Cios lep investment strategy for financial instruments by Cornwall and Isles of Scilly Local Enterprise Partnership

Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

March 2016

Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

Table of Contents 1. Introduction ................................................................................3 2. Background .................................................................................. 4 3. Demand ....................................................................................... 5 4. Additionality to National Schemes ............................................... 9 5. Existing Local Provision/Legacy .................................................. 12 6. The Case for a Fund of Funds...................................................... 14 7. Provisional Fund Allocation Summary ........................................ 18 8. Development and Running Costs................................................ 18 9. Investment Approach................................................................. 18 10. Structure and Governance........................................................ 20 11. The Top Company and its Role ................................................. 21 12. The Holding Company and its Role ........................................... 22 13. The Sub-Fund Managers and their Role .................................... 23 14. Additional Note on Top and Holding Company Appointment . 25

15. Investment Phasing ................................................................. 27 16. Generating Deal Flow ............................................................... 28 17. Outputs and Results ................................................................. 30 18. Operating Costs........................................................................ 37 Appendices .................................................................................... 38 Appendix A .................................................................................... 39 Appendix B .................................................................................... 45 Appendix C .................................................................................... 55

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

Access to Finance in Cornwall and Isles of Scilly Investment Strategy for Financial Instruments in the ESIF 2014-2020 Programme 23 March 2016

1. Introduction The Cornwall and Isles of Scilly Local Enterprise Partnership (CIoS LEP) is working with partners to create in the region, a fund of funds that will assemble a range of financial instruments to provide access to finance support for SMEi business creation, development and growth. The need for a programme of at least this size and nature was clearly set out in the regional Block 1 Ex-Ante Assessment1 undertakenii by the European Investment Bank (EIB) for the Department of Communities and Local Government (DCLG) and published in February 2015. A further Supplementary Ex-Ante Assessment exercise was commissioned by CIoS LEP and undertaken by Blue Sky Corporate Finance later in that same year. The Blue Sky report focused more specifically on need in the CIoS LEP area and consulted widely with experts tasked with the developing the LEPs plans for the future economy streams and with intermediaries in the financial, business and professional services sectors. The report found widespread consensus on the access to finance needs of the area and much overlap on the type of financial instrument that was required to meet each of these needs. A Steering Group chaired by Rob Davey, CIoS LEP Board Director and comprising representatives from CIoS LEP, Cornwall Chamber of Commerce, Cornwall Council, DCLG and the British Business Bank (BBB) is leading the development of the Investment Strategy. CIoS LEP’s expectation is that any new initiative should be up and running in such a timescale intended to complement a suite of business support initiatives designed around plans for the future economy streams. The LEP and its partners across public and private sectors, aim to create an integrated, coordinated, compelling and comprehensive business support and access to finance infrastructure for small and medium sized growth enterprises in the area. This Investment Strategy has been drafted to support development of a ‘fund of funds’ style financial instrument programme and is expected to form the basis of a proposal to DCLG (as Managing Authority for the 2014-2020 ESIF Programme) and private sector investors that will be approached to consider investing alongside. The fund of funds approach has been conceived to offer a range of financial instruments from debt, mezzanine through to equity finance for early stage and more established SMEs.

2. Background 1

https://www.llep.org.uk/content/uploads/2015/07/SME-ex-ante-Block-One-SUMMARY-13-2-15.pdf 3

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments ‘Cornwall and the Isles of Scilly’s economy faces a number of challenges which are reflected in low wages, low productivity and relatively low skills attainment. Our objective to exceed the expected growth in terms of GVA of the overall Cornwall and Isles of Scilly economy shows we have set challenging and aspiration targets.’ CIoS LEP’s ESIF Strategy: The C&IOS ambitions are set out in their European Structural and Investment Fund Strategy published in June 2014. The strategy set out in this report is dynamic, fresh and ambitious. In the document’s opening statement the C&IOS Chair (Chris Pomfret) makes the point that ‘we won’t achieve our vision by doing things the way they’ve been done’. No less importantly, in the context of this report, he goes on to say ‘we strongly support the move away from non-repayable grants and envisage our next programme being a mix of grants, loans, guarantees and other financial tools that enable the funds to be recycled and re-used’ CIoS LEP’s ESIF Strategy outlines a programme that will deliver across three themes – Future Economy, Growth for Business and Conditions for Growth.

The strategy sets out certain key thematic priorities and proposes that investment is focussed upon a number of key sectors in which the region has significant competitive advantages. Defined as the ‘Future Economy’ streams these verticals (‘smart specialisations’) are further sub-divided into 2 substreams which are defined as follows:Future Economy 1 - specialisms in which the area has identified competitive advantages, knowledge and enterprise assets: 

Agri-Tech Digital Economy 4

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments   

E-Health Marine Technology Space/Aerospace Technology

Future Economy 2 -specialisms which play to the geographic strengths and unique attributes of the region:     

Geothermal Offshore Renewables Smart Energy Technology Low Carbon Vehicles Infrastructure & Alternative Fuelling Technologies Heat Networks Green Infrastructure

Access to finance is set to be a critical facilitator of activity to support the CIoS LEP’s goals and plans for a financial instrument is expected to support activities across all three themes.

3. Demand Block I Ex-Ante Assessment Access to finance remains a constraint to business formation, development and growth. In February 2015 the EIB published the Block 1 Ex Ante Assessment of need for public sector backed financial instruments in the South West of England region. EIB was assisted in the research that was undertaken in support of this assessment by consultants Regeneris. This research was funded by DCLG. The EIB report is summarised as follows:‘Analysis shows that total unmet demand in the region could be of the order of £1.7 billion in one year. It is not possible to determine from this type of analysis how much of this is from SMEs that had viable business plans (i.e. those that, as a class of firms, could be supported in such a way that the financial and economic returns to the public sector from doing so would represent value for money, and hence constitutes a market failure)….. The survey does not provide data that allows the split the unmet demand for larger amounts of finance between debt and equity finance. The SBS Survey reports that around 2% of SMEs overall are looking for equity finance. However, this does not necessarily accurately represent the proportion (of SMEs or deal values) that are best suited to equity finance, given the nature of their investment projects. Data presented by the British Business Bank suggests that around 4% of the value of finance to SMEs is in the form of equity. Using SBS data which allows for the size of the SME and variations in the amount of finance sought by type of finance, around 8% of this overall unmet demand is likely to be accounted by equity finance (and 82% by debt finance and a further 10% by other forms of finance). This would imply a total unmet demand of around £140 million per annum for debt (if 10% of propositions were viable) and around £14 million per annum for equity (again if 10% of propositions are viable), in addition to that which is already being met by publicly backed initiatives.’

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments Micros (1-9)

Small (1049)

Medium (5049)

All SMEs

Seeking microfinance up to £25k

Seeking larger amounts

£50

£860

£470

£230

£1,610

£0

£40

£20

£90

£50

£900

£500

£260

£1,700

10%

£5

£90

£50

£30

£170

20%

£10

£180

£100

£50

£340

30%

£15

£270

£150

£80

£510

40%

£19

£360

£200

£100

£680

- those that obtained none of the finance they were looking for - those that obtained some, but not all, of the finance they were looking for* Total unmet demand Scenarios for % that are viable

The Block I Ex-Ante assessment report was largely based upon a historical analysis of demand and did not differentiate between the 6 LEP areas that comprise the South West region. Mapping the determinants of demand may offer some helpful indicators in this respect but it is difficult to define precisely how they influence enquiries and take-up of finance. For example; the CIoS LEP share of SMEs and residents both represent around 10% of the total in the South West region. Data from the Office for National Statistics points to a lower value of GVA per head in CIoS than any of the other sub-regional areas and that the figure is typically around 25% less than the next lowest recorded for the Heart of the South West LEP area and around half of the top performing LEP areas (West of England and Swindon and Wiltshire) in the region. These statistics could support a theory that businesses based in the CIoS area represent inherently less attractive business investment opportunities than those in neighbouring areas (or a greater proportion of non-viable business propositions) but it is much more likely that they are symptoms of a challenging economic landscape with a traditional reliance upon seasonal industries (agriculture, marine and tourism) that are struggling to attract new investment. Either way, these statistics underpin the LEPs core strategy to ‘do things differently’ and reinforce the need for an ambitious and flexible range of investment instruments needed to underpin that strategy.

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments GVA per Head (England=100) - 1997-2012

Source: Office for National Statistics

Blue Sky Report – May 2015 In May 2015, sponsored by CIoS LEP, Blue Sky Corporate Finance undertook further research that was intended to secure a better understanding of the type of financial instrument that would be needed in the area and the priority attached to each of these. This CIoS area specific research focused upon two sources: 

Study of Intermediaries & Professional Advisor s Study of the Impact of the Future Economy Streams

Study of Intermediaries & Professional Advisors This aspect of the study considered the more general landscape of funding needs in the area; the type of financial instruments needed and the priority attached to each. Determining precise levels of demand for finance by consulting SMEs directly is always challenging and for certain types of financial transaction, it may be practically impossible. For example, raising equity finance for a significant new business start-up or for an expansion may be an event that many businesses attempt only infrequently and many SMEs choose to cap expansion by funding growth though cash-flow and debt only. The nature of the technical questions being asked necessitated that this aspect of the study was principally focussed on the advisory network (accountants, corporate finance professionals, growth coaches, fund managers, bankers etc.) in the region. The Blue Sky research was supported by the Institute of Chartered Accountants England & Wales and was widely circulated to their members in the region. Summaries of some of the key findings of this aspect of the Blue Sky research are set-out in Appendix B of this Investment Strategy. 7

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments Study of the Impact of the Future Economy Streams This aspect of the study focussed upon the likely impact of the CIoS future economy stream strategies upon the likely need for financial instruments in the area. The research considered both the likely quantum of finance that would be needed and the type of financial instrument that would best serve each of the specialisms. Micro Debt

SME Debt

Seed Equity

Dev Cap Equity

≤£25k

≤£150k

≤£500k

E-Health



Digital Economy



Sector

Space/Aerospace

Asset Debt Finance ≤£2m

G'tee finance ≤£500m



 

Marine Technology



Agri-Tech



Offshore Renewables



Smart Energy Technology



Geothermal



Findings The most important findings of the Blue Sky study were that the 2014-20 financial instrument programme must be very much larger, wider and more flexible than that deployed under previous programmes. It must also greater than that implied by the EIB/Regeneris Block I Ex-Ante Assessment. If the C&IOS LEP is to deliver the economic outputs set out in its Growth Plan the likely market demand for FIs will be high and would justify a combined (public and private sector) fund of more than £100m (possibly £120m+). ‘The funding required will be a mixture of debt, equity and loan guarantees with at least 50% of the fund (£50m+) orientated towards start-up and early stage debt and equity. To attract the private sector investment match it will most likely prove necessary to balance the risk in the portfolio by investing the balance of the funds in later stage debt, growth capital, development capital and possibly loan guarantees.’ The Blue Sky study supported the need for a variety of Financial Instrument types. These include: 

Microloan and business loan finance Start-up/early stage seed equity finance – This can take various optional forms including a proof-of-concept fund and a business angel co-investment fund or a single fund that might stimulate both. 8

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments  

Growth/development capital Mezzanine finance.

