Kerry Baldwin, Managing Partner at IQ Capital, is chairing a panel aimed at directing pension fund … [+]
By 2030 – and yes, that does seem a long way away – Britain’s major pension providers should be allocating at least 5.0% of their defined contribution funds to unlisted assets, with the aim of both increasing their own returns to savers while also directing additional capital to high-growth scale-up companies.
That should be good news for young businesses in search of the funding they need to grow but a lot of the detail has yet to be worked out. U.K. pension funds don’t have a track record of investing in unlisted companies and the mechanisms that will allow them to do so are not yet in place. To move things forward, the British Venture Capital Association, this week announced that it was convening an industry panel with the aim of identifying and breaking down the barriers to investment.
So what are those barriers? And more importantly, what will the allocation of pension fund money mean for young companies as they hit the scale-up stage of their development?
The U.K.’s innovation ecosystem still has a structural problem when it comes to funding. Broadly speaking, businesses seeking Seed and Series A funding are well supported by domestic and also European VCs. Problems tend to arise further up the funding ladder when larger sums of money are required to scale up nationally and internationally. Indeed, research published at the beginning of the year by HSBC Innovation Banking found that later-stage investment “meaningfully slowed” in 2023,
Capital is available but much of it comes from North American or Asian investors. Money is money, so the recipients are unlikely to complain, but from a U.K. perspective, there is a danger that the most successful British businesses will shift their focus overseas, perhaps listing in New York rather than London when the time comes for an IPO.
New Investment Vehicles
In the summer of last year, pension funds committed themselves to the so-called Mansion House Agreement that will see them allocating more of their money to innovative growth companies. Meanwhile, Chancellor (Finance Minister) Jeremy Hunt announced plans to explore the creation of new investment vehicles through which pension fund money could be channeled.
The move was welcomed by the industry. For instance, Nauren Zahid, director of investment at VC, OpenOcean, said at the time: “Forward-looking start-ups are now presented with the opportunity to secure the necessary capital from domestic stakeholders for global expansion. If executed effectively, this can be a transformational moment for UK tech.”
The challenge now is to make it work.
Why Does This Matter?
So why does this matter? Well, the obvious answer is that Britain’s pension industry is the biggest in Europe with assets under management coming in at £2.5 trillion, so a 5.0% allocation to fast-growth tech companies in, say, the climate or life sciences sectors could, in theory, be game changing.
But will cash-hungry businesses actually see a difference? Kerry Baldwin, Managing Partner at IQ Capital, is chairing the BVCA-convened expert panel. As she sees it, the move to harness the resources of pension funds has the potential to plug a gap in the funding marketplace – the point when businesses require very large rounds. Baldwin explains the problem.
“Our fund is only a certain size, so we can only invest in rounds of a certain size,” she says.
In practical terms, that could mean a company that is about to expand internationally will have to compromise on its hiring – for instance not being able to afford a product marketing executive with the right track record and heft. Pension funds investing working with VC and Private Equity funds could address that problem.
“We will see entrepreneurs getting the rounds they need and the talent they need,” Baldwin says..
What happens during the internationalization phase could be crucial not just for the health and well-being of the companies themselves but also for Britain’s innovation economy. More local investment – so the logic goes – will encourage U.K. companies to stay centered on home turf. Overseas investment, arguably, will have the opposite effect.
Barriers To Investment
Pension funds haven’t agreed to the 5.0% target out of altruism. There is an opportunity to secure higher returns for savers. BVCA figures indicate that private capital industry produces a 10 year horizon return of 17 percent, compared with a 6.5 percent return from the FTSE All Share index. The potential is underlined by a survey from Onward which looks at returns from Australian, Canadian and U.S. pension funds, which do invest in unlisted companies. It suggests the Mansion House deal could deliver a £97,000 boost to a saver over 35 years.
But redirecting money to unlisted companies isn’t going to be straightforward. There is, for instance, concern about investing in “illiquid” assets and the associated costs.
Hence the BVCA panel. ”We are working to unlock the barriers,” says Baldwin. “There is a commitment to find solutions within the timeframe.”
“Some of the discussions will focus on the relationship between pension providers and VC and growth equity funds. We need to understand how we can work together. For instance, what about fees? How do we report?”
So there will be a big focus on practical solutions. But what about the wider issue of culture and knowledge? Pension funds are custodians of saver money and are skilled in balancing risk and return. But is it reasonable to expect them to understand the risks associated with startup and scaleup companies in tech sectors? Have they got the internal knowledge required? It has been noted, for instance, that in terms of post-IPO investment, pension funds seem to be most comfortable with traditional industries – minerals, fast-moving goods, etc – rather than tech.
Baldwin sees a slight mischaracterisation here. “Pension funds do understand the sector,” she says. As she points out, they are already investing, albeit on a very small scale.
And perhaps more importantly, the likelihood is that investment will be directed not to high-risk startups with a few employees and a great idea, but to more established businesses – perhaps with 500 employees – who have already gained market traction.
Clearly, none of this will make much difference to today’s generation of companies hitting the growth phase. The challenge for investors is to release the “billions of pounds” in investment expected by Jeremy Hunt.
