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Investment and policy lessons from the Creative Advantage Fund the UKs first dedicated Venture Capital fund for the Creative industries

PATIENT MONeY
Creative Advantage Fund 2013
Creative Advantage Fund 2013

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Foreword: Lord Smith of Finsbury, former Secretary of State for Culture, Media and Sport Introduction: Thomas Dillon, Chairman of Creative Advantage Fund Questions to consider in creating a fund: Why create a dedicated fund for the Creative industries? How will you define the Creative industries? What will your catchment area be? Will you focus on specific sub-sectors?

contents
How will you balance financial and developmental objectives? What kinds of financial intervention will you make? What is the eco-system in which the fund will operate? What skills and expertise do you need? How will you manage the fund? Summary of key points Creative industries Venture Capital Funds in the UK and elsewhere Credits
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foreword
By Lord Smith of Finsbury, former Secretary of State for Culture, Media and Sport

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When I was Secretary of State for Culture Media and Sport about 15 years ago we really gave a new importance to the creative industries. When we came into Government in 1997 one of the things that was very clear was that no one, in government or elsewhere, knew the extent of the contribution that creative industries made to the economy. I sensed in my bones that they must be important, this whole range of things; architecture and advertising, design, music, film and television must be collectively rather important. No-one seemed to know exactly how important they were. So we did the mapping work. We astonished ourselves with what we found in terms of the overall economic value, the number of people employed and the rate of growth of these industries. We began to put the creative industries on the map and to try and persuade the rest of government, whether it was the Treasury or regional government or local authorities, that these were really important drivers of economic wealth. What we also did was to try and identify where the challenges for the creative sector were. Where were the difficulties? What were the blockages? What were the things that government could help with?

We found a number of particular issues; one was access to workshop accommodation (especially in urban areas where rents tend to be very high). Also, it was possible for creative businesses to obtain synergies from their tendency to cluster together. One of the most important things that we found in terms of challenges was access to finance. Very often small creative businesses (and most creative businesses do tend to be quite small at first) comprise young people setting out with brilliant ideas and bags of enthusiasm. They talk a completely different language from the traditional bank manager. They are not looking for a million pounds so going to the big investment places like 3i, or whatever, really was not realistic. They are looking for 50,00070,000 to set up and to pay the rent for a bit, get some basic equipment and get themselves going. For start up businesses to get that sort of money through those sorts of traditional means tended to be a challenge. Thats where the creation of the Creative Advantage Fund was so beneficial because that was a fund which was deliberately targeted at this sector. The creation of CAF sent a message that said We know the importance of this sector, we recognise how powerful it can be and we want to help to make it happen.

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INTRODUCTION
By Thomas Dillon, Chairman of Creative Advantage Fund (1997)

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Creative Advantage Fund (CAF) was created in 2000 and was Europes first publicly funded venture capital fund for the creative industries. After 12 years of successfully providing support to SMEs in the West Midlands, CAF has recently agreed new investment management arrangements to allow closer co-operation with new investment funds established by Birmingham City Council in 2012.The Board of CAF has commissioned the following document to ensure that the lessons learned by CAF are documented and can be shared with other public agencies interested in supporting creative industry development anywhere in the world. CAF represented a new concept in support for the creative sector. It owed its creation largely to the vision of Sally Luton, then Chief Executive of West Midlands Arts, with whom it has been my privilege to serve as a CAF director throughout the life of the Fund. The fact that we been able to continue to work successfully with creative entrepreneurs in our region during this period is the result of the expertise, energy and indeed creativity of the members of its Board, past and present. I wish to record here my gratitude to them and to all those who have worked for CAF as investment consultants. In particular, the role of Kevin Caley, CAFs fund manager in its first three years of operation, was crucial to its later success. The present paper explains the various factors that should guide policy-makers if they wish to undertake the hugely valuable task of creating a publicly-funded investment fund for the creative industries. We hope that it will be of use to anyone interested in following in our footsteps.

I would offer three supplementary comments. A fund as small as CAF is necessarily vulnerable to the risks inherent in venture capital and of course to the economic cycle. Only portfolio diversification can provide some measure of security and then only if investment decisions are well made. Ideally, therefore, funds modelled on CAF should be built on a larger capital base than its initial 1.3m. Second, it is rare for private venture capital funds to be evergreen like CAF. They are usually socalled closed-end funds with a duration of 10 to 12 years. While the idea of an everlasting mission is inspiring for those running the fund, policymakers should consider whether or not a specific mechanism should be included in its initial design to permit the orderly realization or divestment of the portfolio, in case changed circumstances indicate a need to re-engineer public support for business in the funds catchment area. Finally, it is importantand possibleto control overhead costs in the running of a fund, though only if a relatively hands-off approach is adopted towards portfolio management. It helps, of course, to have the support of a Board that is willing to commit a good deal of voluntary effort to the success of the Fund. CAF has enjoyed that advantage, for which, as mentioned above, I have been most grateful.

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A SNAPSHOT
The Creative Advantage Fund

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CAF invests cash in creative industry SMEs in the West Midlands region in return for an equity stake. The Fund supports and monitors its portfolio companies from initial investment to a final realisation, usually by trade sale, several years later. CAF operates with a lean structure, working on a virtual office basis and on a minimal overhead. Background The concept of CAF was developed by West Midlands Arts1 and its structure was established in co-operation with Birmingham City Council. A total fund of 1.3m was raised with support from the Arts Council, European Regional Development Fund, Birmingham City Council and private donors. Its initial investment round was from launch in March 2000 to the end of December 2001. The Funds business plan was based on creating an evergreen fund with all returns from investments reinvested in creative businesses.

Strategic context the local authority Birmingham City Councils economic strategy highlighted the creative industries as a potential growth sector. Having identified the importance of targeted intervention, the City Council sought suitable partners to enable it to deliver effective support, leading it to support the Regional Arts Board's initiative in setting up a venture capital fund for creative industries. Investment expertise was available from the existing Cityowned Birmingham Venture Capital (BVC) which provided risk capital for conventional manufacturing. BVC was able to serve as the parent company of CAF. The City Council adopted a package of initiatives focused on creative businesses, comprising work spaces; technical assistance through ERDF programmes; and finance using grants, loans and (through CAF) equity investment.

