The Development Bank of Wales will bid to run new debt and equity funds from the British Business Bank, including a £130m fund specifically to back the growth of Welsh SMEs.
Chief executive of the development bank Giles Thorley has also confirmed that while it explored a potential bid to run a new £50m equity fund for the Cardiff Capital Region, it ruled itself out after assessing that its criteria meant it could only identify a small gene pool of investable businesses in the region – that covers the 10 local authorities of south-east Wales.
The fund, which can invest per deal £2m to £5m, is being overseen by professional advisory firm PwC in partnership with fund manager Capricorn, after winning a competitive bid process.
The British Business Bank, which is the economic development bank of the UK Government, plans to launch a £130m fund for Wales in 2023.
The development bank, which is wholly-owned by the Welsh Government, currently manages £200m worth of funds in the north of England for the British Business Bank via the Northern Powerhouse Investment Fund, through its subsidiary FW Capital – and for which there is legacy EU backing.
The British Business Bank has yet to provide specific details on its £130m fund for Wales. However, like the £200m fund for the south-west of England, which is expected to launch in the first half of 2023 with loans ranging from £25,000 to £2m and equity up to £5m, the Welsh fund is likely to consist of a number of funding pots – micro-loans, larger debt and equity – with a competitive bidding process to run them.
Asked if the development bank would bid for all elements, Mr Thorley said: “Yes, but we certainly wouldn’t win all three as I think the British Business Bank would want to see competition in the market and we are very happy with competition as one of the key responsibilities is to foster and grow the financial market in Wales. I think with activities like our management succession fund, we have done that and certainly increased the market for larger management buyout type funds that didn’t exist previously.”
On the likelihood of the British Business Bank insisting that a fund manager(s) selected would have to provide match funding to bolster funds managed, Mr Thorley said: “I think it is unlikely that they would make that a stipulation, although they do that for some of their discreet funds.”
However, if a match is required wouldn’t that preclude the development bank as it would have to utilise existing capital, or secure additional finance from the Welsh Government, so effectively creating a zero sum gain?
The chief executive said: “Not necessarily as you have to remember we have attracted a third partner investor into one of our funds (Clwyd Pension Fund) and we have funds that have included other third parties in England.
“If that is a stipulation then I think our track record, particularly in Wales, as a fund manager of both debt and equity investments, stands for itself and would give ourselves a fair chance. In last year’s Beauhurst report we did 97% of all small equity deals in Wales in the measured period. That is great, but equally it is perfectly reasonable to want to have more equity investors in Wales.”
Mr Thorley said as well bidding on the Wales and south-west of England funds, it would be interested in running other new British Business Banking funds.
He added: “Through FW Capital we have a good working relationship with the British Business Bank in the north of England, and will consider regional fund bids as their details are made available by the British Business Bank.”
New £50m Cardiff Capital Region fund
On the Cardiff Capital Region’s £50m fund – which is known as Innovation Investment Capital – Mr Thorley said: “We thought the criteria for the fund was very narrow and we are talking about a cohort of businesses of under a hundred that were eligible for the type of funding that they were talking about.
“We will wait and see, but I think the new fund manager might find that they go back and ask to vary the terms in due course because they may want a wider brief, but we didn’t think it was suitable for us. However, we are keen to support them as there may well be businesses in our growth sphere that become opportunities for the Cardiff Capital Region fund in due course.”
The development bank is now five years old, having effectively evolved from what was Finance Wales, which was also wholly owned by the Welsh Government.
A significant part of its funding comes via UK Treasury financial transactions capital – which is passed through the Welsh Government to the bank to provide lending and equity to firms. The funding has to be repaid with interest to the Treasury.
Equity
On equity, where the development bank can invest up to £10m per deal, based on numbers – not on value which was asked for – around 23% have been held for more than five years. Some 4% have been held for more than 10 years (those struck by Finance Wales).
