The case for scale-up capital: how the LGPS can drive UK science success .

*This interview first appeared in LAPF Investments.

As one of the UK’s most active investors in university spin-outs, IP Group has helped turn academic research into billion-pound businesses. CEO Greg Smith tells LAPF Investments why patient capital from LGPS could help more companies keep their centre of gravity in the UK.

Can you tell me about IP Group and the opportunity around backing scientific innovation?

“IP Group is a FTSE 250 listed investor in science and technology, and we’ve been investing in this space now for almost a quarter of a century.

“We’re something of a founding father in backing science and innovation predominantly sourced from our great institutions in the UK, our universities and research institutions, and turning them into businesses that can then scale, generate jobs, revenue and profits.

“We’ve been doing this for 25 years and we’re still the most active investor in the space in the UK, accounting for about 20% of all of the investment that goes into university spin outs here in the UK.

“Looking forward, we see immense potential in getting those businesses from being relatively small companies to being really significant.”

Companies like Northern Gritstone, OSE and CIC are doing a great job of backing university driven innovation on a regional or university specific level, how does IP Group differ?

“I guess I’d make two observations. One is, we really like those guys, they are dedicated regional investment vehicles that are solely focused on partnering with those universities, and that’s a good, useful model to have in the ecosystem – and I go so far as to say we were pretty instrumental in the setting up of those vehicles.

“The second point I’d make is the IP Group offers investors – whether it’s in the Enterprise Investment Scheme (EIS) space, whether it’s in the listed balance sheet, or whether it’s in a scale up fund – true, pan-UK access.

“And as you think about the journey from early companies through to scale, and as you think about regional versus national capability within the UK, having a manager that can access the whole of the UK I think is a certainly a consideration that people should be taking into account.”

Can you give me some examples of companies that maybe would never have existed without IP Group’s support?

“In the life sciences space, we were behind Oxford Nanopore, which was the first university spin out to reach unicorn status in the UK.

“We first invested in that business back in 2005 with a very small investment, and we hired the leadership team, and then we helped the CEO to build out a leadership team and a board.

“We funded that business over the course of what must have been 17 years up to the pre-IPO round, investing almost £80 million in total. So having been a cornerstone investor along that journey was quite fundamental to its progress.

“Switching out of healthcare and into deep tech and digital, we had a very successful exit last year from our portfolio from a business that we were the first institutional investor in more than 10 years ago called Featurespace.

“Featurespace applies machine learning and AI to detecting and preventing fraud in card payments. That business grew well in the UK, it was cracking the US market as well, and we sold that business to Visa.”

What are the challenges that the UK is seeing more broadly?

“I would say there’s three main areas that the UK needs to develop– capital, conditions, and consumers.

“The capital piece is around having more long term scale up capital available to invest into these businesses.

“I think we do very well in the early stage. Through EIS, we have some very good tax breaks also for companies, but the challenge is many businesses need to source their scale up capital from either international sources or they get acquired just at the point that they’re hitting the fabled hockey curve of revenues.

“The conditions piece, that is around quite a lot of policy and government positioning, so maintaining our leading position in an early stage by continuing to back things like the EIS incentives, which this government has done.

“It’s also around things like pension reform, and consolidating and bringing together pools of capital.

“We often hear big infrastructure, science or technology projects in the UK are either holed under the water line or delayed by things like planning reform, and that has been one of the positives to come out of the industrial strategy.

“And then the third, consumers, this talks to the wider ecosystem benefits. Places like the NHS would significantly benefit from the adoption of homegrown science and technology products and services.

“Additionally, the companies who are developing those products and services would significantly benefit from local customers as first customers because often when you’re trying to scale and grow a business, one of the key things that unlocks capital is being able to evidence early customer traction.”

What role can local government pensions funds play in supporting growth?

“Local government pension schemes are well suited because of the scale and duration of the capital which is available.

“There’s also something of a dual mandate to be able to have a local impact, whether you define local as around the local authority or local as in the wider UK economy, which means that you can take a slightly longer dated view on what can be seen as quite risky and volatile assets.