West Midlands Arts was an independent regional agency which merged with Arts Council England, the national body for the support and development of the arts, in 2003.
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A SNAPSHOT CONT.
The Creative Advantage Fund

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First Round The intention of the fund in its first round was to make seed capital investments (between 5,000 and 20,000), and larger investments (between 50,000 and 130,000) in small and early stage creative businesses capable of high and fast growth (CAF, 1999). In its first round, the fund received 153 serious enquiries, from which 117 business plans were submitted. Fifteen investments were made in thirteen creative businesses2. CAFs investment allowed these companies to lever in some 1.26m of commercial funds creating jobs and helping creative entrepreneurs to develop their business experience. Following evaluation of the first round a 5.9m follow-up fund, Advantage Creative Fund (ACF), was set up from 2003 developing the CAF model with investments in some 55 creative industry businesses. During this time CAF stood back from active investment and concentrated on monitoring and supporting its investment portfolio. ACF completed its investment programme in 2008.

In line with the projections in CAFs business plan, a number of the 13 companies in the initial round failed to achieve commercial success. However two investments in the film and television sector were strikingly successful and with the monies realised from the exit of these companies CAF made preparations for a second period of investment 2010 onward. Since 2010 CAF has committed a total of 730,000, investing in five companies: Civico Live a provider of online streaming conference services; Artbrand an art publisher serving a number of main retail outlets; 2Fold20 Play a games company creating social games on social media platforms; Zed Cee (Miyson) prestige sports branded clothing and lifestyle products; and Creative Soles a web-based platform providing bespoke footwear design. The Fund made its final investment in June 2012 and the focus of management has now shifted again to active monitoring and support of the portfolio in difficult trading conditions.

Representing design software, film, jewellery design, media/publishing, television, theatre, toy design.
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QUESTIONS
to consider

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If any public body wishes to create an industry specific fund for the development of their emerging creative industries sector, we propose that these are some of the key questions that would need to be considered:

Why create a dedicated fund for the Creative industries? How will you define the Creative industries? What will your catchment area be? Will you focus on specific sub-sectors? How will you balance financial and developmental objectives? What kinds of financial intervention will you make? What is the eco-system in which the Fund will operate? What skills and expertise do you need? How will you manage the Fund?

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q1. Why create a dedicated fund for the Creative industries?

Questions to Consider

In 1998 the Department of Culture Media and Sport produced a mapping document which was thefirst systematic attempt to define and measure the creative industries. It revealed just how economically significant the creative industries were. It calculated that they accounted for almost a million jobs and 4 per cent of GDP in Britain, and earned 7.5bn from exports3. It also showed, though, that the sector was polarised between a myriad of very small firms and sole traders and a handful of very large, often multinational companies. The DCMS mapping document marked the start of a series of interventions by government and local authorities to find ways to support the growth of the sector. The launch of CAF was one such measure and the lessons learned from CAFs first round remain important in informing developments in this country and overseas. One of the reasons why the 1998 report was so important was that it gave a political profile to a cluster of small firms and sole traders who otherwise struggled to have impact in terms of economic policy. The DCMS set out a definition for the creative industries and over time there has been an increasing recognition that the sector has a number of important indirect benefits. These include economic benefits such as adding value to other industries, notably through design, advertising and branding and being major employers of highly skilled people, thus being part of the knowledge economy. These, in turn, foster social and cultural benefits by contributing to the regeneration of towns and cities, and bringing communities and people together through shared experiences.

The extent to which the wider benefits of the creative industries are recognised will be influential in determining the scope of any venture capital fund targeted at the sector and the specific objectives of the fund. It could be argued that the majority of businesses working within the creative sector face exactly the same challenges as any other small and medium enterprise (SME) in accessing external finance to support business growth and development. Businesses that are attempting fast and high growth do not generate sufficient internal revenues to support their development and banks tend not to invest in such businesses because they tend to be in a state of negative cash flow. They are in this situation because they are spending income on developing the business through investment in research and development, developing and testing products, purchasing necessary equipment, recruiting key members of staff and so forth. Venture capital offers a long term form of finance with the added benefit of advice and guidance which can be vital for businesses at start up and early development stages. Creative industries face specific challenges in securing access to equity (or any) finance because investors fail to understand the frequently intangible nature of the product, with collateral being in the form of intellectual property and a business model which may not be market led. They therefore lose out in competition with other small SMEs which are perceived to be less risky and more substantial businesses. Effectively this creates a double equity gap for creative industries and a market failure sufficient to justify intervention by public bodies.

...As the quote from the Risk Capital Study overleaf shows
Archive available at http://webarchive.nationalarchives.gov.uk/ & http://www.culture.gov.uk/reference_library/publications/4740.aspx
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q1 cont. Risk Capital Study

West Midlands Risk Capital Study Regeneris Consulting Ltd (2008)

Specific barriers to investee firms raising finance from the private sector include: Information asymmetries: prospective borrowers/investees are unable to provide the quality and type of information funders require (although in may cases this is thought to be the result of poor investment readiness) and funders are unable to obtain this information at a reasonable cost (e.g. through undertaking due diligence). Lack of security: firms are unable to access debt finance at a viable cost or at all because they are unable to offer security. Lack of track record: perspective borrowers/investees are unable to demonstrate a track record in business (e.g. running successful firms) or a sound commercial/personal credit history. For young firms or would-be entrepreneurs in the creative industries sector, these difficulties can be particularly pronounced and are further compounded or exacerbated by: The unproven (or indeed un-provable) nature of much of the intellectual capital held by creative entrepreneurs and SMEs (and indeed the difficulty in turning much of their intellectual capital into defensible intellectual property). The limited experience of many investors and lenders in assessing creative industry propositions. A lack of experience or understanding of creative industry markets heightens the sense of the unknown for many funders, raising their perceptions of risk. Poor investment readiness: there was wide agreement amongst consultees that investment readiness was a particularly profound challenge when dealing with creative industry firms. Further to poor investment readiness, lack of general knowledge of equity in the business base (in general and the creative industry sector in particular). [CAF] was established in order to overcome these barriers, providing a dedicated creative industries fund with a specific remit to identify and invest in opportunities in the creative industries sector. Since many of the investee companies require seed or developmental finance, or are otherwise likely to take time to generate cash flows and since investment in young creative industries firms is higher risk, it is felt that equity investment is a more appropriate form of finance than debt.

