Obstacle race for start-ups

Innovative small firms are virtually strangled at birth by lack of business skills and the City’s reluctance to take a risk in investments or back new technology

A suicide pact, it would seem, between the money lenders and borrowers ensures that many small firms do not evolve beyond the seedling stage into the larger world of business. Often, these companies fail to make the transition from successful innovator to successful supplier.

Delegates to a seminar last month sponsored by the Department of Trade and Industry, during Science, Engineering and Technology (Set) week, heard that it is a potential disaster not just for the small firms but also for the nation. Product innovation is responsible `for economic growth because it creates markets, jobs and sources of wealth’.

So why do innovative firms fail before they have established a market presence?

What makes the transition from a successful research and development organisation to a manufacturing company so difficult?

More important, what is the secret of those few small firms who go on to become world leaders?

Lack of money, which is usually cited as the main reason by small companies, is not itself a reason for failure according to Professor Alan Hughes at Cambridge University. His study, presented during Set week, of 600 start-up companies sampled over five years concludes that a complex mix of ingredients determine the ability of companies to be commercially successful. Their lack of business skills and marketing information are high on his list.

The City is often hounded for its failure to support innovation, but it is not entirely to blame for the failure, says Hughes. But, at the DTI’s Innovative Enterprise seminar, Dr Peter Harrop chairman of fibre optic company Pinacl, criticised City analysts. He says they are ignorant and arrogant when advising investors on technology they have not studied and do not understand.

Adverse comparisons between the UK and attitudes among money lenders in the US or Germany are inevitable. Duncan Matthews, head of NatWest UK’s innovation and growth unit, refers to the empathy gap. The City, a technology desert that thrives by funding low-risk, established businesses, is at odds with high-risk, innovative firms with no commercial track record, he says.

Nigel Hopes, head of flotations at accountant Coopers & Lybrand, agrees. `There is a funding gap. If you need capital in the £50,000 to £500,000 range, it is much more difficult than if you want to find £5m.’

He accepts that City advisers are inevitably cautious. `The risk of completing the process does not make economic sense because the nominated advisers and lawyers involved have a reputation to protect and will not cut corners,’ he says.

In its report The Innovation-Exploitation Barrier, the House of Lords select committee on science and technology expresses a widely held view that the City is `drifting towards a risk-averse strategy’.

It calls for Government action to monitor two schemes – both backed indirectly by public funds – to ensure they fulfil their original aims. The Enterprise Investment Scheme provides tax incentives for individuals who invest up to £100,000 in unquoted companies. More particularly, the Lords’ committee highlights the Venture Capital Trust schemes which, it says, `do not appear to have achieved in practice their potential for funding technology-based start-ups’.

The stark findings are that funds from VCT schemes are not being used for the intended sector but rather are being diverted to fund asset-backed schemes with `substantial interests in property’.

At the DTI seminar, Elizabeth Garnsey, senior lecturer in business studies at Cambridge University’s engineering department argued the most important ingredient of any successful business start-up is `the will to grow’. She wants a change in the education system with an emphasis on multiskilling so managers of engineering and other science-based firms develop all-important business know-how.

Two DTI funding programmes that have successfully encouraged innovation are the Spur and Smart awards. Miles Brough, managing director of Jesse Brough Metals Group, took advantage of a £156,000 DTI Spur award in 1995 and sees growth as a vital ingredient. The company has a £2m turnover.

* Last month, Brough was among 14 firms that won a DTI TechStar ’97 award for the successful commercialisation of an innovative product or process developed under earlier DTI Smart or Spur awards.

Sulcated Springs, another TechStar ’97 winner, received a £105,000 DTI Smart award in 1994 to develop leaf springs made from composite materials. These are used in Volvo trucks because they contribute half a tonne weight saving on a 40 tonne vehicle and provide a quieter, more comfortable ride.

The firms did not rely on the City to provide funding for marketing their products. Geoff Scowen, proprietor of Sulcated Springs, asked about the Small Firms Loan Guarantee scheme, but was told they are hard to get because many firms are high risk and just starting to build their markets. Brough used funds from a licensing deal which gives foundry engineer Mechatherm International of Kingswinford the right to build and sell Brough machinery outside the UK.

Not all firms are happy to license technology, afraid they might lose control over intellectual property. Again, the House of Lords has called for the patent process to be made faster and cheaper.

The Smart and Spur schemes have been praised by all sectors of the community, but both are officially under review.

One fear is that new guidelines will make them more competitive and less accessible. The House of Lords and NatWest bank, among others, have asked the DTI to consolidate future funding like US programmes such as the Small Business Innovative Research Programme.

NatWest’s Matthews argues that the schemes have become a `selector of excellence’, helping potential investors to appraise a company.

`We know that if a Smart winner comes to us with a business proposition, the idea has already undergone extensive technical assessment and its commercial viability has been a factor in winning,’ he says.

He adds: `If we as bankers, and the UK as a whole, fail to identify high potential businesses, we will find it difficult to achieve the level of competitiveness and wealth generation needed in today’s global markets.’