4. Additionality to national schemes There are a small number of national public sector backed access to finance initiatives and it is important that any regional strategy avoids duplicating/conflicting with these. The EIB Block I ExAnte Assessment noted: The UK Government has been active in trying to stimulate the flow of lending to SMEs in recent years. The main initiatives have included: 



Bank of England - Funding for Lending Scheme: anecdotal feedback from consultations suggest that Funding for Lending has not had any noticeable impact on the supply of debt to SMEs, and that lending has been focussed on mortgages.2 Enterprise Finance Guarantee (EfG). The value of EfG-backed loans in the SW region is the fourth highest of the English regions, behind London the SE, and the NW. The average value of loan backed by the scheme in the region is around £92k, showing that the scheme has been focussed on smaller amounts of debt, but at somewhat higher levels than what would constitute a microloan. The Business Finance Partnership and the British Business Bank Investment Programme iii These two initiatives provide funding to non-bank channels to invest in small and medium sized businesses. At the time of the Regeneris report, £66m had been invested in the SW region, which is equivalent to an annual average of £38m. The average value of investment was £200k, equal to the English average. The overall funding secured across the SW equates to £339 per SME, which is below the England average of £500. The Start-up Loans initiative, set up in 2012 to help 18-30 year olds, has had some impact in the SW region. The latest statistics show that £3m in total has been allocated to 550 start-ups in the SW. The Angel Co-Fund. This £100m Fund was launched in November 2011 with a grant from the Regional Growth Fund. The aim has been to invest between £100k and £1 million in high potential businesses, and to leverage significant co-investment from business angels. It invests in both early and later stage businesses. The latest monitoring data indicates that a total of £3.8 million (including investment by co-investors to the ACF) has been invested in the South West, in 3 companies. This represents 4% and 6% of the value of investment and number of companies in the UK, respectively. We do not have access to regional data on leverage but at the national level to date £3.80 has been levered in from business angel syndicates for every £1 invested by the ACF itself. Enterprise Capital Funds were originally set up in 2005 as a government-backed scheme with the aim of investing up to £2 million in early stage companies. ECFs operate as private companies that back private capital with Government-guaranteed leverage. The limit on the amount that ECFs could invest into any one fund was £25m, which has recently been increased to £50m. The ECFs are typically UK-wide Funds, although regional funds have been supported.

Unfortunately the data on the scheme is not split between lending to businesses and lending to individuals, so it is not possible to verify this using performance data. 9

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

 



For various reasons, two thirds of the value of investment made to date has gone to companies based in London, South East and East of England. The latest monitoring data shows that 11 investments have been made in the South West to date, with a value of £20.4 million (including co-investment). UK Innovation Investment Fund. This Fund provides capital for existing venture capital funds, with a total capital of £330 million (of which £150m has come from the UK Government and £180 million has come from the private sector). It is targeted at small businesses with growth potential and new ventures in the digital, life sciences, clean technology and advanced manufacturing sectors. Regional and sub-regional data is not available for this fund. Aspire Fund. No regional data is available. The Business Growth Fund (BGF) was set up in July 2012 and is backed by a syndicate of banks with £2.5 billion of capital – it focuses on growth equity and mezzanine finance, offering £2m£10m. It is designed to be an evergreen fund. Published data on the Fund’s portfolio indicates that only one £6 million investment has been made in the South West to date (compared to an average investment of £5.6m in England). This chimes with the comments from stakeholders that the Fund is investing in larger propositions in the £2m-£8m range. Tax incentives. Collectively tax incentives are the biggest intervention in the UK equity market by value. The Enterprise Investment Scheme (EIS) provides 30% tax relief for investors making an investment of up to £1m in any tax year. SEIS is a derivative of EIS, which aims to encourage seed investment in early stage companies. Investors receive tax relief of 50% on investments up to £100k and Capital Gains Tax exemption on any gains in SEIS shares. ONS data based on HMRC returns shows that at total of £119m has been invested in the SW region through the EIS scheme, in 479 enterprises over 2009-2012, an annual average of around £36m. This is equivalent to £323 per SME employer, which compare to the English average of £650.There appears to be a general consensus from our consultations that these initiatives have had a strong impact in bringing forward investment from business angels and High Net Worth Individuals in the early stage arena.

Private Sector Finance The available data from the British Venture Capital Association (BVCA) shows that early stage investment in the SW fluctuated significantly and between 2007 and 2010, total investment value halved. After rising to £38 million invested in 2010, this figure has continued to fluctuate, dropping down to an average of £8 million in 2011 and 2013. Since 2010 the number of firms receiving investment in the South West has declined. Before 2010 an average of 27 companies were invested in each year, dropping to an average of 12 per annum over the period 2011-2013. The BVCA also publishes data on later stage growth deals completed in the region (privately and publicly backed). According to this data the level of investment has steadily increased from 1998 when annual investment was £267 million to 2010 when it had risen to £739 million. While the overall trend has been positive, there were years of decline, particularly 200, 2002 and 2004 when average annual investment was £152 million. After reaching a peak in 2010, annual investment figures in the South West have been much lower over 2011-13, averaging £236 million per annum. The number of companies invested in each year has steadily declined since 2006 (98 companies) to 2010 (46 companies) and remaining steady thereafter. Given the role that business confidence plays 10

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments in driving demand for this type of investment, these Funds faced a more challenging climate than the other Funds. Unlike businesses in their early stages of product and business development, established SMEs can easily postpone growth projects whist they wait for conditions to improve. Our consultations suggest that this happened in the South West (as it did in other regions), particularly around 2010 and 2011. New and Emerging Alternate Sources of Finance There is no regional data yet on Peer-to-Peer (P2P) business lending, but this source of finance has reportedly had some take up in the SW but that this more likely to be concentrated in Bristol and to the North of the M4 where proximity to the more mature investment infrastructure of London and Birmingham is important. New and alternative funding sources have also played a role in this market, including equity based crowdfunding platforms. These are presently of a smaller in scale than P2P platforms: the latest review of the UK market found that equity based crowdfunding amounted to £28 million nationally, representing very strong growth from the estimated £4m in 2012 (the average amount of money raised was £199,000). Consultations suggest that these sources of finance have enjoyed only modest penetration in the South West to date. Reward-based crowdfunding (where individuals donate to fund a project with the expectation of a non-financial reward in the event of its success) have also enjoyed only modest penetration in the region. Whilst these new and innovative platforms may play some role in early stage finance in the CIoS area, the view – supported by consultations – is that they are unlikely to serve all of the needs of early stage companies. Some of the consultees have made the point that mechanisms are well suited to project finance but much less well suited to building new, innovative businesses, given the need for a longer term commitment of funds through several rounds of funding and the potential for significant dilution for the initial investors. Further, given that these forms of financing are at an embryonic stage there remains potential for significant levels of write offs to come through from the investments made to date, which would impact on the reputation of the platforms. An overall summary of the key sources of supply of finance to SMEs is provided below. It should be noted that there are significant overlaps between the sources (for example, EfG backed lending is a subset of total SME lending; some funding sources will have provided co-investment for other). Nonetheless, it gives a useful summary picture of the supply side in the region.

Average annual value of Investment, £m

Average value of investment made, £000s (England avg in brackets)

Value per SME Base (England average in brackets)

% change in value 201113 (England avg in brackets)

£8,019 (£7,342) £16,351 (£11,303)

-21% (-12%) 24% (1.5%)

Debt New loans to Small Businesses New loans to Medium sized businesses

£902

£76 (£82)

£1,839

£244 (£295)

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments New overdrafts approved for Small Businesses New overdrafts approved for Medium sized businesses Enterprise Finance Guarantee backed lending Start-up Loans Business Finance Partnership & Investment Programme ERDF backed debt P2P Lending to businesses

£3,493 (£2,094) £2,787 (£2,229) £330 (336) £25 (£65)

-33% (-25%) 9% (-5%)

£339 (£500) £57 (£40)

£3.741

£16,899 (£15,590) £67 ( £81) £90 (£100) £5 (£9) £200 (£207) £68 (£83)

£393 £313 £37 £3 £38

NA £0

£1

Equity Early stage equity investment

£9

Expansion equity investment

£71

Angel Co-Fund

£1

Enterprise Capital Funds

£3

Enterprise Investment Scheme (EIS)

£36

Business Growth Fund

£6

£452 (£1,081) £2,511 (£4,830) £1,277 (£1,832) £1,852 (£1,335) £228 (£344) £3,210 (£5,617)

Equity-based crowdfunding Other crowdfunding (reward-based, donation)

£5

£7

£83 (£355) £631 (£1153) £12 (£30) £23 (£27) £323 (£650) £21 £42 (£26) £60 (£35)

-67% (24%) -50% (62%) NA NA (66%) zero in 2011/12 (46%) NA

5. Existing local provision/legacy There is a range of other sources of supply operating in the region. It is outside of the scope of this report to map these out in detail, but the key sources include:   

CDFIs: In the South West in 2013, £7.8m was invested by CDFIs in 162 businesses representing 15% of the national investment and 8% of the businesses. Local authority run schemes. RGF backed schemes

South West Loans Fund Probably the most significant local scheme is The South West Loans Fund, operated by the South West Investment Group (SWIG) and recently extended to June 2016. The South West Loans Fund is funded by ERDF and provides loan finance for businesses with growth potential. Its key investment terms are: 

Maximum amount £250,000 over 5 years 12

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments    

Commercial rates of interest charged in line with EU guidelines (normally between 6% and 10%) Personal guarantees are required, further security may be requested according to commercial risk Arrangement fee of 1% of loan amount (min. £75) payable on draw down Monitoring fee of 1% of original loan (min. £75) payable per year

The South West Loan Fund is also significant as a holder of legacy funds that may be recycled to support a new financial instrument. On current projections, legacy is expected to be in the region of £2.982m with around £2.23m of that directly attributable to ERDF investment and therefore subject to ERDF geographical and sectoral restrictions. Legacies are expected to become available across six years to 2020.