“So the LGPS is well suited to having an appropriate proportion invested into this asset class.

“We’ve had investment from and have worked with a number of the local government pension scheme pools over the years.

“The other thing, which I think is quite important, is that this isn’t just about venture and investing in companies as an asset class. Many local government pension schemes invest in infrastructure, housing and in commercial space.

“Many of our companies need life science wet labs, they need office space and in order to grow they need to attract talent into a place which is nice to live.

“In financing new innovation businesses, you can create a thread which runs through various other asset classes that the LGPS support locally and nationally and provide for mutually beneficial outcomes.”“Another question in this space is whether there’s enough good stuff to invest in? And our resounding answer would be, yes to that.

“A lot of the companies that are in that space come from university innovation, and there are around 1,500 active UK university spin outs, of which about 60% have raised less than £20 million of capital, and only one or two have raised more than half a billion of capital.

“So there’s quite a ready pipeline of companies that are scaling to the point where maybe series A type investments are relevant and, if there is later stage capital hopefully more of those can go on the journey to Series B and C here in the UK.

“And then another way of looking at it from the top down is if you analyse the amount of capital invested into deep tech over the last 10 years, interestingly the amount of money invested in seed is less than the amount of money invested in series A is less than the amount of money invested in series B.

“However, at Series C, it’s less than Series B, and at series D is even less, and the Series E, less cumulative money is put into Series E companies than seed.

“So businesses are getting onto that first stage of commercial development, and then either a large amount of capital is coming from non-UK sources, and businesses are relocating, or they’re being acquired.

“If you look at that total, there’s something like an extra £10 billion to £20 billion over a 10-year period that could be invested in Series C, D and E type investing.

“Another interesting trend is, when looking at what proportion of that capital at each stage came from domestic UK investors and came from non-UK investors, at the earliest stage – more than a third came from UK investors. By the time we got to Series B and C, it was down to more like 20%.

“So our hunch is, because there’s a lack of scale up capital in the UK generally, just at the point at which these businesses are becoming attractive they get a cornerstone investor that’s non-UK based.

“And so inevitably in the next round, the centre of gravity moves much more to where that source of funding comes from – and that’s the thing that we want to help to address.

“I should say we should be very proud that our businesses in the UK attract a significant amount of foreign direct investment, that’s absolutely to be applauded and we want more of it.

“We just want an appropriate proportion to come from the UK, so rather than being maybe takers of terms and there being an increased risk that businesses relocate their centre of gravity, we’re in a position where we can contribute a proportion of that to the journey, and so more businesses can keep more of their centre of gravity here in the UK.”

Are more asset owners now recognising the fact that above and beyond the obvious financial returns there are other highly significant benefits that will accrue to the UK more broadly?

“The requirement to deliver a financial return is paramount. First and foremost, you’ve got to deliver sufficient financial return for the risk that you’re taking and for the returns that you need to generate in your portfolio.

“But to me, provided you do deliver those financial returns, the more interesting facet of all of this is what that money actually does. And one of the reasons that I’m so compelled by IP Group is it offers the opportunity to bring both financial return and real-world impact.

“I think the reason that is the case is because most of the businesses that we are helping to co-create, fund and back, are addressing very big problems in the world because they’ve come off the back of research that’s looking at either understanding the world in which we live, or addressing the big problems that the world faces.

“And because they’re going after very big problems, the addressable market can be really big. The consequence of that is, if you are successful, you might help 100 million people who suffer from autoimmune disease and suffer from debilitating pain every day of their life.

“And yes, you’ll make a fantastic return, and all of our investors will be very happy. We, IP Group, will be delighted – but I think we’ll be prouder of the fact that we’ve had this massive human impact on the world.

“I think a lot of the reason why businesses and founders and people who work with IP Group stick at what is quite a difficult thing to do and to achieve, is because you’re driven by that fundamental underlying purpose.”