Mr Thorley said patient capital should be seen as “indefinite”, although recognising the need for exits at the right time to support an evergreen investment approach; so using proceeds to invest fresh equity into other firms.
He said: “The key thing about equity investing is that the five–year view is a completely British invention. Equity is indefinite and that is the whole point. And the only reason we have this time frame is that most private equity firms are funded by term funds so they have an investment period, then a realisation period which is normally 10 years from start to finish, and as a result it forces businesses to exit much sooner.
“It is an anathema and in Germany if you own equity they don’t understand the concept of when you sell the business.”
While some development bank equity exits to date have provided positive returns on investment, there have been a number of high profile losses, like battery venture Oxis Energy which went through in 2021 and in which the development bank had invested £3.25m in equity.
Mr Thorley said: “There will always be some that fail and our job is to take a higher risk, particularly in the equity sphere, but we also provide support to businesses. And it is fair to say if you are investing in an SME, particularly in equity, there is virtually no liquidity and you manufacture that by helping the business perform to the best of its ability.”
On exits he said: “We are keen to work with equity-backed businesses on flexible strategies which serve their needs, and work with them to drive exit strategies and return on investment. So, again are not bound by artificial timelines, and will work with all businesses supported with equity to ensure they can make the best possible use of our investment, while aiming to return our capital and achieve the best exit possible.”
Economic impact
Since its launch in 2017, the development bank – which employs around 250 and is headquartered in Wrexham, although the lion’s share of its staff are Cardiff-based – has supported more than 3,000 firms through its investment activities.
Its total impact over the five years has reached £1.2bn against a target of £1bn. In its new five-year plan it is forecasting debt and equity investment of £361m and £290m on property – a total of £651m with a target also of securing the same level of co-investment on deals.
Supporting firms and housing developers to decarbonise will be a key element of its investment strategy.
On its new corporate plan, Mr Thorley said: “It is very much an evolution of the programme and is business as usual.
“And particularly now with the recession, and all of the headwinds, we feel our responsibility is to make sure that we are always open.
“This is what we are here for as we were during Covid in being the first people into the market providing support (£200m Covid-19 Wales Business Loan Scheme) and we are going to be around during the recession.
“And we have already started to see potential customers coming to us who have had deals turned down by the banks... so filling that gap is exactly what we want to do.
“The second piece is in relation to the greening of the Welsh economy or decarbonisation, which is something we have been working on for years.
“For example, we proposed an environmental component to the Wales Property Fund four years ago.
“We are also accelerating plans for an SME decarbonisation fund that we will launch in January. We have also got our four or five other decarbonisation type products that are in the pipeline for development.”
On its debt, he said it is priced in line with market rates.
Mr Thorley said: “Our interest rates are still fixed, so the benefit for customers dealing with a volatile market is at least you have the advantage of knowing the cost of your capital.
“They have ticked up slightly (interest rates), but they range between 4% to 10% and maybe a little bit more in extreme cases.
“There are examples where we are considering, like for decarbonisation, a slightly discounted rate because there are comparable schemes offered by private sector lenders and those (publicly backed lenders) in other parts of the UK.”
But could the development bank, without the reserve capital requirements of high street banks – and the cost of universal banking – go even lower on interest rates to support SMEs in Wales?
Mr Thorley said: “It would be very difficult for us to justify, say, doing 0% finance and it has never really been possible as the reference rate from the EU has never been at zero with the lowest around 0.25%. During Covid our loans were 0% for the first year, but the implied rate was 2%.”
With the UK economy entering recession will the development bank be more understanding on repayment schedules with firms?
The chief executive said: “I think we have always been incredibly pragmatic on forbearance when it is needed. It has to be done on a case by case basis and we provided forbearance to companies through Covid.
“We have a very active team that help support businesses that are in financial difficulty.
“We are very rarely the organisation that pulls the plug and we certainly come way behind the government and other corporate lenders. Our job is to find a stable solution for a business.”
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