Giving startups a leg up

A legacy of research has led to policies that give startups the best chance of success

During the 2018–19 tax year, over 670,000 new businesses were founded in the UK, but if past trends continue not many will be left a few years from now. Data from the UK government showed that over half the businesses started in 2013 had disappeared by 2018, illustrating an unfortunate reality of modern entrepreneurship.

The risk of a new business failing will never go away, but substantial policy changes are giving new ideas the best possible chance to succeed. It is one of the many legacies left behind by Professor of Entrepreneurship at Imperial College Business School Mike Wright. Professor Wright passed away in 2019, but his work continues to improve how UK businesses are being set up for success.

Understanding business lifespans

Professor Wright was the founder of the Centre for Management Buy-Out Research (CMBOR), the first centre of its kind devoted to the study of private equity and buy-outs. The Centre oversaw a database that contained details of 35,000 buyouts and private equity-backed transactions that were undertaken from the 1970s onwards. This dataset, combined with several others, provided a valuable source of information about what happens throughout the lifespan of the average business, particularly when things go wrong.

One critical factor is the equity gap that many UK startups encounter. It’s a well understood phenomenon that most startups face funding challenges early in their life, particularly between the development of an idea and the creation of a business plan.

However, this is not the only funding gap that exists. CMBOR revealed the existence of a second funding gap that opens up once these startups begin to expand, particularly among knowledge or technology-based companies.

Over half the businesses started in 2013 had disappeared by 2018

Venture capital investors find these kinds of businesses difficult to understand. Some consist of intangible assets, like an app or website, making their value hard to calculate. Others are highly innovative and use a business model unlike anything else in the market. There are also businesses with long development paths, meaning their potential profitability won’t be apparent for some time.

Combined, all these factors make these new kinds of businesses difficult to value by conventional measures. Venture capital investors, who need to make careful decisions about where to allocate their money, simply couldn’t calculate their value, and instead focussed on more traditional businesses. This second funding gap was calculated to be £500 million per annum, potentially leaving these particular startups well behind their peers.

State aid funding

Professor Wright’s research through CMBOR was the basis of the UK obtaining state aid clearance from the European Union Commission to help fill this gap. This imbalance in the private equity market, and the research proving its existence, played a significant role in the European Union’s decision to extend state aid funding to the UK’s Enterprise Investment Scheme and Venture Capital Trust Scheme. Combined, this funding doubled the amount of money companies could raise under these schemes from £5–10 million.

But ultimately, this is just a small part of the legacy left by Professor Wright’s work.

“As his work underpinned much UK government policy designed to increase equity investment, under both Conservative and Labour administrations, it is difficult to overestimate the importance of his work to both private equity and the wider business community,” David Petrie, Head of Corporate Finance at Institute of Charted Accountants in England and Wales, wrote at the time of his passing. Businesses will be feeling the benefits of his work for years to come.