South West Loan Fund - Projected legacy receipts Period December 2015 - cash December 2016 December 2017 December 2018 December 2019 December 2020 Total

£m 1.443 0.322 0.646 0.314 0.215 0.042 2.982

Source: SWIG

Start-Up Loan Scheme The Start-Up Loan Scheme is a Government funded scheme that is operated in Cornwall by SWIG and offers unsecured loans to businesses that have traded for up to 2 years, with up to £25k available on 1-5 year terms at 6% fixed with no set-up fee. SWIG’s contract to offer the scheme has been extended to March 2017. A separate Loan Scheme is offered by Dartington Hall Trust managed by SWIG to early stage social enterprises on similar terms. £600k is currently available for the whole of the South West. It is not known whether the Start-Up Loan Scheme is expected to be extended beyond 2017. If a financial instrument was to be put in place for the 2014/20 programme, it is expected to work above the maximum available from the Start-Up Loan Scheme for the simple reason that it is well established and offers loans at rates that a viable financial instrument would struggle to match.

SWIG’s own CDFI Fund This comprises SWIG’s own fund, capitalised from earlier investments.. The fund is intended to be evergreen with all legacies made available for re-investment through SWIG.

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

6. The case for a fund of funds The CIoS LEP’s Strategic Economic Plan sets out ambitious growth targets and a sizeable fund-offunds programme is required on a scale that can match up to these plans. The fund-of-funds proposed comprises an investment pool of around £68m distributed between 4 separate sub-funds (details provided later in this investment strategy), comprising around £36m of ERDF contributions matched with a commercial £9m loan and £23m of deal-level co-investment. ERDF Technical Assistance and legacy contributions from previous funds will be used to support setup costs and working capital until such time that returns for the fund are sufficient to cover costs; at which point future contributions from either of these sources will be added to the investment pool. Final commitments from all sources of funding will be confirmed and agreed during the development process, through liaison between the CIoS LEP A2F Steering Group, legacy fund holders, BIS/BBB and DCLG where their consent is necessary to release legacies. Additional capital may be found from sub-fund managers that pledge additional co-financed investment as part of a successful tender submission (either from their own reserves or from a thirdparty). The main advantage of the fund-of-funds approach to regional financial instruments is that it supports the creation of a range of sub-funds that are each designed to meet the various needs/gaps in the market. It also permits greater flexibility allowing the amounts allocated to each sub-fund to change (to reflect local needs/demand) during the life of the programme. There are various ‘factors’ that influence the proposed allocation of funds between the various subfunds and some of these influences conflict with one another. For this reason the final allocation of the funds is usually a compromise that is agreed during the development of the financial model and the contract negotiations that take place with the various stakeholders. Some of these potentially conflicting influences include:



The private sector co-finance provider is likely to make its contribution to the sub-fund by way of a loan. Accordingly this source of potential ‘match’ will be concerned that the subfund is capable of servicing the loan repayments and may favour earlier cash generating debt instruments over more patient equity investments. DCLG and BIS will naturally focus upon the value for money aspects of the programme. There are various measures of value for money but most of these relate to the ‘outputs’ that are delivered (e.g. jobs created, SME’s assisted etc.).

It follows that some of the key stakeholders will tend to favour lower risk debt instruments and other stakeholders will tend to favour higher risk micro-loan and equity instruments. This is both an advantage of scale of the fund-of-funds approach (the opportunity to create a fund on a scale that can balance the conflicting influences) and it is also an explanation for the proposed split of funds outlined below. The proposed range/size of the CIoS LEP sub-funds is also informed by the research reports outlined in the earlier sections of this report. 14

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Fund 1 - Business Loan Fund - £16.5m ‘Strong evidence pointing towards particular, and growing, difficulties experienced by microbusinesses in obtaining finance. Theoretical unmet demand of c.£95m p.a. if only 10% of rejected firms had solid business plans (in addition to the gap being addressed by current CDFIs and Funds)’. EIB Ex-Ante Assessment – SW Region

A Business Loan Fund is proposed, offering loans of £25k to £150k with the average deal assumed to be in the region of £50k. It is proposed to be of a total value of £16.5m comprised of £7m of ESIF, matched to £4.5m of private co-finance and £5m of co-investment. The EIB Ex-Ante Assessment and Blue Sky study have both confirmed the need for debt finance at the level offered by this fund. This need is compounded by the present uncertainty relating to future funding for Community Development Finance Institutions iv(CDFI’s) in CIoS and elsewhere in England. During the fund manager procurement stage, all options for the most efficient/effective deployment of this fund, including the potential use of one or more peer-to-peer lending platformsv, will be fully explored. This type of debt fund is unlikely to offer a good financial return for the programme but they do expect this fund to yield important and helpful economic benefits and output metrics. Loans will be offered at/or above the commercial interest rates (determined by the European Commission as reference rates over LIBORvi) or through De Minimis, so that there is deemed to be no state-aid. The Business Loans Fund will be able to invest in early stage and more established, profitable businesses that need additional debt support for limited growth/development or working capital. Pricing sensitivity will be tested at modelling stage.

Fund 2 - Seedcorn Early Stage Co-Investment Fund - £16m ‘Approximately 47% of the business base in the region is innovation active. This is higher than the UK average rate of 45%, and is the second highest of all the regions. There have been 81 spinouts in the South West since the year 2000, representing 9% of all spinouts in the UK. Half of all spinouts in the South West have come from the University of Bristol, (40 spin-outs) with an additional 25% (20 spin-outs) coming from the University of Exeter.’ EIB Ex-Ante Assessment – SW Region

The Seedcorn/Early Stage Co-Investment Fund will support early stage, equity-based, tranched investment in innovative technology or knowledge-based businesses. Recipients are likely to be pre or early revenue stage and high-risk but have potential for very high growth and for good return realisation on exit. This fund will be instrumental in supporting new and fledgling ventures formed in the Future Economy sectors and expected to work closely with other support initiatives sponsored by the CIoS ESIF programme. The Fund is proposed to be of a total value of £16m comprised of £11m of ESIF leveraging £5m of deal-level co-investment. The fund is expected to invest between £25k and up to £1m with a cap of £250k on the initial investment and average total investment expected to be around £500k. 15

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The fund will have no sector constraints but will actively seek to support regional University, HEI and private sector technology spin-outs. The EIB Ex-Ante Assessment established that SW Region businesses are relatively more innovate than the UK average and that the region’s Universities are good at commercialising technology. The extent to which either of these factors hold true in CIoS is unknown. However, it is well understood that early stage technology businesses are highly mobile and can be attracted to locations that can both offer useful and creative support networks and sources of flexible finance that are able to keep pace with growth and development. The sub-fund managers will be free to make the investment in any combination of equity, debt or mezzanine and encouraged to make the initial investment in some form of a convertible loan (mezzanine) or redeemable shares. This debt type instrument will attract interest priced to reflect risk and will be repayable when the spin-out technology supported begins to generate sales revenues. The sub-fund manager will also have a ‘put option’ which will entitle them to convert the loan to equity at the same value used for any future equity fund-raising rounds. The more successful spin-outs are expected to need further finance (most likely equity) and it is anticipated that around 60% of investments will convert to equity. This structure will provide a level of protection against unfair/undue dilution at a future equity rounds and provide an exit route for ventures that make it through to commercialisation but no further. The portfolio will be actively and closely managed and follow-on investments will only be made against the achievement of pre-agreed milestones with few investees securing the upper end of the investment range (and some never progressing beyond the initial minimum). This fund is unlikely to deliver stellar financial returns within the timescale of this fund but is expected to create a long-term, strategic investment pipeline of viable businesses that may benefit from later stage investment from other sub-funds or in the commercial mainstream market. Importantly, the sub-fund manager will have contractual obligations to nurture, stimulate and develop the business angel investment community based in the region. During the sub-fund manager procurement phase, all options for the most efficient/effective deployment of this fund, including the potential use of one or more of the emerging crowd funding platforms

Fund 3 - Growth Mezzanine Fund - £16.5m ‘National survey data suggests around 40% of small and 30% of medium sized businesses have problems accessing finance, and this has grown in recent years. Not possible to split theoretical unmet demand calculation for debt vs. equity, but unmet demand for established SMEs as a whole amounts to c.£80m p.a. even if only 10% of rejected firms had solid business plans (in addition to the gap being addressed by current provision)’. EIB Ex-Ante Assessment – SW Region

The Growth Mezzanine Fund will be a total value of £16.5m comprising £7m of ESIF matched to £4.5m of private sector co-finance and a further £5m of deal-level co-investment. The relatively high proportion of smaller businesses in the region, many of who are family concerns for which equity finance may neither be desirable nor viable, dictates that debt finance of this type is

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments needed; and early demand for RGFvii-backed regional mezzanine funding in comparable areas has been very high. The Growth Mezzanine Fund will provide finance of between £150k and £2m. All of the finance provided will take the form of debt and the mezzanine nature of the fund will take 2 forms: Redemption premium The debt finance will attract a commercial interest rate coupon during the life of the loan with a redemption premium payable at the term of the loan to reflect any equity risk taken.  Equity kicker The debt finance will attract a commercial rate coupon during term and the sub-fund manager will take an option to acquire a small equity stake (or profit share) to reflect the equity risk. The Growth Mezzanine Fund will primarily support post-revenue and post-profit viable companies with a compelling case to support the assertion that they are capable of servicing debt only. Within the confines of State-Aid regulations and the framework of ‘off-the-shelf’ instruments, the Growth Mezzanine Fund will be encouraged to support investments into recovery and transitional situations , expansion opportunities, and inward investments and to work with other private sector investors at the margin of their appetite for risk (there is evidence that many investment opportunities are stalled because the banks have a low appetite for risk - this prudence most often manifests itself in the form of a modest loan-to-asset ratio – to unlock the potential of these projects, the fund will lend alongside and at the margin of the private sector lenders). During the sub-fund manager procurement phase, the option of (and conditions relating to) securing private sector co-investment at the sub-fund level will be explored.

Fund 4 - Growth Capital Fund - £19m ‘No sign of mainstream players moving away from fewer, larger deals, leaving a gap at lower levels of equity/mezzanine. Economic recovery suggests demand for expansion could pick up and therefore increase unmet demand and market failure. Not possible to split theoretical unmet demand calculation for debt vs. equity, but unmet demand for established SMEs as a whole amounts to c.£80m p.a. even if only 10% of rejected firms had solid business plans (in addition to the gap being addressed by current provision)’. EIB Ex-Ante Assessment – SW Region

The Growth Capital Fund will support the ambitions of the region’s high growth firms and superstars. This fund will invest between £500k and £2m with an average investment of around £1m. The fund will have a total value of £19m comprising £11m of ESIF funding leveraging £8m of deallevel co-investment. The Capital Growth Fund will focus upon later stage post-revenue and most likely post-profit growth capital requirements and it is anticipated that a material (50% to 60%) proportion of the fund will be invested in debt/mezzanine instruments. No sector specific targets have been set, but within the confines of EU/State-Aid regulations, the fund will be encouraged to support investments in capital equipment, new processes, new product lines, innovation, advanced manufacturing, tooling, inward investment, renewable technologies and bio-technology. 17

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During the sub-fund manager procurement phase, the option of (and conditions relating to) securing private sector co-investment at the sub-fund level will be explored. If co-investment proves to be impossible/impractical, then the sub-fund manager will be contractually targeted (but not mandated) to secure leveraged co-investment on a deal-by-deal basis. Within the confines of State-Aid regulations and within the framework of “off the shelf” investments (Article 38), this fund will also be encouraged to support buy-outs/buy-ins and spin-outs.