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q1 cont. Risk Capital Study

CAF was created to address this perceived failure of the private equity market. The introduction to its business plan states: Access to finance is a crucial issue identified by DCMS as a barrier to growth. There is relatively little likelihood of banks being willing to substantially support businesses whose main collateral is intellectual property. Given the relatively high risks and high potential profits of creative businesses, venture capital money would seem to be the ideal medium for promoting and developing the creative industries. More recent research commissioned by the DCMS (Access to Finance for Creative industries, May 20114) confirms the continued difficulty faced by the sector and which has justified the creation of new Venture Capital Funds in Birmingham, Manchester and London. A further reason why a dedicated fund is justified relates to the provision of expertise and the ability of fund managers to work with credibility in highly specialised market areas. This sectoral knowledge is essential if fund managers are to solicit bids from businesses who may have little understanding of equity finance and to develop those bids to a stage of investment readiness.

In the report evaluating the experience of CAFs first round, the lack of investment readiness was cited as a key obstacle to the fund.The businesses that applied for funding, whether successful or not, were very seldom investment ready.They were inadequately prepared and had ill-defined business plans. The predicted cash flows were usually wildly optimistic and the timescales for achievement were unrealistic. They lacked a strategy showing how an investor would gain a return on any investment. They lacked much of the business infrastructure needed to make best use of additional finance and to demonstrate their ability to give confidence to an investor.(CAF, 2002). The expertise and knowledge of CAFs Board and Fund Managers was essential in helping to address the problem of lack of investment readiness. In establishing a fund it is essential for investors to be aware of the state of investment readiness of the sector and the level of preapplication business support which may be required before investment can be considered.

Dr Stewart Fraser, Warwick Business School and IFF Research Ltd available at http://blueprintfiles.s3.amazonaws.com/1321203959-11-898access-to-finance-for-creative-industry-businesses.pdf
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q2. How will you define the Creative industries?

Questions to Consider

The DCMS defined the creative industries as those industries which have their origin in individual creativity, skill and talent and which have a potential for wealth and job creation through the generation and exploitation of intellectual property and included 13 creative sectors in the mapping exercise: advertising, the art and antiques market, architecture, crafts, design, designer fashion, film and video, interactive leisure software, music, the performing arts, publishing, software and computer services, television and radio. The DCMS definition and list of the creative industries have since provoked considerable debate leading to a range of alternative definitions. This lack of agreement and inclusion or exclusion of sectors creates difficulties in producing data which enables countries and regions to compare the importance of sectors. Furthermore the creative industries are changing rapidly not least as a result of the impact of digitisation which is reshaping long standing business models and leading to the creation of entirely new products. CAF adopted the DCMS definition however this did not obviate the need for extended discussion of the eligibility of bids. A number of proposals

which were put forward by fund managers had elements of invention in their design or production and were thus argued to be creative. The inclusion of computer software as a creative sector and the now universal impact of digital technology means that almost all new products have elements of creativity and intellectual property embedded within them. CAFs response to this was to give primacy to the individual creativity element of the DCMS definition and exclude engineering inventions which were purely software enabled. Having a clear understanding of the sectors which are within scope for investment by any fund is vital.This enables the fund to be marketed effectively and avoids wasted time and effort in responding to ineligible bids.The determination of precise priorities and eligibility is likely to be primarily driven by stakeholder interests and economic circumstances within a funds catchment area. Further assistance to those wishing to creative a mapping exercise of their own is available in the British Council publication (in their Creative Economy series) Mapping the Creative industries: A Toolkit by BOP Consulting.6

http://www.statistics.gov.uk/hub/business-energy/services/creative-andleisure-activities
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http://www.britishcouncil.org/mapping_the_creative_industries_a_ toolkit_2-2.pdf
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q2 cont. How will you define the Creative industries?

Questions to Consider

Gross Value Added (GVA) of the Creative industries (UK, 2008)

Software, Digital Media & Electronic Publishing Architecture Publishing Advertising Radio & TV Film, Video & Photography Music & Visual and Performing Arts Other
The Creative industries, excluding Crafts, account for 5.6% of Gross Value Added (GVA) in 2008. Other categories include Art & Antiques, Design and Designer Fashion.

An alternative approach to a Creative Industry definition by The Work Foundation (June 2007)
est of the Econom y e s i r a t s nd A du cti e in vit tiv a i e Indust l a r u r ie t l u s C
Th

eR

Cr

Core Creative Fields

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q3. What will the catchment area be?

Questions to Consider

CAFs catchment area was determined by the regional focus of the agencies which supported it. There are advantages to venture capital funds being located close toinvestee companies.Spatial proximity between the investee company and the venture capitalist reduces both costs and risks.Less travelling time reduces costs and assists monitoring and post-investment support. Local knowledge of market conditions reduces risk in decision making and improves the postinvestment support that can be offered. This cost and risk reduction is particularly important for small-scale funds making investments at the early stage. There are also disadvantages if the catchment area is too small. Research7suggests that limiting the pool of businesses in which investments can be made reduces the flow of potential deals and leads to the fund missing out on potential opportunities because they are based in the wrong sector or region.

must persuade the investor that there are a lot of collateral benefits. That its going to do this for employment, its going to do that for the arts, and so on and so forth. That is not the way that the Creative Advantage Fund works; our objective is simply to make a good investment. It was the objective of those who set us up that by making good investments we would actually produce all of those collateral benefitswhich I firmly believe we doby making good commercial decisions. Obviously only a part of the creative sector can benefit from this approach. Poets probably dont need 130,000 and they probably wouldnt spend it on anything very sensible if you gave it to them. Other peopletelevision for example, film, music, games and forms of art that we have not even thought of yet, people that can use money and make a return on it for their investorthose are the kind of people Creative Advantage Fund wants to hear from.

