New research published by the Association of Investment Companies (AIC) has highlighted the role played by venture capital investment in the development of many of the UK's small businesses, and has called on the government to maintain its support for the sector.

The AIC represents a broad range of closed ended investment companies, incorporating investment trusts and other closed ended investment companies and Venture Capital Trusts (VCT).

Venture Capital Trusts (which first became available in 1995) are similar in nature to investment trusts, and permit investment (with a degree of income tax and capital gains tax relief) via a listed entity in a range of smaller and potentially riskier unlisted companies

The key findings of the survey conducted by the Association (which polled 15 fund managers employed by 61 VCTs, worth GBP1.4bn of assets) were that:

• Companies post-VCT investment experienced a 47% employment increase;
• The average amount invested by VCTs in any single company was GBP2.5m; and
• 87% of VCT investee companies had a VCT representative on the board.

The AIC research also revealed that the amounts invested by VCTs in small companies fall within the 'equity gap' (defined as the difference between the amount likely to be invested by an individual 'business angel', and the investment level traditionally considered by a venture capital firm) of GBP2m to GBP10m. The average amount invested by VCTs in any single company was GBP2.5million.

The Association went on to suggest that:

"Recent market developments are expected to increase the VCT sector’s focus on stand-alone investment and acting as a substitute for lending where banks have withdrawn from the small business sector."

The findings also suggested, as previously stated, that VCT investment supports job creation.

The AIC explained that:

"The survey received employment data from 303 investee companies which experienced a 47% increase in employment. Their total workforce at the time an investment was made was 17,219 and their total workforce at the time of the survey/divestment date was 25,402."

However, it went on to add that:

"The increase in employment was not evenly distributed, with 46 of the investee companies seeing a decline in numbers employed (from 4,636 at time of investment to 3,076 at the time of the survey/divestment date)."

In terms of the support provided by VCTs for innovation amongst small businesses in the UK, the survey found that many VCT-backed firms undertake R&D and are successfully developing export markets despite their firms’ small size.

"In this research 88 investee companies disclosed dedicated R&D spending totalling GBP55.4m, a significant level of activity in comparison to other smaller companies. 102 investee companies provided data on the level of their turnover derived from exports. The total exports were GBP303m (from a total of turnover of GBP920.7m), averaging nearly GBP3m per company."

Ian Sayers, Director General of the Association of Investment Companies commented, with regard to the survey results, that:

“This research demonstrates that VCT investment provides substantial benefits for UK small businesses and the economy. We urge policymakers to reaffirm their commitment to VCTs which are the best way to support enterprise and future economic growth."

“Companies across the country with the potential for growth have received capital and management input from VCTs which has boosted their performance and increased employment. They operate in a way which, in the short to medium term, pays for itself and over a longer period creates capacity for higher tax revenues."

Urging the government to continue supporting the existing VCT framework, he concluded:

“New initiatives are unlikely to have the substance or staying power of the well established VCT network. All too often new proposals to support small businesses have surface attractions but fail to answer satisfactorily key questions such as “where will the money come from?”, “how long will it take to put a new mechanism in place?”, “will Europe delay the scheme’s introduction?”, and “will it really work better than what we already have?”

Research conducted by the AIC earlier in the month also painted a more optimistic picture for the sector (and by extension, the small businesses that benefit from such involvement), with VCT managers questioned by the Association predicting that the 2010 fundraising season will see a "marked improvement" on last year.

In addition to involvement via a Venture Capital Trust (likely to be most suitable for enterprises requiring backing which falls into the aforementioned 'equity gap'), larger-scale venture capital involvement in a small business can be undertaken in a number of ways:

• Seed financing, which is made available prior to of the launch of the business, and provides backing for the development of the business concept, the creation of a business plan, market research, and finally, bringing the product in question to the market. This type of investment usually requires a fair amount of involvement and support on the part of the venture capital firm, and is therefore generally a less popular option, except for specialist firms.
• Start-up financing is designed to provide support for small businesses through the product development and initial marketing periods. Smaller start-ups are less likely to be of interest to VC investors, but as with seed financing, there are some specialist firms that may be willing to invest.
• Early stage financing: Designed to provide support during the manufacturing and sales process to businesses that have developed their product, but are not yet profitable.
• Development/Growth financing: Designed to assist in the expansion of an existing company.

The way in which the financing reaches the business will vary according to the arrangement that is reached with the venture capital firm or investors in question.