CandidCapital

How the UK venture capital industry can trace its origins back to a pre-war enquiry which, as the catalyst for the creation of 3i in 1945, still influences the industry today.

The foundation of the institutional UK venture capital industry can be traced to the setting up of 3i, as the Industrial and Commercial Finance Corporation (ICFC) on 20 July 1945. The initiative was led by the then private Bank of England as part of a response to the pre-war report of the Macmillan Committee (1), which had identified that small firms were constrained from growing by the prohibitive cost of public capital raising. The other shareholders were the London and Scottish clearing banks. Interestingly, no public money was involved.

In the first thirty years following its foundation, the majority of ICFC’s finance was advanced as preference shares and term loans, not least because of the prevailing reluctance of smaller and medium-sized company owners to cede equity (2). Even by the 1980s, when equity had become a standard part of most investments, there was little belief that ICFC should have any significant role in the development and strategic direction of the business—other than in its ultimate sale, where the Corporation could contribute its considerable expertise in the sale of unquoted businesses (especially in the tax-efficient structuring of such transactions).

ICFC’s, and later 3i’s, success lay in employing investment structures that: produced a strong preferential yield (interest and fixed dividends), the earliest possible repayment of the vast bulk of the capital (repayment of loan and redemption of preference shares) and still left it with a worthwhile shareholding in case the business floated or was sold – and with the minimum of oversight or intervention by the investor. All this was achieved through a complex set of share rights and a subscription agreement which left the management with precious little control over the uses to which they could put any profits not ear-marked for an ICFC dividend.

At its zenith in 1988, 3i had a portfolio of 4,789 investments with an aggregate value of £1.6bn and accounted for over 38.5% of investments made by BVCA members (in the year measured by value, a figure only exceeded in 1990 when 3i accounted for 50.1% of BVCA members’ investment activity). At that time it had a network of 23 regional offices and employed nearly 800 staff. Its influence was felt throughout the industry, not least in the behaviour of its competitors, because it had trained and ‘blooded’ many of the investment managers who ran those competitors. At the time, it would have been true to say 3i’s culture was a highly financially oriented one – its investment executives were, to a large extent, generalists, selected either as graduates or as relatively newly-qualified accountants and other professionals. Indeed, industry knowledge and expertise was concentrated in the ‘Industry Department’, which comprised of a panel of experts who reviewed investment proposals put up by the investment executives in the regional offices.

3i has changed from what it was in the 1980s and is now organised into three divisions concentrating on buy-outs, development capital and venture capital. While the buy-out and development capital divisions remain financially oriented, the venture capital division is organised, and operates, much more along the lines of a US venture capital firm.

However, while it is true that 3i today has a more diverse investment approach, it is reasonable to conclude that its traditional finance-centred approach to investment, combined with its ubiquitous influence on the industry, may well be a significant factor in why the UK venture capital industry has been so much more successful in managing and developing private equity funds than venture funds.

Although there had been a handful of specialist UK venture capital firms such as Advent, in IT and telecoms, and Abingworth, in life sciences, founded during the 1980s, frustration with the finance-centred approach of the UK industry during the 19990s led a number of different groups and individuals to set up or develop funds consciously modelled on the best US West Coast funds. Hermann Hauser, the co-founder of Acorn computers (whence ARM, the global semiconductor IP business, span-out), joined forces with an experienced venture capital team to form Amadeus Capital Partners in 1997. Pond Ventures was formed in the same year by the Irving brothers and others.

So far, however, none of these investors have matched the track-record of the established US funds, such as Accel, Kleiner Perkins, Mayfield, Menlo Ventures, Oak or Sequoia.

(1) Macmillan Committee (1931) Report of the Committee on Finance and Industry. London, HMSO
(2) Coopey R & Clarke D (1995) 'Fifty Years Investing in Industry' p38. Oxford, OUP