Of course the fund wants entrepreneurs. It wants Whilst it is likely that the catchment area of a fund will be driven by political considerations and to encourage entrepreneurship. It wants to receive applications for investment from people who are the interests of stakeholders, it is important that really going to go somewhere and actually those research has been undertaken to establish that people have a virtuous greed. They want to make there is a sufficient pool of investment ready (or as much money as possible. They want their near-investment ready) businesses to deliver the company to be as successful as possible and they long term sustainability of the fund. want to be as successful as possible. They dont Thomas Dillon Chairman, Creative Advantage Fund actually want to be working for the Fund. What we are really looking for is some confidence We might have 30% of their company and if they are a proper entrepreneur they are going to that the investment will produce a commercial say As soon as I can get that 30% back, thats return; that is to say, that we will get our money what Im going to do. I can make more out of my back and more. companyand the more of the company I have, the more Im going to make. Although the objective of the fund was to foster the creative industries, the method by which the That is absolutely what the Fund wants its fund was to do that was by being commercial. applicants to do. We want them to buy us out as To be clear about that, a lot of applicants for shareholders and make us rich in the process. investment from public sources think that they

Harrison and Mason (2000), Doran and Bannock 2000 cited in K Morgan PhD
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q4. Will you focus on specific sub sectors?

Questions to Consider

Small companies (and Maverick was small but CAF achieved two successful exits in the first growing) had to make a decision. How do we round which together returned 1.2 million participate in this market place? to the Fund. This sustained the Funds core overheads and enabled the second round of We had started off as a lifestyle company. We had investments.Both the successful exits were from continued that creativity, which had grown out of the film & television sector, a sector which at the time was going through a period of consolidation. lifestyle, but we turned it into a business in this period and I think the CAF investment assisted in Maverick TV was purchased by All3Media. that process. Hotbed Media, on the back of considerable growth and success, purchased back their own However five years after the CAF investment, it shares through negotiation with the Fund. was time to participate in the consolidated market and we decided to join All3Media. All3Media Jonnie Turpie Founder and Director Maverick TV is the largest independent production company in the UK. We joined All Three because we felt Maverick used the investment to build and that the fulfilment of Mavericks destiny could develop the company to build and deliver our be achieved even more productively in that business plan. We exceeded our business plan environment given the working and professional and we were enthused by that. By exceeding environment we found ourselves in. the business plan that meant we were creating more products, producing and selling more Conversely a number of investee businesses programmes. suffered because of specific market conditions. This poses a question as to whether a fund might This was at a time when legislation was wish to focus its investments on specific subchanging. In 2003 the government at the time sectors where market conditions are perceived and Secretary of State for DCMS brought in the Communications Bill which changed independent to be more favourable or whether it is more advisable tospread the risk by investing across a production forever. broad spectrum of sectors. Instead of attracting production fees for each Specific national or regional economic strategies production we actually retained some of the IP and market conditions may point a fund towards and the ability to sell it with the broadcaster investing in specific sub-sectors but, given the rather than the broadcaster selling that IP. range of factors which influence the success or Therefore we were in control of our own destiny. otherwise of an investment and the inherent risk in all equity investment, it may be more advisable Those things together - a successful, growing to seek to achieve a balanced portfolio without company, a new business model and what undue concentration in one particular sub-sector. happened in the following two years - meant that the independent production sector consolidated.

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q5. What is the eco-system in which the fund is operating?

Questions to Consider

A venture capital fund is part of a broader business support and development ecology and, to be effective, needs to be integrated into that ecology by policy makers and public agencies in a conscious way. At the front end of the business a fund will be dependent on the quality and availability of measures that foster demand. These include a programme of proactive marketing of the venture capital concept to educate the sector about the options for external finance. This helps to stimulate a steady feed ofbusiness plans and applications. Also vital is support for businesses throughout the life cycle. Different forms of finance need to be available, including grants and loans, and second stage equity. Non-financial support is crucial and initiatives including incubation support, training opportunities and easily accessible advice need to be available. A fund will want to develop close working relationships with second stage investors and business angels to help broker additional investment into an investee business in a timely way (and without undue dilution of its own interests). During the monitoring phase a fund will need to be connected to a wide network of creative industries entrepreneurs who can be drawn upon as Non Executive Directors (NEDs), mentors and consultants. As a single mechanism a venture capital fund will only have limited impact; as part of a raft of initiatives, it will begin to be a major factor in developing the creative sector. An investment ready company needs to be surrounded by a number of elements to give it the best chance of success.

High Growth Good Financing

Mentoring

Investment Creative

NEDs Second Stage

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q6. How will you balance financial and developmental objectives?

Questions to Consider

CAF was set up as an evergreen fund. The financial objective of generating sufficient funds to ensure sustainability between phases of investment and ensuring the long term continuation of the Fund was therefore the overriding objective. However discussions by the CAF Board around the concepts of success and failure, and the proportion of time which was required to be spent (for reasons discussed earlier) on activities which were more akin to business support and investment readiness than assessment and monitoring, suggest that any new fund would be wise to be clear at the outset regarding the balance between purely financial objectives and developmental objectives relating to the broader support of the sector. The larger part of the CAF fund was provided from the public sector and its creation was justified in the context of a failure in the private equity market. One of CAFs conditions of investment was that it would finance businesses as a last resort after traditional sources have been exhausted (CAF, 1999). This requirement addressed European State Aid regulations.By being a funder of last resort, the fund avoided presenting unfair competition to the private sector, or creating market distortions. The Fund also sought to combat the problem of potentially distorting the market by making investments on commercial terms. As stated in the business plan:

The intention of CAF in its first round was to prove to private investors that the rewards from investments in the creative industries were worth the risk. If the fund distorted the private market by providing unfair competition it would not meet this objective, but instead have the opposite effect of pushing the private sector further out of the market. This would result in limiting the options available to creative businesses, rather than improving the options for external finance. State Aid regulations similarly specified that the follow-on fund, ACF, must be a publicly-owned fund in which investment decisions are not subject to the influence of public authorities and must be motivated by purely commercial considerations (Chief Executive's Note to Board Members, March 2003, Private Papers). However, building on CAFs experience, ACFs primary purpose was to grow the creative sector in the West Midlandsa developmental objective rather than a financial one. The advantage of considering the importance to be attached to having specific developmental objectives is further highlighted when considering the success or otherwise of individual investments. From a purely financial perspective, CAF made two successful investmentsdefined as investments which returned significant profits to the Fund on theirexit. Conversely three of CAFs investments had failed by 2003 in that no monies were returned to the Fund and the businesses ceased trading. Other investments returned some monies but not to a significant extent.

