Millionaires tackle funding gap for UK hi-tech startups

Wealthy people have stepped into fill the funding gap that has seen investment in technology startups fall to one tenth of boom-time levels. But enterprise chiefs say that rich investors lack the clout to correct the investment market failure, leading to calls for the government to step in.

A meeting of 15 startups and investors at Wednesday's annual showcase hosted by the St John's Innovation Centre in Cambridge, which claims to have been Britain's first technology business incubator when it was formed 22 years ago, also heard how the private sector thinks it can correct its own funding failure.

The stakes are high for British hi-tech startups, which lack investment to turn their ideas into viable commercial opportunities, yet feel more pressure than ever to compete on the global market with engineers graduating in their thousands in China, India and Brazil.

Dr Paul May, executive director of innovation at the East of England Development Agency, suggested that the UK is in an "innovation arms race" with the emerging economic giants, but that only wealthy individuals are priming the pumps.

"The provision of early stage finance is clearly a market failure. The amount of finance available last year was one tenth of what it was in 2000. In Cambridge the good news is that angel investors have picked up a bit of the slack," he said.

Martin Graham, former head of markets at the London Stock Exchange (LSE), told the same meeting that he is forming a worldwide network of angel investors to form a startup fund to stand alongside an SME stock exchange he intends to launch in 2011 in competition with the LSE's Alternative Investment Market.

"The world is full of thousands of family offices which control trillions of pounds of assets. And they are very interested in investing in early stage companies where they can obtain a higher risk-reward ratio," he said.

"Their problem has been an inability to access those opportunities. These guys are bombarded with thousands of emails and phone calls, and they just can't process the information they get."

Startups and investors are doubtful that angels can carry the responsibility for correcting the funding market's failure, however.

Mike Bradley, managing director of hi-tech startup Input Dynamics, said that angels are cautious about investing because they have become used to having their investments kicked out by venture capitalists (VCs) later on.

"It's very hard to get money for anything. If any angels invest now [and] a VC comes in later, they crucify the angel," he said.

"If an angel invests £100,000 and a VC comes in later, they usually ignore that previous investment. So a lot of angels don't see how they can get a return on their money."

Top-tier mobile phone manufacturers are interested in Input Dynamics' touch-sensitive software, but the startup has fallen a year behind schedule for want of £1m to commercialise its software. The firm has survived to date on £100,000 worth of grants and £50,000 invested by five of its founders.

Paul Anson, who became a business angel in Cambridge in 2006 after selling his printing technology business for £30m with his eight business partners, suggested that angels can't fill that entire gap.

"There are more opportunities for angels to invest because of the funding gap, [but] the fragmented nature of the angel investment market means that there isn't really enough money to go round," he said.

Anson believes that more public money is needed to fill the gap. "If the government wants to encourage more angel investment it should do more matched funding," he explained.

David Gill, managing director of the St John's Innovation Centre, called on the government to step in as financial institutions have abandoned small firms in search of big returns from management buyouts, and large mergers and acquisitions.

"The finance sector has turned its back on early-stage, particularly technology, companies," he said.

Banks have been happy to throw cheap money at these major and highly leveraged deals, which promise returns of 20 per cent and make startup funding seem a waste of time to anyone looking only at the numbers. But Gill pointed out that the big deals would never have been funded had the banks not been confident that the tax payer would bail them out if the balloon burst. It did.

"It was the tax payer who was left holding the baby," he said, adding that startups are still gasping for good money.

Gill called for a "government-funded 3i for the 21st century". 3i was formed from a post-WWII initiative to get banks lending to small businesses. In recent years, the company stopped the startup funding for which it became famous to concentrate on big-ticket deals.

Gill suggested that the government should "prime the pumps" with a £100m injection of public money into private venture capital funds. Capital for Enterprise, a public vehicle that has already distributed £60m between six private funds since 2006, should manage this fund of funds.

Everyone is waiting to hear how much money the government will have for startup funding when the result of the public spending review is published on 20 October.

Business secretary Vince Cable prepared startups for life in cost-cutting Britain in a speech at the Queen Mary hi-tech incubator in East London, also on Wednesday.

"There is no justification for taxpayers' money being used to support research which is neither commercially useful nor theoretically outstanding," he said.

Government thinking, however, appears to be in tune with the startup community, in that the Regional Development Agencies due to be disbanded deal with geographical areas too sparsely populated with startups to compete seriously with the likes of Silicon Valley. This is even true of Silicon Fen, at the centre of which is Cambridge University, ranked the world's best this week in part for the innovations it promotes.