Wanted: risk-seeking capital to fund creative destruction
Public-private initiative provides much-needed lifeline to growth companies
10 Aug 2020 | Keith Mullin
Keith Mullin
Keith Mullin

THERE'S been a lot of talk recently about whether the global economic debacle caused by government-imposed Covid-19 shutdowns could unleash a wave of creative destruction. If such a wave were to crash onto the economic scene, the pain being felt by stakeholders throughout society might be seen over time to have been worth it, provided it is short-lived and the transitionary phase is properly nurtured and evolves at a reasonable pace.

The starting point for economic transformation will always be a cadre of willing entrepreneurs with bold ideas. But developing ideas also demands the right set of incentives. One of those incentives is access to development finance and venture capital from a combination of public and risk-seeking private sources.

The economic destruction stemming from Covid-19 has been indiscriminate and wreaked havoc everywhere. Despite hopes of V-shaped recoveries, it’s clear that national economies will recover at different speeds and it will probably take years for world economic output to regain what it lost during the pandemic. It’s not even as if we’re at the bottom of the cycle, as localized lockdowns start to multiply to cap rising infection rates. The wave of corporate bankruptcies and downsizing is in its early stages.

The notion of creative destruction has been around since the days when Charles Darwin and Karl Marx were contemporaneously evolving similar theories in their respective fields. It gained popularity in economics post-World War II. The idea of the old, inefficient and obsolete being swept away in the wake of something truly disruptive has an idealistic, almost romantic ring to it. As the world has moved inexorably into a technology-enabled New World, it’s arguable that a cycle of creative destruction has been turning for years.

Ironically, one of the stumbling blocks to a more rapid process of transformation cited throughout the Covid-19 crisis has been the tendency of governments to want – perhaps naturally – to minimize economic hardship and attempt, like King Canute, to hold back the tide.

Because that protective tendency has resulted in indiscriminate, all-encompassing and huge ‘money-now-questions-later’ Covid fiscal and monetary stimulus, it has provided yet another protective shield for zombie companies that in normal economic times and under normal monetary circumstances would – and arguably should – have gone to the wall years ago; companies that have only managed to eke out a fragile existence because of ZIRP/NIRP and other monetary policy actions.

Creative destruction holds that as assets become obsolete or surplus to requirements in a given status quo, they should either cease to exist or devalue until such point as they offer perceived value to third party disruptors who can take control of heavily discounted assets and who are better equipped than previous owners to recycle them and create value-add; the theory being that employees benefit as the green shoots of modernization and progressive thinking are given space to evolve.

Hence, this period should, in time, be seen to have been a golden era for the broad universe of business angels, seed funders, early-stage investors, crowd funders, development financiers, venture capitalists, private equity investors and opportunistic trade buyers. Getting deals done is always ultimately going to be about price, but if risk-seeking capital can pick up assets or find investment opportunities at reasonable values with reasonable return profiles, financing conditions are as good as they’re going to get.

Governments felt they had to move quickly at the outset of the pandemic to prevent the worst, and it’s easy on so many levels to applaud their alacrity. But as initial public support schemes start to expire, there needs to be a real shake-out that separates the wheat from the chaff. Subsequent schemes need to focus on nurturing growth companies.

As such, it is of no surprise that the British Private Equity & Venture Capital Association is supportive of the 500-million-pound sterling Future Fund, a public-private initiative launched by the British government in April to support creativity in UK and certain non-UK high-growth and innovative companies. Administered by the British Business Bank (BBB), the Future Fund will extend three-year fixed-term convertible loans of between 125,000 pounds and 5 million pounds – but only if companies achieve match-funding from professional or high net worth investors.

The loans come with a minimum 8% non-compounding interest that accrues until the loans convert and interest is either repaid or converted into equity. Loans automatically convert into equity at the company’s next qualifying funding round, or at the end of the loan if they are not repaid. Eligible businesses must have previously raised a minimum of 250,000 pounds in equity investment from third-party investors in the last five years; funding can’t be used to repay borrowings or pay dividends, bonuses or advisory fees.

As of July 21, the BBB had approved 468.7 million pounds of convertible loans for 465 companies – 82% of which went to companies with mixed gender senior management and 59% to management with mixed ethnicity. There had been a total of 781 applications in the first two months of the Fund’s operations. Such schemes could be a much-needed lifeline to growth companies.

Start-up tracker Plexal (using data from Beauhurst) notes that while UK start-ups have raised 3.2 billion pounds since the start of lockdown, the number of deals fell 17% over the same period of 2019 (-28% for seed-stage companies). Investment levels across the board are down 37% and the amount going to tech start-ups receiving investment for the first time is 81% lower.

Have you read?