However the academic evaluation of the fund, which was undertaken as a PhD research The Fund is dedicated to the commercial exploitation of products and services made by creative industries SMEs. programme,8includes quotes from some of the failed investees and those whose applications The Fund will invest capital with the objective of making a commercial return commensurate with normal were rejected, highlighting how beneficial the experience of applying to/being supported by venture capital investments and intended to produce sufficient profits for the Fund to replace any of the losses the fund had been in developing their business understanding. that are bound to occur with a fund of this type.

PhD Dr K Morgan

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q6 cont. How will you balance financial and developmental objectives?

Questions to Consider

it is a learning experience, and that is something. I don't know whether other people have commented on this, but for a growing company to get involved in venture capital has been a very useful experience as this allows us to learn the ropes that may help us in the future either with CAF or A N Other or another form of investment. It is equity buy out on a small scale and we learned how to do it by doing it with CAF. We are now doing it again on an industrial scale where the figures are serious.But we have learned how to put a business plan together, how to write it and put projections together, without using accountants It gave us that opportunity, if we had gone for the big one to start with I think we would have been out of our depth a bit. In the latter commentCAF is perceived as a stepping stone helping businesses become ready for larger investments.So whilst from one perspective CAF was trying to attract applications from businesses that were investment ready, part of their role, as a public sector mechanism, was to improve investment readiness in the businesses that were applying to and accessing the Fund. If a new fund intends to fulfil an educational or developmental role alongside an investment role then the explicit recognition of both roles by stakeholders should be agreed at the outset.

Jonnie Turpie Founder and Director, Maverick TV Maverick has always been an innovative company. Its always been a company that addresses and engages with new technology as it develops - right from analogue small cameras through to online platforms used now. I think that CAF were interested that we were a television company, part of an established industry, although changing both through legislation and technology changes. I think that CAF felt, as a lot of investors do, that they are looking for technological growth and the application of technology rather than just the creation of content. That encouragementto think about what the future services, technologies, media opportunities might be - enabled Maverick to grow its multiplatform approach from traditional high quality television through to multiplatform online services which we are now delivering at scale. That was a big benefit of the investment. If you were to ask me what Maverick felt on exit from the fund and the move across into All3Media, one of the things was the payback. In other words we had been part of creating a West Midlands creative industry fund, we participated in that fund and now by exiting we were actually flowing finance back into the fund and that gives us some pleasure. It means that the success of Maverick will hopefully lead to the success of other creative industry companies in the future.

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q7. What level of intervention will you make?

Questions to Consider

Another area where clear objectives must be agreed in advance relates to the type and level of funding to be applied to the portfolio. In its first round CAF intended to make an equal mix of seed funding investments alongside equity up to a limit of 130,000. This level was determined by the perceived gap in the private equity market at the lower end of the venture capital spectrum for seed capital, start up capital and early expansion capital. The need for a focus on this area was confirmed by an independent report (Deloitte and Touche 2002) which identified an equity gap for all sectors for amounts of less than 300,000. The small size of the CAF fund meant that the ceiling was set at no more than 10% of the total fund for any investment which would ensure that risk was spread across a portfolio of at least ten businesses. Six of the thirteen business supported by CAF received the maximum investment of 130,000. Two of these received it in two tranches. Another three of the investee companies received over 100,000. Only two seed capital investments9were made. One business received 10,000, the other 30,000. The business that received the 10,000 later received a second tranche of investment of an additional 45,000 in the fund's transitional phase (between the end of the first round in December 2001 and the launch of the second round in September 2009). The business that received 30,000 failed after failing to secure further investment. In the first round the Fund typically invested in a mix of redeemable ordinary shares and preference shares (an instrument akin to debt). The investment agreement included a mechanism to require the investee company to buy back its shares if it achieved a specified level of profit. A multiplier would then operate on the average net profit for the two preceding years to produce

the sale price receivable by the Fund. However, this mechanism never took effect in practice and at least in theorycould have created adverse incentives in investee company management to limit reportable profits. In the case of an extraordinary success, it would also have operated to limit the Funds return. The preference share element was designed to provide the Fund with income to cover operating costs. However, this was not effective. Interest on preference shares is only payable if there are distributable profits. It was usually a long time before portfolio companies were in such a position of profitability to have to pay such interest. In the meantime, the liability for interest that accumulated in the investee companys balance sheet could cause concern (albeit irrational) to company management. When CAF launched its second round in 2009, it dispensed with the previous investment structure and made simple investments in ordinary shares. If a company became distressed and it was felt that a further equity investment was inappropriate, a loan might be made, sometimes with an option to convert the loan to additional ordinary share capital in case of default of repayment. It introduced a drag along clause into its investment agreement which in theory would allow it to compel a sale of the business. Although such a sale could hardly ever take place without the support of investee company management, it was considered that this would provide some leverage for the Fund in moving investee companies towards realisation. Of the thirteen businesses that the CAF invested in, nine attempted to secure second stage finance in the first round or transitional phase. The interviews undertaken in the academic evaluation with investee companies show that the investment from CAF was regarded as sufficient to build

amounts below 50,000

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q7 cont. What level of intervention will you make?

