The UK government’s Covid-19 venture capital fund was mainly invested in what a director overseeing the portfolio called ‘zombie companies’, leaving it with ‘a sizable tail of inactive companies’, according to documents seen by the Financial Times.
The Future Fund, a £1.1bn portfolio set up by then-Chancellor Rishi Sunak and managed by the state-owned British Business Bank, invested in 1,190 mostly early-stage companies. start at the height of the coronavirus pandemic.
Minutes of a BBB audit committee meeting in June 2021, seen by the FT, reveal that Dharmash Mistry, a non-executive director, said that “most companies in the [Future Fund] wallet had. . . limited chances of growth on a sufficient scale to succeed” and would therefore become “zombie companies”.
Minutes from a BBB audit committee meeting in February 2022 included a warning from Mistry, an experienced early-career investor in several non-executive positions, that the portfolio was “likely” to have “a large queue of dormant companies and it would be helpful if this could be signaled in advance to manage expectations”.
The minutes also reveal that the BBB initially assumed in March 2021 that the probability of default for companies that received the government’s Future Fund convertible debt was 54%.
The scheme, which was open for applications from May 2020 to January 2021, matched up to £5 million in funding raised by companies from third-party investors if they met certain conditions. The government did not do any commercial due diligence, but relied on the judgment of the co-investors.
The Future Fund was aimed at non-profitable businesses that were not served by other government Covid support schemes. Sunak said in May 2020 that the fund would help “fuel the growth and innovation we will need as we recover from this crisis.”
But BBB’s June 2021 audit committee minutes report that Mistry said the open process for Future Fund applications had created “natural adverse selection.”
The program attracted companies that wanted “either to accumulate as much funding as possible because the prospects were excellent or because the funding could not be obtained through other investment channels”, according to the minutes quoting Mistry. . Mistry did not respond to a request for comment.
A BBB spokesperson said: “Due to the early stage nature of venture capital investments, write-offs are relatively high, with financial returns being driven by a number of outlier high performing companies.”
The BBB highlighted data published by Horsley Bridge, a private equity investor, showing that typically more than half of seed investments suffered a loss. More than 60% of the returns came from just 6% of the investments.
While the government has sought to highlight the Future Fund’s technology investments, it has also drawn attention for backing some unusual ventures, including a jazz streaming service, a cannabis products company and an event organizer. hedonistic parties.
The funding came in the form of a three-year convertible loan – debt that the government can convert into equity when companies then raise private investment. So far, BBB loans to 400 companies have been converted into shares.
The BBB spokesperson said: “Given that the convertible loans are designed to convert to equity over three years, it is encouraging that a third of Future Fund companies have now continued to raise more capital from the industry. private.”
In cases where companies are unable to raise new investment, they may be required to repay their Future Fund loans with a premium, an issue that will become more acute as companies reach the end of the three-year term. year.
In February 2022, BBB’s audit committee minutes record an official warning that “the probability of default [for companies yet to convert] would increase. . . as we move closer to the first deadline in June 2023.”
These concerns were expressed ahead of a warning from the BBB in June that tech valuations were falling, at a time when the UK economy looked more robust than today.
Demanding full repayment of BBB loans could spell insolvency for the companies the Future Fund was meant to support.
BBB’s audit committee minutes were released pursuant to a Freedom of Information Act request. Officials had marked certain passages for redaction on the grounds that they could harm the business interests of the bank or its partners. However, officials neglected to remove the redacted text from the document before it was published.