Whilst there has been much talk about encouraging greater numbers of start-ups in Wales, it is equally important that these businesses scale-up quickly and create jobs and prosperity within the economy.
As discussed in this column last year, business angels are critical in helping potential high growth start-ups to establish themselves in the market.
But whilst such informal investment is important, research has shown that it is more formal equity vehicles, such as venture capital, that really enable firms to grow especially in technology-intensive sectors.
In order to gain investment, firms will normally submit their plans to venture capital businesses who will then, if they are interested in the proposal, undertake a process of due diligence to examine the business model, the products or services and most important of all, the ability of the venture team to deliver.
If they are satisfied with this, then the venture capital firm will invest in the company in exchange for equity. They will also take an active role within the business, usually by taking a place on the board to ensure that the company is meeting key milestones in order to trigger further rounds of investment.
The aim for the venture capital business – which normally sets up a specific fund to make a small number of investments in a limited number of firms - is to make a profit on their investment through an exit, typically after four to six years which is achieved through an acquisition/merger with another firm or a flotation on the stock exchange.
Given that the focus of venture capital is to grow high potential new firms, it is not surprising that it is often associated with innovative start-ups that as they grow require and attract highly qualified engineers, higher salaries, and requirements for service provision from other companies.
The profile of such firms - risky, early stage and requiring large amounts of capital - means that banks normally run a mile from investing into these ventures. More importantly, the experience, expertise and knowledge which venture capitalists bring to the firm is normally not available from traditional funding providers.
However, this type of funding is important to the economy because technology companies, if successful tend to grow more rapidly than other sectors, creating proportionally more new products and markets than larger companies.
In fact, studies have shown that venture backed companies outperform non-venture backed companies on most operational performance indicators including revenue, productivity, gross income and, most importantly, employment. They also become the launch pad for other innovative products and technologies and they help create a culture of entrepreneurship more widely within the business community.
So what is the position in Wales when it comes to venture capital funding?
According to a study by Roger Maggs, one of Wales’ most successful venture capitalists, the vast majority of venture capital funding in Wales is provided by Finance Wales, the Welsh Government’s funding arm for SMEs.
Unfortunately, his research shows that the vast majority of this funding has largely ignored those high potential start-ups that can make so much difference to the Welsh economy.
For example, during the period 2009-2013, Finance Wales invested venture capital in only nine start-up companies, which equates to just 12 per cent of the total equity funding into Welsh businesses.
Indeed, the majority of seems to have gone into supporting management buy-outs (MBOs) which will maintain successful companies but will not lead to the innovation and growth required by a region such as Wales which is the poorest in the UK. Whilst other equity providers across the UK invested, on average, in 5.5 start-ups per million head of population, the figure for Finance Wales was 3.
Of course, that was the situation under the old mandate and structure of Finance Wales and it will be interesting to see what will happen going forward when the new Development Bank for Wales is established.
It is not a supply issue as research suggests that there seems to be sufficient supply of available venture capital funding. The problem is therefore not the quantity of finance but in how the investment of the available funds is organised and there are concerns as to whether a single, large and centralised entity such as Finance Wales is the optimum vehicle for direct venture capital investments in start-ups.
Instead, should the Welsh Government seek to encourage, as other successful countries have done, the attraction of venture capital companies with the experience, expertise and, most importantly, a successful track record of developing innovative businesses? Certainly, that has been the approach for life sciences in Wales where the Arthurian Fund, led by Sir Chris Evans, is independently responsible for providing venture capital into this sector and there is no reason at all why this model could not be adopted for other sectors.
And with Wales only investing 2 per cent of all UK venture capital funding over the last decade, it is clear there needs to be a radical change to ensure that those firms with the potential for growth are provided with the capital they need to make a difference to the Welsh economy.