Questions to Consider

a foundation for the business. However this money was quickly spent and the majority of the businesses needed more finance to assist further development quite soon after the CAF investment. The difficulty that the requirement for follow on funding presents to an early stage venture capital fund which has invested to its maximum level is that the second stage investor may force an aggressively low equity revaluation and thus a significant dilution of the first stage investment. Failure to agree such dilution may lead to loss of second stage investment and potentially failure of the business. CAF did not include any anti-dilution mechanism or ratchet in its investment agreements, to address the issue of dilution that might arise

should a new investor seek to provide further equity funding. Although it retained a lock on the issue of new equity, in practice commercial realities were unlikely to give this much protective effect. The same might be said, however, had a ratchet been theoretically applicable to any new investment. It is business reality, not legal provisions, which play the largest role in such a situation. The prospect of dilution of funds at the point of second stage investmentcan threaten the ability of an early stage investment fund to reap the full benefits from their investment.This risk can be mitigated either by the fund having the capacity to make larger investments (and thus create a larger Fund) or by developing strong relationships with potential second stage investors and brokering access to such funds.

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q8. What are the skills and expertise needed to establish a fund of this sort?
Questions to Consider

As mentioned earlier, the skills and expertise of CAFs Board and Fund managers were essential in establishing the credibility of the Fund and being able to identify and work with investee companies both prior to and post investment. However the creative industries consist of a number of discrete sub-sectors each with distinct ways of doing business. A fund is unlikely to be able to appoint fund managers with specialist knowledge in every sub sector. For that reason it is vital that the funds decision making mechanism involves, or has access to, a wider pool of knowledge so that informed opinion can be accessed in a timely way. This can be achieved through establishing an advisory board or network of associates which can both provide a strategic overview and be used to draw down advice as necessary. Although the involvement of creative industries entrepreneurs in decision making is important, it can be difficult to persuade busy individuals working in small organisations to give up the time necessary to engage with a fund. It can also create difficulties in terms of confidentiality and competition, particularly where a fund is operating in a relatively small catchment area or in sub-sectors where the number of businesses is comparatively small.Whilst such issues cannot be entirely overcome, sensitivity to and awareness of the potential pitfalls inherent in peer assessment are important. The appointment of a Non Executive Director (NED) to represent the interests of the Fund is a further tool to ensure that Fund Managers

keep abreast of developing issues. CAF has appointed NEDs to each of its investee companies often the CAF-appointed business advisor who supported the investee company to get to their pitch. In the academic evaluation which drew on anonymised feedback from investee companies, there were conflicting views about the role of the NEDs. They were perceived on the one hand as confrontational and directive and, on the other, as supportive and enabling. The response to the NED will, to a large extent, relate to the relationship between individuals involved (difficult to predict) and whether the fund adopts an aggressive monitoring strategy or is more hands off (see next section). In either event it is crucial that the NED understands the sub-sector, the culture of the creative industries and the culture of the small business, for this relationship to be a success. Whether supportive or demanding, theNED needs to offer the business complementary skills and knowledge. These qualities are important, but they are also quite rare and CAF found it difficult to meet the expectations of its investee companies in that respect. As one of the management team stated in the academic evaluation: As far as the general principle, though, I think it is a good principle. I just think that it is an expensive one and a difficult one to fulfil in getting the right sort of person, with the right sort of degrees of expertise and the level of commitment that is necessary. Because it is time consuming and it will take a lot to fulfil that role.

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q9. How will you manage the Fund?

Questions to Consider

The way in which a fund is managed will be determined by a variety of factors including the objectives set for the fund (see above) and the timescale within which funds are anticipated to be allocated. The ERDF contribution to CAF required funds to be fully committed within 22 months of launch. This deadline meant that the fund had a very short time to test the concept of a venture capital fund specifically for the creative industries, and too short a time to create the fund as a sustainable feature of the support infrastructure. Venture capital is a patient form of finance and returns are made when the business is making sufficient profits for the fund to draw on dividends. Exits are not usually planned until five to seven years after the investment. The initial phase of twenty-two months was not long enough for sufficient returns to be made to the fund to allow it to continue and sustain its momentum. This situation was exacerbated by the small fund total. 1.3 million is a small amount for a venture capital fund and this combined with the short deadline jeopardised CAFs sustainability after the first round. Although described as a patient form of finance equity investments are frequently aggressively monitored in order to drive up profits and returns to the funds. To operate a fund in this way requires a significant investment in overhead to maintain a network of advisers and so that Fund Managers can actively solicit investments and keep in close contact with investee businesses. CAF made healthy returns on two companies: one was sold, generating c. 820K in total for the

Fund (including dividends and interest of some 25K) from a 130k investment over about seven years. The experience of CAF shows it takes seven years to generate exits. In part because of ERDF conditions and the small scale of the fund, CAF developed an alternative lighter touch approach with a commensurately lower overhead. Extract from West Midlands Risk Capital Study Regeneris Consulting Ltd December 2008 increased ability to make follow-on investments would have enhanced portfolio performance. At present the fund is limited by rules on the second follow-on investment and a lack of funds in future for follow-on investment. This means the fund is diluted in its equity share of firms and may lose control and abilty to capitalize on initial investments. CAF [was] set up as an evergreen fund whereby funds invested are to be retained and recycled by the Fund. With the benefit of hindsight, CAF recognizes agreeing how realised monies can be used in more specific terms at the outset could have prevented difficulties of this kind. Regeneris perceives disagreement over the uses of CAF realisations as characteristic of many publicly-backed venture capital and loan funds where insufficient attention is paid to what will happen to receipts at the outset. Also Regeneris perceives the evergreen funding model has been one which has generated some uncertainty, over issues such as future financial forecasting and control of the fund.

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q9 cont. How will you manage the Fund?

