Apart from a few long established firms, notably GSK and Astro-Zeneca in pharmaceuticals and Rolls Royce and BAe Systems in aerospace, the UK is virtually unrepresented in sectoral league tables of the world’s largest industrial companies.
This illustrates not just the continuing loss of successful UK companies to foreign acquirers, but also the lack of potential UK acquirers for promising future start-ups.
The Green Paper highlights the increase in availability of venture capital for STEM based start-ups, in part due to the impact of R&D Tax and Expenditure Credits (RDEC) on investor returns. But VC’s make their money mainly by selling their businesses to corporate acquirers. Listing businesses on the London market has tended to be just a stepping stone to the same outcome, even when the UK IPO market was more buoyant that it is today.
Selling out to a larger business is often, possibly even usually, the best result for both founders and investors, and investments in the UK by overseas based companies make a major contribution to the UK economy.
But to build a more rounded and resilient industrial base, with continued capacity for growth over the long term, it is essential that we provide better support to the small number of ambitious entrepreneurs with the desire and ability to build a major company over the long term - people like Hermann Hauser, cofounder of Acorn and Arm, Mike Lynch, founder of Neurodynamics and Autonomy, and James Dyson. Venture capital investment was avoided, delayed or minimised in each case. Instead it was lead customer, or in the case of Dyson, licensee funding, that played the key role in getting their businesses established, and enabled their founders to retain independent control, at least until over a decade after IPO.
Of course, both the funding situation and pace of competition is very different to that of four decades ago when these UK businesses started. Venture capital is much more readily available and new firms must scale quickly to compete in global markets. But lead customer funding for the development and trialling of innovative technologies to transform those customers’ own operations remains an important feature of the innovation economy. It can be transformational during a start-up’s formative years.
Some founders of major US companies have also benefited from lead customer contracts. Microsoft, built on licensing versions of the operating system it developed for IBM to PC clone manufacturers is the leading example.
But some US entrepreneurs have also been able to maintain managerial control of the VC-backed businesses they created well beyond IPO, by the use of dual class shares, giving them enhanced control of major strategic decisions. Mark Zuckerberg, the founder of Facebook, now Meta, retained less than 25% of the ownership of Facebook post IPO, but over 50% of the voting rights. The founders of Google only agreed to taking the company public after a dual class share structure was proposed giving them controlling voting rights. My colleague, Professor Bobby Reddy, advocates for greater acceptance of dual class shares by investors in UK companies, and has proposed an innovative UK approach to foster the listing of companies, potentially with dual class shares, in the UK.
The principal form of federal government innovation funding for US start-ups takes the form of 100% funded procurement contracts, and successive UK Chancellors and Prime Minsters since 2005 have committed to introduce something similar in the UK. But in the absence of earmarked funding, spending departments like Defence and Health have been unwilling to pay more than lip service to Downing Street announcements. The proposals for solving this problem in my 2017 review for Downing Street were lost in the turmoil of Brexit. They remain as relevant today. The rule changes in the 2023 Procurement Act seem unlikely to solve the funding problem.
In 2017, the Royal Academy of Engineering awarded its prestigious Queen Elizabeth Prize to the US founder of a company largely built on US SBIR contracts for the DoD, DARPA, NASA plus the private sector. Eric Fossum funded Photobit in this way from 1995 to 2000, by which time it had revenues of $20m. Today we all have camera chips based on his technology in our phones. It is a disappointing paradox that no British company could have followed a similar funding path.
UK government funding for innovation in companies has grown by orders of magnitude over the last quarter of a century, totalling over £14 billion a year at the last count. But nearly 90% of this is in the form of blanket subsidies, partly a reflection of the opprobrium historically attached to politicians accused of trying to “pick winners” since the 1970’s. The most recent published data shows the British Business Bank investing just £100m a year directly in start-ups.
In 2023 R&D Tax and Expenditure Credits cost the Treasury £10 billion, some 20% of which is now believed to have been claimed through fraud or error. And RDEC is of little value to the founders of promising start-ups and fast growing companies with neither venture capital nor sufficient retained profits to increase investment in R&D.
The other main subsidy, the Patent Box, is designed to encourage firms to commercialise UK IP in the UK and costs the Treasury £1.4 billion a year. But in practice its value seems to be greatest to tax planners. By doubling the intergroup royalty rate on IP originally developed by the UK start-up on which its success was built, one US corporation was able to generate annual tax savings worth £50k for each of its 600 UK employees.
How to help more UK STEM based start-ups grow to maturity in the UK remains probably the most difficult problem for our Industrial Strategy to address. The attraction of UK companies to foreign acquirers largely reflects our position as an open, English speaking economy with strong legal and education systems and a powerful research base.
Selling less of the family silver: Better UK innovation and industrial policies for economic growth, published by the Centre for Business Research at Cambridge Judge Business School in July 2024, was written by Professor Bobby Reddy and myself to try to analyse and address this difficult problem. It proposes nine new, or modified policy instruments, together with a rebalancing of overall innovation policy spending across different instruments to improve its cost effectiveness.
The report draws on our experience in the private sector in science and technology companies, venture capital, and M&A and IPO transactions, together with our more recent research at the University of Cambridge. The report, together with publications covering the detailed evidence base on which it draws, can be downloaded at www.davidconnell.org