Spreading the Risk

Boris Johnson has asked pension funds to invest more in start-ups. There's a dichotomy here, as pension funds are looking after the long-term interests for their fund members, who are generally rather risk-averse with their futures. That said, most pension companies provide their members with a spread of risk strategies so they can invest in the more risky but high return investments in the early years of contribution, and less risky investments the closer they are to retirement - you don't want to lose your retirement fund by placing it all on red.

However, surely this is the realm of Boris' friends, the venture capitalists, rather than pension funds? At least that's what you'd think, but venture capitalists aren't that keen on risk these days. They're notorious for not investing in young companies and there's generally a cut-off age before which they won't invest and behave more like private equity investors, who prefer evidence of a history of growth and income stream.

There is, however, a method in the desire that start-ups should be the focus of investment. America was a powerhouse of innovation and growth precisely because it held the record for business failures in the 1800s, but what made it a powerhouse was the fact that start-up businesses failed early and the associated cost of failure was therefore very low, enabling investors to pull out and reinvest elsewhere without being ruined, fuelling the stock market growth. The vast majority of start-ups fail in the first year anyway.

The mindset of professional investment companies these days is to invest in mature companies with an existent track record of growth. Mature companies, however, focus more on buoying their share value and dividends, rather than ensuring they have the cash reserves to innovate or weather storms, such as the Covid pandemic. The end result is companies that become too large to fail and have to be bailed out by the taxpayer - they're companies which don't actually deserve to exist through lack of foresight, and certainly not into the increasingly uncertain future.

Start-ups therefore have to rely on crowdfunding platforms to generate operating revenue - precisely the kind of investment that is spread among a large number of investors and is money such investors can afford to lose without it affecting them disastrously. 

When you think about it, the largest possible spread of investor risk is when the risk is spread across the entire population of a country - and that's done via taxes that are allocated to supporting start-ups. Thus, while I agree with the strategy of investment being focussed on start-ups, this should be coming from government through taxes.

There are government schemes, such as EIRC, which we ourselves have taken advantage of, whereby the investor in a new business gets 50% of their initial investment back within a tax year in the form of cash-back from the government. However, that's still down to individual investors who have sufficient cash to risk losing, which isn't a large number. That is, however drying up and the percentage the government put in by way of a tax rebate has reduced.

A few years ago the UK government committed £250m to start-ups, but that's a pitiful amount when you consider the number of start-ups and them being, by definition, companies that either don't yet have a revenue stream or have not reached break-even.

Prior to Brexit, the UK was actually a hub for start-up investment but, having cut ourselves off from the world's largest market, we're no longer such an attractive proposition; it making sense to base yourself within a large market.