7. Provisional fund allocation summary

Conditions for Growth

Business loan fund (£25k-£250k) Mezzanine (£100k-£500k) Growth Capital (£100k-£1m) Seedcorn Early Stage Co-I (£25k - £750k) Total

Growth for Business Theme

Fund

Future Economy Theme

The diagram below clarifies the ESIF, co-finance and co-investment elements of each sub-fund and how together they make up the fund of funds and support the three CIoS ESIF strategic themes.

   

Indicative Funding structure ESIF (£m)

7 7 11 11 36

42 42 58 69 53

Cofinance (£m) 4.5 4.5 0 0 9

% 27 27 0 0 13

Coinvestm't (£m) 5 5 8 5 23

Total (£m)

30 30 42 31 34

16.5 16.5 19 16 68

8. Development and running costs The value of ESIF proposed to be allocated to investment capital has been set at £36m. The final commitment will be agreed during the development process, through liaison between the CIoS LEP Financial Instrument Steering Group, the LEP Board, the ESIF committee and DCLG. Development, set-up and early stage operating costs are proposed to be met from ERDF Technical Assistance, up to a maximum value of £400k, returns from the South West Loan Fund (total of £2.982m between years 1-5 and a further £835k contribution from ESIF. Any further legacies from funds established by the former Regional Development Agency are another important potential source of contribution to the funds proposed. Information on this source has been requested from BIS’ fund manager, the British Business Bank. Additional capital may be found from sub-fund managers that pledge additional co-financed investment as part of a successful tender submission (either from their own reserves or from a thirdparty).

9. Investment approach To facilitate maximum flexibility and to help mitigate against the impact of funds under-performing or lack of demand, some investable capital may be held back and only allocated to a fund once 18

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments demand and fund manager performance has been established – so-called ‘soft-allocation’. In the event that a new investment priority was to arise and funds were available through this route, money could be allocated to an entirely new sub-fund. None of the sub-funds is anticipated to have a sole-sector focus. However, it is entirely reasonable to direct sub-fund managers to attract enquiries from certain sectors as part of their marketing activity. It is also entirely practical that investment by sub-sector may well be one of the KPIs by which the performance of the fund is measured and managed. The fund will be operated over ten years, with a 5 year core investment phase and a further 5 years to realise returns. Sub-fund managers will be invited to hold a proportion of allocated investment capital beyond the investment phase to support follow-on. Each sub-fund manager will be expected to draft a comprehensive sub-fund investment strategy for the fund under their control. The strategy will be subject to endorsement and regular review by the Investment Advisory Panel. Sub-fund managers will be encouraged and invited to bring forward proposals for co-investment at the sub-fund level. As part of the sub-fund manager procurement process, prospective bidders will be invited to put forward proposals for 3rd party (private sector) co-investment and proposals on the quantum of potential co-investment and the terms associated (term, the basis of returns, fees and governance). Whilst it is anticipated that sub-fund co-investment may be more viable for some sub-funds than others, the option to bring forward prospective co-investors at the sub-fund -level will be open to all bidders. The sub-fund manager will be expected to confirm that State Aid regulations are met in full. Each quarter the fund-of-funds holding company will produce a report to all stakeholders including coverage of performance against output/deliverable targets and where appropriate, corrective action plans agreed with any sub-fund managers that are performing materially off plan for any/all KPI’s. At procurement stage, in order to maximise the attraction for as wide a cross section of fund managers as possible, prospective bidders will be encouraged to consider combining the two debt (Business Loan and Growth Mezzanine Funds) and two equity funds (Growth Capital and Seedcorn Early Stage Funds).

Thematic Hypothecation The ESIF budget contributions are allocated from various programme themes (known as ‘Priority Axes). The allocation to the CIoS fund-of-funds are sourced from Priority Axes 1 and 3, shown as €m as follows:   

Priority Axis 1 – Research and Innovation Priority Axis 3 - Competitiveness of SMEs. Total allocation

€24.5m (52%) €23m (48%) €47.5m (100%)

The allocation from Priority 3 is further sub-divided (including % of total allocation): 

3a – Start-up and early stage business development 19

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€6.6m (14%)

Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments   

3b – SME finance 3c – Low carbon 3d – Growth

€7.5m (16%) €3m (6%) €5.9m (12%)

Fund managers appointed to run sub-funds will be required to find and make investments that follow these themes as closely as possible. The CIoS LEP area is big. Options for remote offices to support deal flow generation in all parts of the territory will be explored during the detailed planning stage. Any prospective sub-fund manager’s proposal that commits to wider representation and network coverage is to be welcomed. Cost will be a consideration. Fund manager costs will be kept to a minimum by taking into account the total fees received by a sub-fund manager, including the annual fees from the holding company as well as any proposed arrangement fees, monitoring fees, interest, dividends and directors’ fees also earned by the subfund manager through the life of the fund.

10. Structure and governance The proposed CIoS Investment Fund will build on lessons learned from existing fund of funds models in the North of England and elsewhere. It will comprise 4 separate limited partnershipviii based subfunds under a not for profit Holding Company.

Each sub-fund will be of a sufficient size to make a meaningful and viable impact on the gap for SME finance in the region. The benefits of such a structure are as follows: 

 

The Holding Company has a coordinating, strategic management/governance role that allows investment capital to be allocated (and flexibly re-allocated) in a way that suits the changing regional needs of the CIoS finance market over time. The Limited Partnership structure prevents leakage of VAT over other managed alternatives. Limited Partnership structures are commonplace in commercial fund management and are a preferred model for co-financing partners. 20

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The Top Co will receive and aggregate returns to form legacies for future re-investment whilst minimising tax, cost and clawback considerations that might arise otherwise through multiple legacy holders.

All board members of the Top-co and Holding Company will be appointed through an open and competitive selection process that is compatible with Nolan and other standards for public appointments. They will be selected for their management and financial services expertise and know-how, empathy of SME business conditions and the aims and objectives of the CIoS LEP and its partners. The private sector co-finance is expected to be introduced as a loan. It is anticipated that the provider may claim and retain the right to appoint a director to the Top Co and/or the Holding Company but not to participate as a partner in any of the Limited Partnerships formed at sub-fund level. Its rights will be set out and enforced through its loan agreement. Each sub-fund will be established as a Limited Partnership (LP) established between the Holding Company and a procured, professional fund management firm that performs the role of ‘General Partner’. The General Partner is responsible for all investment decisions and day to day management of the sub-fund limited partnership, in line with a management agreement set out and agreed with the Holding Company. Procured sub-fund managers acting as General Partners in a LP based fund structure, will be authorised and regulated by the Financial Conduct Authority (FCA)ix. The sub-fund manager's remuneration will be linked to performance of certain key performance indicators (KPIs) that will include investment deal flow, the geographic spread of investments, financial returns to the limited partnership to form legacies, jobs created and businesses assisted. It is likely that sub-fund-managers will be encouraged to co-invest in the sub-funds to further align their interests with that of the other stakeholders. The CIoS LEP will agree a sub-fund level investment strategy and KPIs and these will in turn, inform the drafting of Investment and Operating Guidelines (IOGs). The IOGs describe in detail how and where investors want their money to be used and support the procurement and contracting of subfund managers and all subsequent investment decisions made by them.

11. The Top Company and its role The key functions of the Top Company are as follows:    

Accountability for grants and loans – ERDF grant agreements, co-investment loans, bank overdrafts etc. Secretariat function for the Board Convening strategic development/management/review Approving the Holding Company’s annual business plan with budgets for investment activity, marketing and other development undertakings.

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments The Top Company will be a not for profit ‘evergreen’ company limited by guarantee and will exist to set and review the region’s strategic access to finance response and ensure continuity across future funding rounds. Board members at all levels will be appointed under Nolan principles and in line with other standards for public appointments. The Top and Holding Companies annual operating costs will be examined in detail during the financial modelling phase. One of the disadvantages of the 2-tier model is that it may be more expensive to operate than the comparable type single tier model.

12. The Holding Company and its role The key functions of the Holding Company are as follows:         

Secretariat function for the Board Investment Advisory Panel and various committees Formulating (for the approval of the Top Company) its annual business plan with budgets for investment activity, marketing and other development undertakings. Treasury function for investment capital funds Liaison with stakeholders and interface with sub-fund managers Strategic marketing – business development will be undertaken by fund managers Procurement and contracting of sub-fund managers Performance reporting and management of sub-fund managers Consolidated management accounts and reports for the Holding Company and Limited Partnerships if necessary IT systems – it will host and manage a common portfolio management system and customer relationship management system that all appointed sub-fund managers will be required to use as a condition of contract

Returns from investment will be retained in specific accounts by the Holding Company. Board members will be appointed under Nolan principles and selected from individuals with skills and experience that are consistent with the requirements of good governance. Sub committees will be established with oversight responsibility delegated from the board for audit, risk management, remuneration and regulatory affairs. The Holding Company Board will act as the Investment Advisory Panel and its representation will draw in additional expertise from investment professionals to support strategic development, will review Investment and Operational Guidelines (IOGs) for each sub-fund and review them regularly as the fund progresses. IOGs will be made a key term of reference in contracts with sub-fund managers that administer each portfolio. Key parameters for the IOGs will be as follows:  

Investment KPIs - geographic, sectoral, size, value etc. Investment range, purpose and focus Pricing and terms of investment 22

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments    

Fees – arrangement and monitoring NED appointments Economic output targets Investment targets

13. The Sub-Fund Managers and their role The primary focus of all the sub-funds will be to invest in SMEs that have been unable to access some or all of the finance they need to get started and grow through traditional mainstream sources. The finance will be used to create new businesses and help existing ones to grow and expand their services and operations, creating new jobs and increasing GVA. The sub-fund managers appointed will be tasked with making investments across the whole CIoS LEP area. The role of the appointed sub-fund manager in each of the sub-fund LPs is underpinned by an Investment Management Agreement and defined by the fund’s Investment and Operational Guidelines (IOGs) which are attached as a schedule to the Investment Management Agreement. Key sub-fund manager roles include:     

   

Business development and support of promotional activity. Drafting and regular review (with the Holding Company) of a sub-fund investment strategy. Liaison with market intermediaries, including the Growth Hubs. Appraisal of new proposals against investment criteria established by the Investment and Operational Guidelines. Decision making – the sub-fund manager will be required to work with LP partners to define decision making procedures including discretionary limits at which deals must be referred to an investment committee. Negotiation and legal documentation of investment terms. Management of the portfolio in line with targets for investment and returns set down by the IOGs and Fund Management Agreement. Collection of economic outputs Reporting on fund performance against KPIs to the Holding Company and limited partners.

