A report by the Northern Ireland Audit Office (NIAO) into an Invest NI scheme set up to help emerging SMEs access finance has estimated that the scheme could return losses of £28 million in public money.
The report outlines that, while there is a high level of uncertainty over how investments will perform up to their operational date until 2024, current information suggests that Invest NI could recoup just £73 million of its £101 million investment, while private investors who put in £77 million could return a profit of £44 million.
The Access to Finance Scheme, which was established in 2009 as a response to considerable contraction of commercial lending to SMEs, was aimed at providing a range of funding to seed and early stage SMEs.
Rationale for the scheme lay in the Invest NI assumption that the significant lag in venture capital and equality between Northern Ireland and the UK was due to significant market failure, contradicting to two reports in 2008 (Varney Review on the Competitiveness of Northern Ireland) and 2009 (Independent Review of Economic Policy) which pointed to low levels of venture capital activity being due to a lack of demand rather than lack of supply.
Between 2009 and 2024, the strategy is providing £181 million to SMEs, of which Invest NI is contributing £104 million, while £77 million of private funds has been levered through seven different funds, each managed by appointed fund managers. The NIAO report points out that Invest NI will pay an additional £24.8 million of the £33.9 million fees to fund managers.
Although these fees are largely similar to those being paid in the UK, the report does suggest that Invest NI’s decision to centrally manage its funds through an in-house approach could work out being more costly than had it adopted the European model, as it may have enabled the securing of EIB investment funding at lower interest rates that it is currently paying its private investors.
The report is critical of the strategy’s fee structures, suggesting that they focus heavily on the number and value of investments made rather than providing incentive “to deliver strong financial and economic outcomes”. It stipulates that bonuses for achieving financial return targets are relatively small and no sanctions for not meeting these targets exist. It also points out that because state aid requirements require the funds to be managed on a profit-driven basis, there is no incentive to achieve wider economic targets such as employment, GVA and productivity.
It states: “In overseeing the funds, it is therefore important that Invest NI strikes a balance between ensuring that investment targets are on schedule, whilst not pressurising fund managers to make poor investment decisions”.
Subsequent fund manager contracts included robust termination clauses and the ability to withhold fees after Invest NI’s attempts to have the contract of one of its earliest fund managers terminated in 2014, eventually resulted in a £0.45 million settlement fee to E-Synergy in 2017. Between 2009-2017 E-Synergy was paid management fees of £2.75 million.
The report does highlight that the strategy is still at an early stage, pointing out that investments in some funds will continue until 2019 while the loan repayments or exits from investments will continue until 2014. However, it adds that of the 68 per cent of funding that has been allocated “in several funds both the volume and the value of activity is behind schedule”.
Invest NI has stated that investment in the funds is not solely for narrow commercial return but was also done for wider policy reasons. Gauging the overall success will be made more difficult by the fact that no aggregated targets or key performance indicators have been established for the overall strategy, while targets and forecasts have only been set for four of the seven funds.
Interestingly, the report points out that the contrast between the potential public funding loss of £28 million and the potential private investment profit of £44 million reflects that “Invest NI has had to subordinate much of its funding to secure private investment”, meaning that private investors are fully repaid their investment and annual returns before Invest NI recoups anything.
The report concludes by highlighting the experience of a predecessor scheme prior to the strategy, illustrating the challenges facing Invest NI in obtaining a financial return on its investments. The Crescent Capital I Fund saw £7 million of Invest NI investment matched by £7 million of private investment. Subordination meant that the private investors received all £13 million of total returns. The report observes: “Some £55 million of Invest NI’s investment in current funds is subordinated and therefore at higher risk of not obtaining a return on investment.”