Questions to Consider

A new fund needs to give consideration to its style of investment - whether it will wait for the big fish to swim by or or invest in intensive fish farming. In any event the fund cannot exist in a vacuum investee companies need to be surrounded by the right mix of peer and mentor support, technology infrastructure, innovation culture, secondary funds, growth exemplars and training to allow it to reach full potential. Creative industry businesses are frequently thought of as lifestyle businesses unsuitable for equity investment. It is important however to distinguish between the culture of creative businesses which may give priority to issues such as creativity, innovation and talent development rather than a ruthless focus on the bottom line, and creative businesses which are structured in order to support a particular lifestyle and where profits are converted into higher salaries rather than reinvested in the growth of the business. Given the lack of awareness amongst the sector regarding the nature of equity investment,CAFs

experience was that some businesses found themselves seeking equity funding and then balking at the consequences. Although the options for exit were highly relevant to the ultimate value of its investment, in its first round CAF put little emphasis on this at the time of investment or subsequently.Although CAF imposed certain limits on management remuneration, these limits were not very actively managed. In retrospect, it is arguable that a more stringent attitude to remuneration would have fostered a more exit-focused attitude on the part of investee company management. A simple measure to discern the structural lifestyle business would be to talk to businesses about their projected exit strategies and the planned return tothe fundat an early stage. Whether or not the investee company has considered how it will exit from the fund is an important indicator of whether they fully understand the implications of equity investment and their level of investment readiness.

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q9 cont. How will you manage the Fund?

Questions to Consider

Jonnie Turpie Founder and Director Maverick TV

Mavericks board decided that at the point in our life of growing the company, which was nearly ten years in, we were starting to believe that we had a successful company, a lifestyle company - we enjoyed making our range of productions. But we The change in mindset and lifestyle that felt that there were further opportunities beyond discipline brings can be sometimes problematic where we were. and difficult in the creative industries - but if you believe your business is available and up for We thought that one way to achieve that growth growth then I think you find ways to do that. would be to sell some equity in the business Having the liberation of finance to take some of and attract some investment for that equity, to the pressure away from the project delivery and invest it in further infrastructure and additional the profit out of each project can enhance the people at a higher level, to take some of the creative opportunities in the company. burden of development off the few very talented and committed people that were running the I think we would agree that our further operation at that time. liberation and exit from CAF into a larger company has liberated some of our creativity, and If there is anything to learn from our experience of working with CAF as an investor at that time, it that of our wonderful creative directors, to fulfil even more opportunity. is that it does allow you to think of your company

as a business. There are pressures put on you to fulfil the reporting structure: you work with a financial non-exec on your board on a monthly basis to ensure your business is growing. So it actually enhances your attitude to growth and thats very valuable.

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Summary
of Key Points

Creative industries face specific challenges in securing access to equity (or any) finance because investors fail to understand the frequently intangible nature of the product, with collateral being in the form of intellectual property and the business model which may not be market led. They therefore lose out in competition with other small SMEs which are perceived to be less risky and more substantial businesses. Effectively this creates a double equity gap for creative industries and a market failure sufficient to intervention by public bodies. (See page 9 for details) The expertise and knowledge of CAFs Board and Fund Managers were essential in helping to address the problem of lack of investment readiness. In establishing a fund it is essential for investors to be aware of the state of investment readiness of the sector and the level of pre application business support which may be required before investment can be considered. (See page 11 for details) Having a clear understanding of the sectors which are within scope for investment by any fund is vital.This enables the fund to be marketed effectively and avoids wasted time and effort in responding to ineligible bids. The determination of precise priorities and eligibility is likely to be primarily driven by stakeholder interests and economic circumstances within a funds catchment area. (See page 12 for details)

Whilst it is likely that the catchment area of a fund will be driven by political considerations and the interests of stakeholders, it is important that research has been undertaken to establish that there is a sufficient pool of investment ready businesses to deliver the long term sustainability of the Fund. (See page 14 for details) Specific national or regional economic strategies and market conditions may point a fund towards investing in specific sub-sectors but, given the range of factors which influence the success or otherwise of an investment and the inherent risk in all equity investment, it may be more advisable to seek to achieve a balanced portfolio without undue concentration in one particular sub-sector. (See page 15 for details) As a single mechanism a venture capital fund will only have limited impact; as part of a raft of initiatives, it will begin to be a major factor in developing the creative sector. (See page 16 for details) If a new fund intends to fulfil an educational or developmental role alongside an investment role then the explicit recognition of both roles by stakeholders should be agreed at the outset.(See page 18 for details)

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Summary cont.
of Key Points

The prospect of dilution of funds at the point of second stage investment can threaten the ability of an early stage investment fund to reap the full benefits from its investment. This risk can be mitigated either by a fund having the capacity to make larger investments (and thus create a larger fund) or by developing strong relationships with potential second stage investors and brokering access to such funds. (See page 20 for details) Although the involvement of creative industries entrepreneurs in decision making is important, it can be difficult to persuade busy individuals working in small organisations to give up the time necessary to engage with a fund. It can also create difficulties in terms of confidentiality and competition particularly where a fund is operating in a relatively small catchment area or in sub-sectors where the number of businesses is comparatively small. Whilst such issues cannot be entirely overcome, sensitivity to and awareness of the potential pitfalls inherent in peer assessment is important. (See page 21 for details)

A new fund needs to give consideration to its style of investment - whether it will wait for the big fish to swim by or invest in intensive fish farming. In any event the fund cannot exist in a vacuum investee companies need to be surrounded by the right mix of peer and mentor support, technology infrastructure, innovation culture, secondary funds, growth exemplars and training to allow it to reach full potential. (See page 23 for details) A simple measure to discern the structural lifestyle business would be to talk to businesses about their projected exit strategies and the planned return to the fundat an early stage. Whether or not the investee company has considered how it will exit from the fund is an important indicator of whether they fully understand the implications of equity investment and their level of investment readiness. (See page 23 for details)

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Creative industries Venture Capital Funds

In the UK & Elsewhere

Country & Programme Culture Venture Fund MALTA creativemalta.gov.mt

Description The Culture Venture Fund is a specialised investment scheme based on capital participation involving shared ownership that seeks a return on investment from creative ideas and profitable outputs. Through a revolving fund, the Culture Venture Fund will seek to invest in high risk innovative small and medium sized creative enterprises that require capital for specific ventures in areas such as film, performing arts, games, fashion, architecture, television, digital and visual arts, heritage etc. The proposed financing model will not allow the Fund to invest in more than 49% of total investment whereas financing conditions and repayments will be established on a case-by-case basis. The minimum investment should be set at EUR50,000 with a maximum of EUR500,000 whilst ensuring that the de minimis regulation is set as the general framework for the operation of the Fund. Based in Malta. Small enterprises employing fewer than fifty people, and whose annual turnover or annual balance sheet total does not exceed EUR10 million. Medium-sized enterprises that employ fewer than 250 people, and whose annual turnover does not exceed EUR50 million or whose balance sheet total does not exceed EUR 43 million. Presenting a project of viable and profitable investments. Being profitable without profitability resulting from subsidies.