All sub-fund managers will be procured in accordance with an open and transparent procurement process. Factors that will influence the selection of sub-fund managers (in accordance with weightings to be determined) include: 

Experience, past performance and credentials. Their understanding of and commitment to the CIoS LEP area. This will include their proposals to ensure that the objectives of the LEP and its partners are understood, their proposals for ensuring that the entire LEP geography is covered and investment targets are met.

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments 



Where appropriate, their proposals (if any) for co-investment at the sub-fund level including the quantum of any proposed co-investment and the terms/conditions/contingencies associated with that investment. Value for money. Fund management fees will be performance driven and a competitive procurement process will ensure best value rates are contracted. Arrangement fees, monitoring fees, interest and dividends are to be open, transparent and held to the account of the costs of running the programme. Commitment – All prospective sub-fund managers will be invited to commit (between 1% and 3%) of the fund size from their own resources to ensure the alignment of interests. This investment will not be compulsory but will count towards the procurement tender score. Conflict of Interest – All prospective sub-fund managers will be invited to set out the processes and procedures that they will employ to avoid conflicts with other funds they manage (or may manage in the future).

The procurement exercise will require each sub-fund manager to specify two layers of cost. The first will be based at (or below) the value of the cost of operating in the region and the second will comprise their anticipated profit margin that might be generated for performance at or above satisfactory/minimum KPI levels. The investment strategy has been developed on the basis that all sub-fund manager arrangement fees, interest charged, monitoring fees, non-executive fees, dividends etc. are declared, accounted for and held to the account of the holding company. As part of the procurement process prospective sub-fund managers will be invited to set out their proposals for costs/fees to be charged to investee companies on the basis that these will contribute to (or cover) the fund management fees proposed. Any subsequent contract will then reflect the proposals set out in the tender response. All of the funds proposed will be managed by experienced fund management teams – this will be a condition of contract. Each of the sub-funds is proposed to be established as a Limited Partnership, formed between the Holding Company and a subsidiary of a fund management firm that procured to run the fund. The selected sub-fund manager is appointed with the Limited Partnership to be General Partner. Under a Limited Partnership structure, payments to The General Partner for fund management services are made as profit share and in line with the fund management firm’s bid submission to perform the GP role. One of the features of a Limited Partnership structure is that payments made in this way may be made without attracting VAT and over the lifetime of the fund. Payments the each sub-fund manager will be allocated between fixed share, representing the direct and auditable costs of running each sub-fund; and variable share, representing the sub-fund manager’s profit margin over direct costs. Fixed share is payable monthly in advance as long as the fund is not subject to an event of default against any investors’ covenant review, EC fund and State Aid regulations and default triggers3. Payment of the variable share is triggered by the achievement of certain key performance indicators (to be agreed) and these might include: 3

In previous fund of funds, Loan to Value covenant review and default triggers were established at 60% and 70%. 24

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Value of investment placed in client SMEs Number of SMEs that receive investment Cash returns made to the sub-fund as repayments, interest, dividends, fees and capital uplift. Hypothecated thematic KPI investment targets

The KPIs for sub-fund managers will have to be closely aligned with private sector co-finance covenants.

14. Additional note on Top and Holding Company appointment This section is based upon a discussion paper tabled at Steering Group on 14th March 2016.

Top and Holding Companies The draft CIOS LEP investment strategy envisages a ‘2-tier’ governance structure with a ‘TopCo/Hold-Co’ sitting above a number of sub-fund managers. The steps required to bring this structure into existence are set out in various EU Guidance notes:Sub-Fund Managers It is universally accepted that sub-fund managers used to deliver any financial instrument will be procured under a transparent and open competitive procurement procedure. Top-Co/Hold-Co Up until Oct 2015 the prevailing wisdom from the managing authority (DCLG) was that there were various options for bringing into existence the Top-Co/Hold-Co structure for a fund-of-funds type approach. These options included the universally popular choice of using a ‘call’ process to establish this level of the governance structure. In Oct 2015, the EU published a draft guidance note (this guidance has since been adopted) and this note appeared to rule out the option of using a call procedure for this purpose. Clarification of this note has since confirmed that the use of a call procedure is not permitted for financial instruments. The two remaining options to bring into being a Top-Co/Hold-co structure are: a. A transparent and open competitive procurement b. The appointment of an entrusted entity

a. Transparent and open competitive procurement For this option, Top-Co/Hold-Co structure are to be procured by DCLG as the Managing Authority. It is understood that if this option was selected, that DCLG would be likely to use Crown Commercial Services (CCS) to manage the procurement process. It is impossible to be 100% certain about the way in which CCS might perform this service but it would be fair to say that their experience in this field is limited. CCS have also stated that they would run the Top-Co/Hold-Co structure procurement and the Sub-Fund manager procurement processes in sequence (rather than in parallel) so that the Top-Co organisation procured by the initial process can then assist them with the process of procuring sub-fund managers. DCLG/CCS have estimated that this sequential procurement process could take between 48 and 64 weeks to deliver sub-funds – prohibitively long. 25

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b. Appointment of an Entrusted Entity An alternative to a full procurement is the appointment of an ‘entrusted entity’ as Top-Co/Hold-Co structure. An entrusted entity may be appointed to run the Top-Co/Hold-Co structure without any need for a procurement process What is an Entrusted Entity? The EU Guidance notes on financial instruments stipulate that EIB, EIF and the British Business Bank meet the criteria as entrusted entities. Perhaps more importantly, EU regulations lay out a series of criteria that define what an entrusted entity should look like and how it should be structured. These include:         

Evidence that the entity will have adequate economic and financial viability Evidence that the entity will have an organisation and governance structure that is robust enough to assure DCLG Evidence that the entity will have efficient and effective internal controls Evidence that the entity will operate an accounting system capable of providing reliable information in a timely manner Agreement that the entity is willing to be audited by EU, Commission and member states Evidence of a robust and credible methodology of appraising financial intermediaries (fund managers) Evidence that management costs and fees will be within guidance thresholds Evidence of a credible approach to the issue of ‘match’ Adequate proposed measures to avoid conflict of interest Etc.

Interestingly and as a volte-face on the policy operated under the previous programme, it appears to be a consensus view that to meet EU rules the entrusted entity should be 100% public sector owned. Entrusted Entity Options Organisations that may be considered as entrusted entities include: 

The European Investment Bank and European Investment Fund – both are specified by EU guidance as being entrusted entities. Based upon previous conversations it is unlikely that EIB/EIF will be interested in participating in a CIOS fund for two reasons a) because the fund size is likely to be too small for EIB and b) because EIF has previously stated that they are not convinced that there is a large enough SME base.



The British Business Bank (‘BBB’) – representing a sovereign fund manager that is in public ownership (by BIS). BBB is presently preparing to become the entrusted entity for the Northern Powerhouse and Midlands Engine Investment Funds. In both of these cases their involvement is understood to be part funded by a Treasury grant. In both of these cases, the engagement of BBB has included a proposal by BBB that they make substantial investments (£50m NPIF and £32.5m MEIF) from their own balance sheet resources into the funds concerned.



The establishment of a local entrusted entity – the option of establishing a local entrusted entity has been explored by most of the regions that have previously debated/considered this topic. Of these the most advanced is probably the North East LEP

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments The North East LEP favoured the option of establishing their own local entrusted entity because they were concerned that the other options would cede control of the fund away from local partners. Instead of ‘opting in’ to one of the EU or Central Government entrusted entity options, the NE LEP has (with the help of DCLG) developed a plan to create a local authority owned entity that will hire or procure the resources necessary to meet the entrusted entity ‘test’ when these resources are needed. This plan was ‘signed off’ by DCLG in January 2016 and approved by Treasury in February 2016. The North East LEP plans to start the sub-fund manager procurement process in March 2016.

Third party finance to the Top Co Presently, we have assumed that £8m would be lent by a third party to the Top Co to match ERDF and for ‘on-lending’. It is worth bearing in mind that it is likely that this too would be subject to a full OJEU procurement but that it is an exercise that may be undertaken in parallel with that to select fund managers. Our understanding is that any loan procured must be on pari-passu terms – or at identical (or worse!) terms for risk, reward and timing as the public sector. We suspect that any provider that would be willing to be involved in this way, would only consider investing in the debt funds where repayments are more predictable and sooner to arrive.

Appointment to key roles - conclusions and recommendations The appointment of a Top-Co/Hold-Co structure through a call process is not an option. The option of Top-Co/Hold-Co procurement looks to be fraught with risk and the least attractive in terms of timescales If it is possible, then the entrusted entity route appears to be the most attractive option in terms of timetable to deliver sub-funds. In determining the best entrusted entity option available, we recommend that the steering group: 

Consider making contact with the EIB and EIF to seek a view on their willingness to consider becoming an entrusted entity and the terms and conditions that might be associated.



Consider making contact with the British Business Bank to seek a view on their willingness to consider becoming an entrusted entity and the terms and conditions that might be associated.



Start to consider and work-up options on a local entrusted entity option.

We would also recommend that informal approaches be made to test third party lenders appetite to support the £8m debt requirement at the Top Company.

15. Investment phasing The Fund is proposed to be modelled for a 5 year investment phase and a further 5 years for realisation.

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments ESIF programme rules permit the investment phase of the fund life to be extended to 2023. With this in mind the recommendation is that the initial investment term of 5 years is built into the model and that the option to extend this investment period (by up to a further 2 years) is kept open in all of the contracts agreed (DCLG, private sector co-finance and sub-fund managers). This way, the option of seeking an extension during the life of the programme, subject to a business case to be approved by the holding company, DCLG and other investors; is kept open. With respect to equity portfolios, it is likely that proper consideration will be given to holding some investment capital back specifically for ‘follow-on’ during the realisation phase and help safeguard the fund against dilution by other investors in subsequent funding rounds.

Total

£m

Business Loan Fund

2.5

3.5

16.5

100

Growth Mezzanine

2.5

3.5

16.5

100

Growth Capital

2.5

3.5

4.5

100

Seedcorn Early Stage VC

3.5

100

Total

9.5

14.5

Year

16.

