Creating Risk Capital. Ian Whalley
if he is not understood. [2] Nonetheless some clarification of terminology as used in this book may be helpful.
An enterprise is much the same as a firm or a company, where individuals take part in productive activity of one kind or another. It may adopt a corporate structure, the main form of economic association for enterprise offered by the state in the major market economies. This corporate form is referred to in Britain as a company and in the USA as a corporation. As a practical matter, all these terms are used interchangeably in this book to describe an enterprise, whether a business or a non-profit concern. Enterprise and company are, however, the preferred terms, the first conveying a sense of endeavour and risk, and the second the idea of a group of people with a common objective.
A limited company is the legal term in Britain for a company owned by its members or shareholders whose liability is limited. A limited company with capital over a certain size and allowed to issue shares to the public is known as a public limited company or plc, and a plc whose shares are quoted on a recognised stock exchange may be described as a quoted or listed company, or simply as a public company. The latter term does not mean a state-owned enterprise, unless those shares, or a majority of them, are held by the state.
A non-profit or not-for-profit organisation is one which may earn surpluses, but may not distribute them to the persons who control it. A co-operative is a firm in which ownership is assigned to its members, usually a particular constituency such as customers, suppliers or employees. A mutual is a firm which is owned by its members, all of whom provide the same services and receive the same benefits, but the term is also often applied to institutions such as building societies, where some members are savers and others are borrowers.
Risk capital is, as its name implies, money or other property which is at risk. As such it could come in various forms, but in its purest form it refers to the ownership capital, or equity capital, which carries the rights to control a firm and to appropriate its profits, and bears its losses ahead of others who deal with it. The preferred terms are risk capital and venture capital, conveying again the idea of active endeavour and risk, in contrast to equity capital, which may carry a sense of passive ownership.
In the context of royalty funding, the investor(s) would be the institution(s) or individual(s) providing capital to a specialised royalty funding organisation described as the royalty funder. The royalty funder would use this capital to provide royalty funds to individual enterprises and build up a portfolio of such funds.
Endnote
2 Christopher Fildes, A City Spectator: Bulls, Bears, Booms and Boondoggles as chronicled in CITY & SUBURBAN (Nicholas Brealey Publishing, 2004), p. 2. [return to text]
Background
I first became interested in enterprise and risk capital when I was training to be an accountant. To a youthful mind, these terms conjured up a romantic image of merchant venturers crossing the globe and pioneers of new technology, all opening up frontiers in their various ways.
It was clear then, back in the 1960s, that most able and ambitious people have always needed risk capital to finance their projects, just as Columbus did for his voyages of discovery over five centuries ago. Risk capital remains central to the financing of new ventures and projects. It supports the companies of the day and helps to create the companies of the future. In short, it is one of the keys to a dynamic and prosperous society.
Yet, at that time, in the 1960s, it was almost impossible to find risk capital in Britain. There were a number of stock explanations for this situation, including one to the effect that penal taxation discouraged risk-taking and enterprise. None of these explanations, however, seemed wholly convincing in a country which had led merchant enterprise overseas since Elizabethan times, and where the Industrial Revolution had paved the way for investments in countless projects in trade and industry all over the world. British capital had financed pioneer enterprises – from plantations and mines to ports and railways – in Europe and the Americas, Africa, Australia and Asia, in the nineteenth century. In the twentieth century, a firm of London investment bankers, O.T. Falk & Partners, had backed the young jet pioneer Frank Whittle. [1]
So it was that my interest led me to a merchant bank in London, but this was a period when risk capital was widely considered in the City as less than respectable, and even as, in the language of the time, ‘a bit spivvy’. So while the bank concentrated more on project and corporate financing, I went to its office in the USA, where I observed the provision of substantial amounts of risk capital, focused on a small number of new technology high-growth businesses, which was fast becoming the industry known as venture capital.
When I returned to Britain, however, there was still little in the way of a risk capital community, other than organisations created or encouraged by the government to fill a number of perceived financing gaps, such as in overseas development, the small business sector, exports, films and new technology. The last of these seemed to present particular challenges, so I moved accordingly to the National Research Development Corporation (NRDC).
National Research Development Corporation
NRDC financed many private sector development projects and ventures alongside its mainstream business of licensing to industry the intellectual property generated in universities and research establishments. These projects presented all sorts of risks and challenges – management, technical, commercial and, not least, financial.
NRDC operated in practice more or less autonomously in this demanding environment. It was expected to adopt business disciplines in order to make ends meet and to finance its own operations. This it did successfully, consistently reporting substantial profits until it was privatised as the core of British Technology Group, which became a quoted company.
While it was in the public sector, NRDC did not generally find it appropriate to adopt the normal business approach of seeking an ownership share of companies in exchange for the risk capital provided. Yet it had to use business and financing methods which brought sufficient reward to justify the risks involved. Accordingly, it adopted an alternative method of financing, akin to its main licensing activity, which took the form of a contribution to the costs of the development effort in exchange for levies on the sales which resulted.
It soon became clear that the method used by NRDC was attractive to its clients, not only because it was a rare source of risk capital for their projects, but also, importantly, because it allowed them to maintain their independence: it did not involve any dilution of ownership or control, nor any borrowing. In effect, NRDC had adopted a method that enabled companies and entrepreneurs to hire risk capital and reward it fairly, without incurring any debt. And it seemed likely that if this method could be made fully commercial, it could have many applications beyond the financing of new technology projects.
Endnote
1 John Golley, Genesis of the Jet: Frank Whittle and the Invention of the Jet Engine (Airlife Publishing, 1996), pp. 67-69. [return to text]
A wider opportunity
In this book I have built on this background with the aim of describing a coherent, integrated way of providing risk capital for hire on a commercial basis, grounded in established business practice. The result shows a means for enterprises of all forms and sizes to raise risk capital without losing their independence, or borrowing. At the same time it respects the interests of investors with regard to security, risk and return.
The book is based on practical observations of individual cases over many years, ranging from projects carrying all the risks of start-up enterprises and new technology to major capital undertakings and infrastructure projects in Britain and overseas. In this period I had the pleasure and interest of working with a number of very able and motivated people. It is they who inspired and maintained my interest in this absorbing and