3i Group PLC - Filling the Capital Gap in the 1940s

Filling the Capital Gap in the 1940s

Prior to the 1940s, there existed no true venture capital market. As early as the 1930s, in Britain, this situation led to the recognition of a gap in corporate financing among British businesses struggling to cope with the effects of the global depression. While larger companies were able to turn to the country's banks or to the public market for investment capital, the country's smaller and midsized companies faced the banks' reluctance, or even unwillingness, to provide capital. At the same time, these businesses, especially the many small family-owned companies, were too small and unprepared to turn to the public market for funding.

The British government launched a commission, known as the Macmillan committee after its chairman, to investigate the situation. The lack in access to capital funding became known as the Macmillan gap. In the 1940s, the government began working on a proposal to fill the gap, with the Board of Trade and the Treasury coordinating the effort with the Bank of England and the country's clearing banks. If the Board of Trade favored a government-sponsored institution, the Treasury, in conjunction with the Bank of England, insisted on the formation of a body that raised its capital in the private sector. The Bank of England went further, suggesting the new institution be created by the country's five clearing banks, and thus entirely removed from the government. As for the clearing banks, they remained hostile to the idea altogether.

Nonetheless, the discussion led to the creation of two new corporate financing companies in 1945. The first was the Finance Corporation for Industry (FCI), which was set up to provide long-term financing for large-scale businesses. The second, called the Industrial and Commercial Finance Corporation (ICFC), was more directly aimed at filling the MacMillan gap. The ICFC in particular was marked by the disagreements among the various founding members, resulting in the new corporation's independence from the government as well as from the Bank of England and the clearing banks.

The ICFC's mission was to provide funding to small and midsized businesses on a national scale. Despite the corporation's independence, it was nonetheless subjected to funding limits, set at a range between £5,000 and £200,000. The ICFC's independence, however, placed it in a competing situation with the clearing banks, which, with the Bank of England, were also the company's shareholders. Although the clearing banks were expected to support the ICFC's development by providing operational support and by passing on investment opportunities that fell outside of their own sphere of operations, in practice the banks did little to help the ICFC. Indeed, the banks attempted to hamper the company's growth, sending it only hopeless investment cases, and even wooing potential ICFC clients with their own funding offers. The clearing banks also attempted to restrict the ICFC's access to capital and, when loaning to the ICFC, attempted to do so at high interest rates.

The result of the hostility of its own shareholders was that the ICFC gained a strong sense of self-reliance. The need to maintain its own commercial viability obliged the company to build its own risk assessment and evaluation methods, with expertise in evaluating all levels of a potential investment. The ICFC was also adept at attracting business. Two important factors played a role in many customers' decisions. The first was that the ICFC, unlike the banks, did not usually take an active role in its investee companies, including not placing its staff on their boards of directors. The second factor was ICFC's ability to play off small firms' reluctance to turn over an equity stake in their business in exchange for capital funding from a bank. Instead, these firms preferred to turn over equity to the ICFC. In this way, as well, the ICFC was able to share in the successful growth of the companies it supported, which helped to minimize the losses from less successful investments.

Through the 1950s and into the 1960s, the ICFC expanded on a national scale, launching a network of branch offices that eventually reached 14 in number. This network gave the group greater access to local and regional markets. The company's expansion became especially strong after 1959, when it received permission from its bank shareholders to begin raising capital externally. At the same time, the company began adding subsidiary operations, such as the Estate Duties Investment Trust (EDITH), which placed institutional investors in companies faced with the loss of major shareholders.

In 1962, the company, acting on government fears of a growing "technology gap," joined in the creation of Technical Develop Capital (TDC), which targeted technology-based investments. In this way, the ICFC took on the characteristics more commonly associated with the American version of venture capital (which coupled technology investments with handson investment management) then providing financial foundation for the first boom in the U.S. technology market.