Generating Deal-flow

Building on experience at comparable funds, established relationships between intermediaries such as Growth Hubs, bank relationship managers, accountants, legal and corporate finance advisers and their clients will be exploited to the full. Properly briefed intermediaries can help potential fund beneficiaries to understand the process of application and approval and can help to manage expectations throughout. Intermediaries can help the fund to filter out inappropriate deals or those that are best handled wholly by commercial provision and in so doing, can limit the amount of time given by investment managers to applicants that are unlikely to yield investments, for whatever reason. There are four stages that can be identified in this process:

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

Introduction – The vast majority of businesses have value-added relationships with at least one adviser from a professional intermediary or business support network. Forming a direct relationship with firms would be expensive and would risk a level of response and raised levels of expectation that the fund would have difficulty meeting. Through sub-fund managers and its online presence, the fund will provide information and updates on finance products, clarity on target ‘sweet-spot’ propositions and for introducers with the most significant potential, will establish close, account managed relationships. Filtration – intermediaries that understand the fund’s investment criteria and risk profile will proactively sift clients that have potential to include the fund in their financial packaging plans. Corollary to this, clients that are outside the fund’s target groups can be filtered to other sources. Planning – the quality of proposals that are received by Funds via a professional intermediary are usually of far greater quality than those that are received directly from unsupported businesses and they are generally well packaged with finance from banks and other complementary sources. Completion – Intermediaries help clients to gather information to support applications and provide advice that speeds the process at all stages.

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17.

Outputs and results

The following is an indicative estimate of the levels of outputs that a £68m fund could achieve based upon the performance of previous funds. Output/KPI

Business Loan Fund

Growth Mezzanine

Growth Capital

Seedcorn Early Stage

Total all funds

Fund value (£)

16,500,000

19,000,000

16,000,000

68,000,000

Value of deal level co-investment (£)

5,000,000

8,000,000

5,000,000

23,000,000

Investable capital

11,500,000

11,000,000

45,000,000

62,500

445,946

1,117,647

516,129

264

349

9,450,446

12,421,710

9,803,315

6,513,412

38,188,883

1,348

371

166

189

2,074

New businesses created

New to company products

New to company markets

Average investment Businesses supported with investment Cash returned (£) Jobs created

Outputs that are contractually required in return for ESIF investment vary depending upon the Priority Axis and Investment Themes that the ESIF is drawn from. The CIoS Investment Fund proposed in this investment strategy will draw from two Priority Axes - PA1 and PA3 and within PA3, from three individual 30

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments Investment Themes – PA3a, PA3c and PA3d. Each theme has a slightly different focus and this has determined the way that each sub-fund calls upon its ESIF contribution. The following table establishes the % proportions of Priority Axes 1 and 3 proposed to be taken up by each fund so that a minimum value for money indicator may be calculated for each output type.

Value (€m)

Value PA1 (€m)

Total PA Theme value

47.329

24.5

Business Loan Fund Growth Mezzaninine Growth Capital Seedcorn E/S Total

9.08 9.08 12.97 12.97 44.1

2.724 4.1768 4.5395 10.376 21.8163

Fund

% of PA1

Value PA3a (€m)

% of PA3a

Value PA3c (€m)

6.594 11 17 19 42 89

3.178 2.4516 0.7782 0 6.4078

% of PA3c

10.395 48 37 12 0 97

Value PA3d (€m)

% of PA3d

5.84

1.816 1.816 3.891 2.594 10.117

17 17 37 25 97

1.362 0.6356 3.7613 0 5.7589

22.829 23 11 64 0 99

The following table uses the % proportion of PA1 utilised to set a value for money benchmark for PA1 investment. Output contribution per fund PA1

Output description

Business Loan Fund

Growth Mezzaninine

Growth Capital

Seedcorn E/S

TOTAL

C001

558

Number of enterprises receiving support

106

234

497

C003

Number of enterprises receiving financial support other than grants

C005

Number of new enterprises supported

C007

772,256

Private investment matching public support to enterprises (nongrants)

84,948

131,284

146,729

324,348

687,308

C008

Employment increase in supported enterprises

C028

Number of enterprises supported to introduce new to the market products

C029

Number of enterprises supported to introduce new to the firm products

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Value PA3 (€m) % of PA3

6.356 4.9032 8.4305 2.594 22.2837

28 21 37 11 98

Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments The following table uses the % proportion of PA3 utilised to set a value for money benchmark for PA3 investment. PA3

Output descriptions

Business Loan Fund

Growth Mezzaninine

Growth Capital

Seedcorn E/S

TOTAL

C001

2,129

Number of enterprises receiving support

596

447

788

234

2,065

C003

157

Number of enterprises receiving financial support other than grants

152

C005

883

Number of new enterprises supported

247

185

327

857

C007

2,551,859

Private investment matching public support to enterprises (nongrants)

714,521

535,890

944,188

280,704

2,475,303

C008

888

Employment increase in supported enterprises

249

186

329

861

C028

Number of enterprises supported to introduce new to the market products

C029

272

Number of enterprises supported to introduce new to the firm products

101

264

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments The following table combines both PA1 and PA3 output values to provide a single set of benchmark KPIs.

PA1 and PA3

Output descriptions

C001

Number of enterprises receiving support

C003

Number of enterprises receiving financial support other than grants

C005

Number of new enterprises supported

C007

Private investment matching public support to enterprises (nongrants)

C008

Employment increase in supported enterprises

Business Loan Fund

Growth Mezzaninine

Growth Capital

Seedcorn E/S

TOTAL

658

542

894

469

2,562

169

253

194

336

117

899

799,469

667,174

1,090,916

605,052

3,162,611

254

194

337

117

901

C028

Number of enterprises supported to introduce new to the market products

C029

Number of enterprises supported to introduce new to the firm products

118

343

NB: Arithmetic errors may be caused by rounding.

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments Set against the best value benchmarks, the variances are shown in the following tables by fund and in aggregate.

PA1 and PA3

Output descriptions

C001

Number of enterprises receiving support

C003

Number of enterprises receiving financial support other than grants

C005

Number of new enterprises supported

C007

Private investment matching public support to enterprises (nongrants)

Business Loan Fund

Business Loan Business Loan Growth Fund Fund (variance) Mezzaninine (modelled)

Growth Mezzaninine (modelled)

Growth Mezzaninine (variance)

Growth Capital

Growth Capital (modelled)

Growth Capital (variance)

658

264

-394

542

-505

894

-877

264

218

-45

253

-227

194

-194

336

-336

799,469

5,750,000

4,950,531

667,174

5,750,000

5,082,826

1,090,916

8,250,000

7,159,084

C008

Employment increase in supported enterprises 254

1,348

1,094

194

371

177

337

166

-171

C028

Number of enterprises supported to introduce new to the market products

-11

-18

C029

Number of enterprises supported to introduce new to the firm products

-33

-68

118

-115

PA1 and PA3

Output descriptions

C001

Number of enterprises receiving support

C003

Number of enterprises receiving financial support other than grants

C005

Number of new enterprises supported

C007

Private investment matching public support to enterprises (nongrants)

Seedcorn E/S

Seedcorn E/S (modelled)

Seedcorn E/S (variance)

TOTAL

Total (modelled)

Total (variance)

% variance

469

-438

2,562

349

-2,213

-86

169

349

180

106

117

-86

899

-842

-94

605,052

5,500,000

4,894,948

3,162,611

25,250,000

22,087,389

698

C008

Employment increase in supported enterprises 117

189

901

2,074

1,173

130

C028

Number of enterprises supported to introduce new to the market products

C029

Number of enterprises supported to introduce new to the firm products

-36

343

-252

-73

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments The following two tables indicate how outputs are likely to be delivered across the 10 year life-time of the fund. Business Loan Fund PA1 and PA3

Output descriptions

C001

Number of enterprises receiving support

C003

Number of enterprises receiving financial support other than grants

C005

Number of new enterprises supported

C007

Private investment matching public support to enterprises (nongrants)

C008

Employment increase in supported enterprises

C028 C029

Number of enterprises supported to introduce new to the market products Number of enterprises supported to introduce new to the firm products

Growth Mezzanine

Yr 1

Yr 2

Yr 3

Yr 4

Yr 5

757,576

Yr 6-10

Total

Yr 1

Yr 2

Yr 3

Yr 4

Yr 5

264

1,060,606

5,000,000

757,576

1,060,606

5,000,000

204

286

1,348

286

Growth Capital PA1 and PA3

Output descriptions

C001

Number of enterprises receiving support

C003

Number of enterprises receiving financial support other than grants

C005

Number of new enterprises supported

C007

Private investment matching public support to enterprises (nongrants)

C008

Employment increase in supported enterprises

C028 C029

Number of enterprises supported to introduce new to the market products Number of enterprises supported to introduce new to the firm products

Total

371

Seedcorn Early Stage

Yr 1

Yr 2

Yr 3

Yr 4

Yr 5

1,052,632

Yr 6-10

Total

Yr 1

Yr 2

Yr 3

Yr 4

Yr 5

1,473,684

1,684,211

1,894,737

8,000,000

625,000

1,093,750

1,250,000

1,093,750

937,500

5,000,000

166

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Yr 6-10

Total

189

Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

The following table indicates the level of output generation to December 2018, assuming a launch of Jan 2017.

