A brief history of everything (relating to Nesta Investments)
Nesta has always taken a fundamental interest in how innovation can improve people’s choices and lives for the better. This interest manifests itself through our research and policy work, our grant programmes and the investments we have made. This short series of blog posts aims to capture some of the findings and lessons from this last activity…. investing in innovation to help it demonstrate market efficacy and to reach a scale that enables commercial self-sufficiency.
Since our foundation, over 20 years ago, Nesta has consistently deployed a portion of its capital directly to start-up and early stage businesses. Through an in-house investment team, Nesta has invested in over 250 companies across the fields of health innovation, industrial processes, education, arts, science and culture, supporting cutting edge technologies and novel ideas to reach the next stage in their development towards commercial solutions.
Our investment history can be broken into three main phases, each governed by different strategies and outcome objectives:
1/ Seed investing (2000-2006)
2/ Technology venture investing (2007-2012)
3/ Impact investing (2012-current)
This first post, covers the ‘Seed investment’ years from 2000-2006.
Nesta was founded in 1998 as a non-departmental public body (a ‘quango’), with a mission to foster innovation in science, technology and the arts. A £250m endowment was established (from National Lottery funding) to enable Nesta to operate independently. With such a broad remit around innovation, Nesta had to make some decisions about where and how it wanted to operate to create the advancements in innovation it sought. As part of our approach, Nesta decided to use a portion of the endowment capital to invest directly into businesses and ideas that had potential to create notable impact across the sciences, technology and the arts.
After analysing the UK investment landscape at the time, recognising the quality of (fundamental and applied) research coming out of UK universities, research bodies and even individual inventors, Nesta concluded that there was a shortage of investment capital available for new / start-up ideas and sought to redress this by making small seed investments into a large number of spin-outs, start-ups and raw ideas. Over the course of 6 years between 2000-2006, Nesta invested £17m into 212 businesses operating in the arts (50), health (42), sports/leisure (18) and industry/engineering (102).
The objective of these investments was to encourage entrepreneurial activity at a time when there was very little seed funding available in the UK market, and specifically to support individual inventors to develop their ideas into investable propositions, (either spinning out of a research lab, a corporate R&D department or even their garden shed!). As such, there were no financial return expectations when this seed activity commenced, although this changed towards the end of the period.
Nesta experimented with different funding models, which became increasingly commercial over time. Of the 212 investees, 32 received grants (with very soft repayment clauses in case of success), 84 were ‘royalty’ deals (i.e. taking a share of future revenues related to the innovation), 17 were convertible loans (debt funding that converts into equity ownership on certain conditions) and the remainder, 79 were equity investments.
This pace of investing (c.30 deals per annum) was pretty relentless for the investment team and left little time for post-investment support and management, meaning that the team were often reacting to news and developments from the portfolio.
Additionally, due to the breadth of innovations covered (from a ghost train in Blackpool to livestock monitoring software to tofu-based bio materials!), Nesta often used expert external assessors to pass judgement on the viability of the applicants’ submissions, further disconnecting the in-house investment team from effectively monitoring progress of the portfolio companies.
As the size of this seed stage portfolio grew, so did the follow-on capital needs of these companies, such that by 2006 Nesta realised that it was unsustainable to maintain the pace of investment.
The financial returns of this phase of our investment history are pretty abysmal by any financial benchmark. Of the 212 investments, 41 were transferred at cost (£6.7m) into the ongoing ‘Venture’ portfolio – the second phase of Nesta’s investment history, which will be the focus for the second blog in this series – leaving 171 investments (£10.3m) to be managed to a conclusion (i.e. end of the royalty arrangement, wind-up, share sale, etc). As of October 2019, there are 5 companies still active in this portfolio, albeit where our value is close to zero, with a further 28 deemed as ‘zombies’. The remaining 138 have either been wound-up or exited. Of the £10.3m of funding provided to these businesses, only £0.3m has been returned to-date…
…but that was not the measure of success that was originally envisaged for this programme of investments, which was conceived to address a funding gap in the UK innovation ecosystem and to encourage entrepreneurial activity amongst researchers, scientists, inventors and artists.
The key lessons from this phase of our investment history were:
– to narrow the investment focus and in so doing;
– to build in-house knowledge of target sectors;
– to be more closely involved with the progress of portfolio companies;
– construct a smaller portfolio with deeper engagement and;
– reserve greater financial capacity to provide follow-on funding.
These learnings were applied to the second phase of Nesta’s direct investment history: early stage technology venture investing, which I will write about in an upcoming blog.