Partners Creative Malta Creativity Trust

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Creative industries Venture Capital Funds

In the UK & Elsewhere

Country & Programme CultuurInvest BELGIUM pmv.eu/nl/diensten/ cultuurinvest

Description CultuurInvest was established in 2006 because of the lack of private investment in the creative industry. CultuurInvest was placed under the aegis of ParticipatieMaatschappij Vlanderen (PMV) nv. This was to make it clear to the market that the instrument differs from subsidy instruments like those of the Culture Administration of the Flemish Region. CultuurInvest operates as a rolling fund and moneys invested must flow back into the Fund with a return. For this reason commercial criteria are applied when assessing dossiers. The basis for decisions lies first and foremost in a well founded business plan and a competent team of entrepreneurs. Cultural criteria are important to the assessment but are not decisive. CultuurInvest grants loans to, and takes participations in, enterprises. Thus, enterprises can be structurally financed via subordinated loans for a longer period. The loans are always granted to enterprises, never to individuals. CultuurInvest does not require any personal guarantees from entrepreneurs, which clearly distinguishes the instrument from a bank loan. Since the start of CultuurInvest in 2006 the fund has invested in 53 companies. The total impact on the market is estimated to be EUR18.6m. This amount includes both the funds Culture itself invests the resources that other parties also invest. CultuurInvest is responsible for 9.2 million Euros and the remaining 9.4 million Euros are contributed by banks, other investors or entrepreneurs themselves.

Partners PMV nv

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Creative industries Venture Capital Funds

In the UK & Elsewhere

Country & Programme VC Fonds Kreativwirtschaft Berlin GERMANY ibb-bet.de

Description Established in 2008, VC Fonds Kreativwirtschaft is a 30m Euro venture capital fund, the first of its kind in Germany to be solely aimed at companies from the creative industries. The initial investment period was planned to last until 2013. The fund is managed by IBB Beteiligungsgesellschaft which is a wholly owned subsidiary of Investitionsbank Berlin. The fund is a joint initiative of IBB and the State of Berlin and was co financed by the ERDF. The amount invested per round of financing is up to1.5M EUR, with a maximum of 3M EUR per company over multiple rounds. The VC fund will only participate in syndicated rounds with private investors that cover at least 50% of the respective financing round (pari passu terms). The VC fund will only hold minority shares in the portfolio companies. The holding period will usually be in the range of 57 years. During the first two years of operation (20082009), 250 companies from the creative industries were evaluated, and 10 companies were financed. The fund invested 6M EUR, and a further 20M EUR were contributed by private co-investors to the 10 companies.

Partners IBB Beteiligungsge sellschaft European Regional Development Fund

Nordic Business Angel Investor Network business.kreanord.org

The Nordic Business Angel Investor Network for Creative industries is an online platform providing a brokerage service between Business Angels and Investors in the participating countries and creative industry entrepreneurs. Launched in 2012, the platform is an initiative of the Nordic Council of Ministers. Its aim is to increase access to venture capital and attract foreign investment in Nordic countries.

Nordic Council of Ministers

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Creative industries Venture Capital Funds

In the UK & Elsewhere

Country & Programme The Creative Capital Fund ccfund.co.uk

Description The CCF is a 6.5m equity fund that helps talented entrepreneurs and businesses in Londons creative industries achieve their potential by providing seed capital investment and business support. It was established in March 2005 as part of the Creative London programme. Creative London is the strategic agency for the creative industries and is part of the London Development Agency. The CCF will make equity investments of up to 650,000 in promising early stage companies. The CCF operates as a matching fund and so every 1 invested by the CCF must be matched by at least 1 in equity from private investors on the same terms. Typically, the CCF will invest up to 75,000 in its first tranche of investment. As each investee company grows and hits commercial milestones the CCF may invest further funds up to a possible total CCF investment of 650,000 (1,300,000 including matching funding). In addition, the CCF works closely with seasoned entrepreneurs and professionals throughout London to offer these nascent businesses not just investment but also the mentoring and support critical for success.

Partners AXM Venture Capital

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Creative industries Venture Capital Funds

In the UK & Elsewhere

Country & Programme The North West Fund for Digital and Creative thenorthwestfund.co.uk

Description The North West Fundfor Digital & Creative provides a flexible equity package for growth oriented businesses operating within the Digital & Creative sector. The sectorincludes companies operating across a broad range of activities; from television production through tosoftware development; social networking tools and e-commerce; design to advance digital hardware innovation; and includes advertising and marketing communication companies, electronic publishing, computer games developers, and broader information and communication technology industries. TheNorth West Fund for Digital & Creative provides finance from 50,000 to 2mto businesses seeking finance to support a broad range of needs from start-up and early stage development through to expansion plans for trading businesses. In return, the Fund Manager will require an equity share in the business. Capital structures can include a combination of equity and loan support as best suits the needs of the company.

Partners AXM Venture Capital

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ACKNOWLEDGMENTS
With thanks to

Lord Smith of Finsbury for his foreword and contribution to the CAF guide online. Thomas Dillon, Chairman CAF Karen Stokes, Finance Director CAF The board members and investment consultants of CAF past and present The 18 investee companies of CAF in the first and second round of investment from 20002012 Dr Kath Morgan for the analysis, context and quotations contained in her academic evaluation of CAF which formed the basis of her PhD thesis.

As a companion to this document, a web-based guide The CAF guide to investment readiness has been produced for creative industry companies with growth potential. This document is available for download at www.thecafguide.com and at the CAF website www.creativeadvantagefund.co.uk
Production Credits

Design by MayNinth: www.may-ninth.co.uk Document Created by Sally Luton and Creative Shift: www.creativeshift.uk.com

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