Outputs generated by 2018 Output descriptions

PA1 and PA3

Business Loan Fund

Growth Mezzaninine

Growth Capital Seedcorn E/S

Total

C001

Number of enterprises receiving support

125

C003

Number of enterprises receiving financial support other than grants

125

C005

Number of new enterprises supported

C007

Private investment matching public support to enterprises (nongrants)

1,818,182

2,526,316

1,718,750

7,881,429

C008

Employment increase in supported enterprises

204

306

C028 C029

Number of enterprises supported to introduce new to the market products Number of enterprises supported to introduce new to the firm products

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

18. Operating Costs Holding Company operating budget

Investment Investment Phase Phase

Holding company costs

Holding company salaries

Total Investment Phase Year From To

1 5 £ 240,000 40,000 1,600 15,000 3,000 1,000 300,600 5,000 14,000 13,000 47,548 79,548 50,000 12,000 11,000 9,000 4,000 1,500 2,500 1,080 91,080 15,000 3,400 17,420 12,000 47,820 35,000 18,660 1,300 15,000 69,960 589,008

Vat Salaries Non-Exec Directors Fees HR Services SLA inc recruitment 1 Travel & misc expenses 1 Training and development 1 Temporary/Agency staff 1 Staff costs Legal Fees 1 Accountancy & Audit 1 Professional Fees Other 1 VAT Payable Finance audit and legal Rent 1 Rates Utilities Insurance Stationery 1 Hospitality 1 Photocopiers & Postage 1 Other Office Expenses 1 Accomodation and services Sponsorship/Events 1 Public relations 1 Advertising 1 Misc expenditure 1 Marketing IT support, development and maintenance 1 Telecoms 1 Web & E-Mark Sup & Maint 1 Web & E-Mark Dev 1 ICT Total Budget Holding Company set up costs (incl VAT) H Co costs start month H Co Inflation rate

500,000 1 2%

Realisation Phase Year 6 10 £ % 132,000 55% 22,000 55% 880 55% 8,250 55% 1,650 55% 550 55% 165,330 2,700 54% 7,560 54% 7,020 54% 25,149 54% 42,429 47,500 95% 11,400 95% 10,450 95% 8,550 95% 3,800 95% 1,425 95% 2,375 95% 1,026 95% 86,526 2,550 17% 578 17% 2,961 17% 2,040 17% 8,129 16,450 47% 8,770 47% 611 47% 7,050 47% 32,881 335,296 57%

Current prices

Years £

Staff costs Finance audit and legal Accomodation and services Marketing ICT Total Annual

Holding company costs with inflation Inflation multiple 2% Staff costs Finance audit and legal Accomodation and services Marketing ICT Total annual costs Total Fund Annual %

300,600 79,548 91,080 47,820 69,960 589,008

51% 14% 15% 8% 12% 100%

£ 165,330 42,429 86,526 8,129 32,881 335,296

£ 49% 13% 26% 2% 10%

Emp'ers NI & 7% pension (20% total) £ 17,000 12,000 6,400 0 3,000 1,600 40,000

Total £ 102,000 72,000 38,400 0 18,000 9,600 240,000

1.0200 2

1.0404 3

1.0612 4

1.0824 5

1.1041 6

1.1262 7

1.1487 8

1.1717 9

1.1951 10

300,600 79,548 91,080 47,820 69,960 589,008 45,000,000 1.309%

306,612 81,139 92,902 48,776 71,359 600,788 45,000,000 1.335%

312,744 82,762 94,760 49,752 72,786 612,804 45,000,000 1.362%

318,999 84,417 96,655 50,747 74,242 625,060 45,000,000 1.389%

325,379 86,105 98,588 51,762 75,727 637,561 45,000,000 1.417%

182,538 46,845 95,532 8,976 36,304 370,194 45,000,000 0.823%

186,188 47,782 97,442 9,155 37,030 377,598 45,000,000 0.839%

189,912 48,738 99,391 9,338 37,770 385,150 45,000,000 0.856%

193,710 49,713 101,379 9,525 38,526 392,853 45,000,000 0.873%

197,585 50,707 103,407 9,715 39,296 400,710 45,000,000 0.890%

Ratio of H Co Costs to Programme Contributions Programme Contributions Bank ERDF Legacies introduced Arrangement fees Monitoring fees Total Programme Contributions Holding company costs Holding company set up costs

CEO FD Middle mgr Middle mgr Admin Admin Total

Base £ 85,000 60,000 32,000 0 15,000 8,000 200,000

1.00 1

9,000,000 36,000,000 4,217,000 49,217,000 4,991,725 500,000 5,491,725 £ 3,445,190 (2,046,535)

Check Maximum permitted Margin available

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Title

Years

11.16% % 7.00%

Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

Appendices

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

Appendix A Blue Sky Study Key Findings The survey was completed by a sample of professional advisors, accountants, lawyers, experts and intermediaries located in the C&IOS LEP region. The survey posed a series of questions.

Question 1 - Are public-sector interventions required? Most intervention types scored highly with the highest priority given to sub ÂŁ100k SME loans and SME loan guarantees; closely followed by SME equity and mezzanine finance.

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Question 2 - What type of regional/SME finance is most important? The highest priority was given to finance for expansion closely followed by finance for research/innovation. Finance for business recovery ranked last but one.

Question 3 - Where is the gap? Perhaps unsurprisingly early stage and start-up equity came out as the highest priority, closely followed by development capital.

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

Question 4 - Specialism priority? In many cases, the existing network of professional intermediaries are not always the people best qualified to judge this question. Impressively in the case of the C&IOS LEP, the survey responses closely corresponded to the LEPs own priorities. This is commendable and speaks well of the LEPâ&#x20AC;&#x2122;s communication with the regionâ&#x20AC;&#x2122;s network of intermediaries/advisors.

Question 5 - Map of financial instrument by growth sector

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

The map overlaying the type of finance required by Future Economy Stream sectors is broadly consistent with that established from the one-to-one telephone interviews:

SME Debt

Seed Equity

Dev Cap Equity

≤£25k

≤£150k

≤£500k

E-Health



Digital Economy



Sector

Micro Debt

Space/Aerospace

Asset Debt Finance ≤£2m

G'tee finance ≤£500m



 

Marine Technology



Agri-Tech



Offshore Renewables



Smart Energy Technology



Geothermal



Question 6 - Importance of national interventions Tax incentives designed to encourage early stage investment (EIS/SEIS) scored highest, followed by R&D tax credits and sector specific funds.

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Intermediary survey - summary findings The survey feedback from intermediaries confirmed that the C&IOS LEP’s Future Economy Streams will require the support of a wide variety of financial instruments. Many of these smart specialisms are nascent market sectors; these and the more established specialisms will thrive upon the creation, attraction or spin-out of micro and early stage businesses. Most of the types of business that will be generated under the Future Economy stream ambitions will fit very clearly into the recognised market ‘gap’ for private sector finance. Without the support of public sector backed financial instruments, they will struggle to raise the capital they will need to start or grow. The research supports the case for a variety of new and innovative finance products to support the LEPs growth plans. It also supports the case for a sizeable fund to support the LEP’s ambitions for a range of vibrant growth sectors in their area.

Outputs Required The CIoS LEP has set some ambitious targets for its ERDF programme outputs. These include:  

700 New Enterprises 4,500 Jobs to be created 4,000 Businesses to be supported

Whilst not all of these targets will be fulfilled by the FI component of the programme, it will be expected to support/facilitate their achievement. 

Offshore renewables is expected to create 100 new businesses and 700+ new high value jobs.

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments         

Agri-tech already employs 25% of the LEP workforce and, according to respondents, this sector has the potential to ‘double’ in size. The majority of businesses in the region are micro-enterprises and this sector notoriously finds it difficult to secure finance. The PWC report noted that between 200 and 600 growth businesses in the region have been unable to obtain finance from traditional sources. Digital Economy already supports 1000 businesses in the region and ‘substantial’ growth is anticipated. The Smart Energy Integration study has already identified 130 businesses in the region that have ambitions to enter the market. Marine Technology is reportedly capable of supporting ‘substantial’ growth. E-Health is anticipating 15 to 20 medium sized enterprises and ‘many more’ startups/SMEs. Allowing for follow-on investment a start-up/early stage equity fund of £10m will support between 40 and 60 businesses (only 8 to 12 per annum). Growth/Development capital equity funds are (allowing for follow-on investment) unlikely to make more than 6 to 10 investments per annum.

For the CIoS LEP to achieve its Future Economy Stream ambitions, a substantial and flexible financial instrument will be needed to underpin its growth plans. The financial instrument will need to cover a wide spectrum of financial products from micro and business loans to development capital, mezzanine and early stage venture capital – all borne out by the surveys outlined in this investment strategy. If the CIoS LEP is to deliver the economic outputs set out in its Growth Plan the likely market demand for FIs will be high.

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

Appendix B Fund Story Boards

Cornwall and Isles of Scilly LEP Financial instrument planning story board V5 – 8th March 2016

Growth Capital Fund £17.5m

The Growth Capital Fund will support the ambitions of the region’s high growth firms and superstars. This fund will invest between £100k and £1m with an average investment of around £750k.

The fund will have a total value of £17.5m comprising £10m of ESIF funding matched against £7.5m of deal-level co-investment. The Growth Capital Fund will focus upon later stage postrevenue and most likely post-profit growth capital requirements and it is anticipated that a material (50%) proportion of the fund will be invested in debt/mezzanine instruments. No sector specific targets have been set, but within the confines of EU/State-Aid regulations, the fund will be encouraged to support investments in capital equipment, new processes, new product lines, innovation, advanced manufacturing, tooling and inward investment. During the sub-fund manager procurement phase, the option of (and conditions relating to) securing private sector co-investment at the sub-fund level will be explored. If co-investment proves to be impossible/impractical, then the sub-fund manager will be contractually targeted (but not mandated) to secure leveraged co-investment on a deal-by-deal basis.

Within the confines of State-Aid regulations and within the framework of “off the shelf” investments (Article 38), this fund will also be encouraged to support buy-outs/buy-ins and spinouts.

Total value

£17.5m

Investment phase end

Month 84

From commencement to placement of final 45

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments follow-on tranche. Realisation phase end

Target month 120

Range

£100k - £1m

Average deal size in 3 tranches

£750k

Tranche 1 average

£500k

Tranche 2

£350k to 40% tranche 1 portfolio

Tranche 3

£350k to 15% tranche 2 portfolio

Months between tranches

12 months

Share equity

50%

Share debt

50%

Share convertible mezzanine

Non performing portfolio

30% at month 24

% of non-performing portfolio recovered

20% after 9 months

Loan term (where applicable)

48 mths

Interest rate

8% over libor

Annual dividend

3% of investment value

First dividend payable

Month 24

Capital Gain A

2x money on 20% portfolio

Capital Gain B

1.5x money on 25% portfolio

Capital, dividend and capital gain received.

Month 60

Economic outputs Businesses assisted

Leverage

57% - £10m

New business starts

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Likely that realisation period may extend beyond year 10.

Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments New jobs created

TBC

Management costs Management fee – investment phase

4% pa

Management fee - realisation

2% pa

Arrangement fee -

1.5% advance

Monitoring fee

1% of advance

Interim bonus

£500k payable month 60

Final bonus

£1m

Seedcorn Early-Stage Co-Investment Fund £15m

The Seedcorn Early Stage Co-Investment Fund will support early stage, equity-based, tranched investment in innovative technology or knowledge-based businesses. Recipients are likely to be pre or early revenue stage and high-risk but have potential for very high growth and for good return realisation on exit. This fund will be instrumental in supporting new and fledgling ventures formed in the Future Economy sectors and expected to work closely with other support initiatives sponsored by the CIoS ESIF programme. The Fund is proposed to be of a total value of £15m comprised of £10m of ESIF matched to £5m of deal-level co-investment. The fund is expected to invest between £25k and up to £1m with a cap of £250k on the initial investment and average total investment expected to be around £500k. The fund will have no sector constraints but will actively seek to support regional University, HEI and private sector technology spin-outs. The EIB Ex-Ante Assessment established that SW Region businesses are relatively more innovate than the UK average and that the region’s Universities are good at commercialising technology. The extent to which either of these factors hold true in CIoS is unknown. However, it is well understood that early stage technology businesses are highly mobile and can be attracted to locations that can both offer useful and creative support networks and sources of flexible finance that are able to keep pace with growth and development. The sub-fund managers will be free to make the investment in any combination of equity, debt or mezzanine and encouraged to make the initial investment in some form of a convertible loan (mezzanine) or redeemable shares. This debt type instrument will attract interest priced to reflect risk and will be repayable when the spin-out technology supported begins to generate sales revenues. The sub-fund manager will also have a ‘put option’ which will entitle them to convert 47

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments the loan to equity at the same value used for any future equity fund-raising rounds. The more successful spin-outs are expected to need further finance (most likely equity) and it is anticipated that around 60% of investments will convert to equity. This structure will provide a level of protection against unfair/undue dilution at a future equity rounds and provide an exit route for ventures that make it through to commercialisation but no further. The portfolio will be actively and closely managed and follow-on investments will only be made against the achievement of pre-agreed milestones with few investees securing the upper end of the investment range (and some never progressing beyond the initial minimum). This fund is unlikely to deliver stellar financial returns within the timescale of this fund but is expected to create a long-term, strategic investment pipeline of viable businesses that may benefit from later stage investment from other sub-funds or in the commercial mainstream market. Importantly, the sub-fund manager will have contractual obligations to nurture, stimulate and develop the business angel investment community based in the region. For this reason, it is vital that the fund is able to co-invest alongside SEIS/EIS backed angel investment. During the sub-fund manager procurement phase, all options for the most efficient/effective deployment of this fund, including the potential use of one or more of the emerging crowd funding platforms. The range of acceptable co-investment must/will be clarified at an early stage.

Total value

£15m

Investment phase end

Month 72

From commencement to placement of final follow-on tranche.

Realisation phase end

Month 132

Probable that realisation period may extend beyond year 10.

Range

£25k - £1m

Average deal size in 3 tranches

£500k

Tranche 1 average

£100k

Tranche 2

£400k to 50% tranche 1 portfolio

Tranche 3

£500k to 20% tranche 2 portfolio

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments Months between tranches

6 months

Share equity

Share debt

20%

Share convertible mezzanine

80%

Share of mezz converted

66% at month 6

Non performing portfolio

50% at month 12

% of non-performing recovered

Interest rate applied to debt

10% over libor

Debt term

48 months (12 mths CRH)

Annual dividend

Capital Gain A

2x money on 10% portfolio

Capital Gain B

1.5x money on 20% portfolio

Economic outputs Businesses assisted

Leverage

50% - £7.5m

New business starts

100%

New jobs created

TBC

Management costs Interim bonus

£250k payable at month 60

Final bonus

£250k

Management fee – investment phase

4% pa

Management fee - realisation

2% pa

Arrangement fee -

1.5% advance

Monitoring fee

1% of advance

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

Business Loans Fund £14.5m

A Business Loan Fund is proposed, offering loans of £25k to £350k with the average deal assumed to be in the region of £90k. It is proposed to be of a total value of £14.5m comprised of £7m of ESIF, matched to £2.5m of private co-finance and £5m of co-investment.

The EIB Ex-Ante Assessment and Blue Sky study have both confirmed the need for debt finance at the level offered by this fund. This need is compounded by the present uncertainty relating to future funding for Community Development Finance Institutions (CDFI’s) in CIoS and elsewhere in England.

During the fund manager procurement stage, all options for the most efficient/effective deployment of this fund, including the potential use of one or more peer-to-peer lending platforms will be fully explored.

This type of debt fund is unlikely to offer a good financial return for the programme but they do expect this fund to yield important and helpful economic benefits and output metrics.

Loans will be offered at/or above the commercial interest rates (determined by the European Commission as reference rates over LIBOR) or through De Minimis, so that there is deemed to be no state-aid. The Business Loans Fund will be able to invest in early stage and more established, profitable businesses that need additional debt support for limited growth/development or working capital. Pricing sensitivity will be tested at modelling stage.

Total value

£14.5m

Investment phase end

Month 60

Realisation phase end

Month 120

Range

£25k - £350k

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From commencement to placement of final follow-on tranche.

Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments Average deal size in 3 tranches

£90k

Tranche 1 average

£40k

Tranche 2

£35k to 10% tranche 1 portfolio

Months between tranches

12 months

Share equity

Share debt

100%

Share convertible mezzanine

Non performing portfolio

15% at month 18

% of non-performing recovered

20% after 9 months

Interest rate applied to debt

8% over libor

First loan repayment month

Month 1

Final repayment

Month 60

Economic outputs Businesses assisted

161

Leverage

50% - £7.5m

New business starts

15%

New jobs created

TBC

Management costs Interim bonus

£500k payable at month 60

Final bonus

£500k

Management fee – investment phase

3% pa

Management fee - realisation

1.5% pa

Arrangement fee -

1.5% advance

Monitoring fee

0% of advance

Growth Mezzanine Fund £14.5m

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

The Growth Mezzanine Fund will be a total value of £14.5m comprising £7m of ESIF matched to £2.5m of private sector co-finance and a further £5m of deal-level co-investment. The relatively high proportion of smaller businesses in the region, many of who are family concerns for which equity finance may neither be desirable nor viable, dictates that debt finance of this type is needed; and early demand for RGF-backed regional mezzanine funding in comparable areas has been very high. The Growth Mezzanine Fund will provide finance of between £100k and £500k with an average deal size of £350k across 3 tranches. Interest rates charged will be in the region of 9% plus upside (see below) and will offer a capital repayment holiday as standard of 12 months on an average 4 year term. All of the finance provided will take the form of debt and the mezzanine upside aspect of the fund will take 2 forms: Redemption premium The debt finance will attract a commercial interest rate coupon during the life of the loan with a redemption premium payable at the term of the loan to reflect any equity risk taken.  Equity kicker The debt finance will attract a commercial rate coupon during term and the sub-fund manager will take an option to acquire a small equity stake (or profit share) to reflect the equity risk.

The Growth Mezzanine Fund will primarily support post-revenue and post-profit viable companies with a compelling case to support the assertion that they are capable of servicing debt only.

Within the confines of State-Aid regulations and the framework of ‘off-the-shelf’ instruments, the Growth Mezzanine Fund will be encouraged to support investments into recovery and transitional situations , expansion opportunities, and inward investments and to work with other private sector investors at the margin of their appetite for risk (there is evidence that many investment opportunities are stalled because the banks have a low appetite for risk - this prudence most often manifests itself in the form of a modest loan-to-asset ratio – to unlock the potential of these projects, the fund will lend alongside and at the margin of the private sector lenders). The Growth Mezzanine Fund is expected to be subordinate to private sector co-investment. Where personal guarantees are taken from owner/managers, they are expected to cover less than the full value of the loan.

During the sub-fund manager procurement phase, the option of (and conditions relating to) securing private sector co-investment at the sub-fund level will be explored.

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments Total value

£14.5m

Investment phase end

Month 72

Realisation phase end

Month 120

Range

£100k - £500k

Average deal size in 3 tranches

£350k over 60 months

Tranche 1 average

£250k

Tranche 2

£150k to 40% tranche 1 portfolio

Months between tranches

12 months

Share equity

Share debt

80%

Share convertible mezzanine

20%

% of portfolio converted

5% at month 9

Non performing portfolio

15% at month 36

% of non-performing recovered

10% after 9 months

Interest rate applied to debt

10% over libor

Term

48-60 months, 12 months CRH

7 years

Economic outputs Businesses assisted

41 (too high – test increase in average value or absolute value of funds available).

New business starts

New jobs created

TBC

Leverage

52% - £7.5m

Management costs Management fee – investment phase

3% pa

Management fee - realisation

1.5% pa 53

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments Arrangement fee -

1.5% advance

Monitoring fee

1% of advance

Interim bonus

ÂŁ250k payable at month 60

Final bonus

ÂŁ250k

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments

Appendix C Glossary (in order of appearance) i

SME: Small and medium sized enterprises defined as those employing less than 250 FTEs (full time equivalents) and turnover less than â&#x201A;Ź50m or balance sheet value less than â&#x201A;Ź43m. ii

Ex-Ante Assessment: The objective of the Ex-Ante Assessment is to assess the rationale for a Financial Instrument (FI) against prevalent market failure or suboptimal investment and to ensure that the FI will contribute to the achievement of the Programme and ESIF objectives. It will also help to avoid overlaps and inconsistencies between instruments implemented at different levels. The exante assessment shall be completed before the Managing Authority (DCLG) decides to make programme contributions to a FI and shall be submitted to the monitoring committee for information purposes in accordance with Fund specific rules. The Ex-Ante Assessment was undertaken in two Blocks. The first was a comprehensive regional market demand assessment. The second was an evaluation of investment strategies developed by LEPs in response to Block 1. iii

The Business Finance Partnership ran until April 2013 and the Investment Programme has superseded it. The Investment Programme makes some money available to equity investors as well as lenders. iv

Community Development Finance Institutions (CDFIs) lend money to businesses, social enterprises and individuals who struggle to get finance through high street banks and loan companies. CDFIs help deprived communities by offering loans and support at an affordable rate to those who cannot access credit elsewhere. v

Peer to peer lending is a method of debt financing that enables individuals to borrow and lend money - without the use of an official financial institution as an intermediary. vi

London Interbank Offered Rate or LIBOR is a benchmark rate that some of the world's leading banks charge each other for short-term loans and serves as the first step to calculating interest rates on various loans throughout the world. vii

Regional Growth Fund or RGF is a competitive Government fund operating across England to provide grants to private sector projects and programmes with significant potential for economic growth, leveraging in private sector investment and creating or protecting jobs and support particular areas and communities that are currently dependent on the public sector for employment to transition to private sector-led growth and prosperity. viii A Limited Partner is a partner in a partnership whose liability is limited to the extent of the partner's share of ownership. Limited partners generally do not have any kind of management responsibility in the partnership in which they invest and are not responsible for its debt obligations. Limited partnership structures are frequently used for commercial investment platforms with partners agreeing to appoint one partner as a General Partner that assumes all management responsibility.

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Cornwall and Isles of Scilly LEP Investment Strategy for Financial Instruments ix

The Financial Conduct Authority (FCA) regulates the financial services industry in the UK. Its role includes protecting consumers, keeping the industry stable, and promoting healthy competition between financial service providers.

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