate growth. There is certainly a huge issue here as the clearing banks have hundreds of thousands of zombie companies in their business support units. Many of these companies are “tired but not terminal” and owned by mangers who are at or beyond their normal retirement date. They are unable to get out because they are unable to get bank finance to arrange a management buy-out in the way that they might have done before the financial crash. There is no doubt a significant area of opportunity here and there is much that the professional community could do to reach out to such companies. They could offer creative solutions not only to their owners but also to the next generation of managers who might have the energy and enthusiasm to run such businesses more successfully.
- Lifestyle Businesses
The Working Paper suggests that older companies could be more successful. However, it does not really address the ownership of such businesses, the dynamics of their management and the aspirations of their owners. The vast majority of owner managed businesses are “lifestyle” companies. As long as they provide a good living for their owners, they have no real incentive to change. Outside equity and all of the discipline which comes with it is perceived as a threat and they do not see any real need to create shareholder value as the sale of the business is the last thing on their mind. The reality is that such businesses are unlikely to go through a period of accelerated growth unless they are forced to change by some external event. It therefore seems unrealistic to see the vast majority of owner-managed businesses, which are typically “lifestyle” businesses, as the primary drivers of economic growth.
- Making the Future
On the other hand, last week’s Economist contains a special report about technology start-ups www.economist.com/topics/start-ups. The world will increasingly be defined by security – of energy, water, health, food, cyber, personal and national. As the global population rises from 7 billion to 10 billion by the middle of this century these issues will come into ever sharper focus and they will only be solved by innovation and disruptive new technologies.
Of the top 100 global companies started since 1975, 25 originated in California, 16 elsewhere in America and only one (Indetex, the holding company of Zara, the women’s fashion chain) in Europe. Jaguar Land Rover is an Indian company and in a few years Chinese consumer brands will become as ubiquitous as Samsung and Hyundai. As the Working Paper recognises, many of our best high growth technology companies are corporate rather than university spin-outs. However, they all find it difficult, if not impossible, to sell into the public sector.
The taxpayer would be entitled to ask why we undertake research if we do not commercialise it and the available grant assistance is modest compared with the amount of regional selective assistance given to companies like Amazon to create hourly paid jobs and the extraordinary boost given to companies which benefit from outsourced public sector contracts. EIS relief is an essential component of this funding universe. However, it is an investment by government rather than a cost as EIS funded companies overall contribute more in payroll taxes than their shareholders receive in EIS relief.
The Scotsman article reporting on the Working Paper quoted Brewdog and SkyScanner as examples of the type of consumer-facing company policymakers should be supporting. While Brewdog is a brewery, its growth has been fuelled largely by leading edge financial innovation in the form of crowdfunding. SkyScanner is a consumer facing business but, it is at heart a very clever technology company. Sir Michael Moritz of Sequoia Capital, who recently backed SkyScanner on a £500 Million valuation, described it as the most exciting technology company in Europe. He should know – he also backed Yahoo, PayPal and Google. Policymakers might also like to reflect on the fact that Sir Michael is Welsh. What might he have been able to achieve here if we had a buzzing technology environment like they have in California which has enabled him to become one of the world’s most successful venture capitalists.
If we wish to create taxpaying jobs for our children we have absolutely no choice but to keep innovating to stay at the top of the value chain. If we fail to do so our workforce will increasingly be reduced to minimum wage service sector jobs and sub-contract manufacture for Chinese and Indian companies. While we need people to work in the hospitality industry, care homes and prisons (and increasingly such people come from abroad) we ignore innovation at our peril.