Mind the gap

Mind the gap

How can more venture capital funds be attracted to Scotland? Peter Ranscombe meets up with Sinclair Dunlop, managing partner at Epidarex Capital, one of the country’s first funds, to find out his views.

Scotland has an enviable reputation when it comes to supporting start-up and spin-out businesses. With a flourishing business angel community and an ecosystem full of incubators, accelerators and advice, there is no shortage of routes for entrepreneurs. The life sciences sector is slightly different though. If you want to develop a drug to treat a disease or come up with a technique for any other type of therapy then chances are you’re going to be measuring the investment you need in millions or tens of millions of pounds.

Step forward Sinclair Dunlop. In 2014, he raised £48m to launch a venture capital fund that is providing start-up funding for early-stage, high-growth companies that target areas with an unmet medical need. Originally badged as Rock Spring Ventures, his company is now known as Epidarex Capital. When plans for the fund were unveiled in January 2013, initial investors included Aberdeen, Edinburgh and Glasgow universities, along with the European Investment Fund, Scottish Enterprise through the Scottish Investment Bank, and Strathclyde Pension Fund.

At the time, Dunlop and his team were praised for mobilising investment from one of the UK’s biggest local authority pension schemes. When the fund closed in May 2014, the initial investors had been joined by King’s College London and Eli Lilly, one of the world’s largest pharmaceutical companies.

So far, the European arm of Epidarex – which also runs a similar fund in the United States – has invested in six companies. Four are traditional spin-outs from universities: Edinburgh Molecular Imaging; Glasgow-based diabetes specialist Caldan Therapeutics; Clyde Biosciences of Glasgow, which is testing how drugs affect the heart; and Sirakoss, a synthetic bone graft developer from Aberdeen.

Sinclair 02The other two portfolio companies have an interesting difference – they both emerged from industry rather than academia: Brighton-based drug developer Enterprise Therapeutics was founded in February 2015, while Topas Therapeutics of Hamburg was spun-out from Frankfurt-listed drug developer Evotec.

Venture capital funding is essential for early-stage drug developers and therapeutics companies because of the large sums of money involved in creating treatments – but it’s also important in many other parts of Scotland’s entrepreneurial ecosystem. Once a technology company raises seed funding from business angels, it may well need private equity or venture capital to scale-up, providing the link in the chain before considering an initial public offering (IPO) to join the stock market or a trade sale.

Indeed, the so-called ‘venture capital gap’ has become an almost mystical feature in Scotland’s innovation landscape, a gaping chasm talked about in hushed-tones, into which businesses disappear if they can’t raise enough funding. Over time, the gap has shifted, with business angel syndicates joining forces to fund bigger deals and lasso finance from first Scottish Enterprise’s and later the Scottish Investment Bank’s co-investment and venture funds.

Yet that venture capital gap has persisted. So how can Scotland attract more venture capital funds to help life science companies, technology businesses and other innovators?

“There are some cultural pieces to that answer and some economic pieces to that answer,” explains Dunlop, who left Scotland in 1994 to study in the US, before returning to launch Epidarex in 2013. “Culturally we need to continue to work harder to embrace risk and get comfortable with a more Americanised version of what risk is.

“Failure is not inherently a negative scenario. Failure can be in many cases an extremely useful learning process. On many occasions, I would rather back a life sciences start-up chief executive when he or she had failed, in some cases for reasons beyond his or her control. Someone who has gone through that process is often a more back-able proposition than a first-time entrepreneur.

“Both the public and private sectors need to understand that if we’re going to build the ‘great Scottish biotech’, if we’re really going to have a US$1bn biotech company in Scotland one day, then we’re going to have to take a lot more risk – scalable risk – on the way between here and there.”

Dunlop points to the initial success of online fantasy gaming firm FanDuel and flight comparison website Skyscanner, the two Edinburgh-based technology ‘unicorns’, each with a valuation of US$1bn. He thinks the life science industry could learn some lessons from them by studying their ‘tipping points’, the moments at which they were able to attract international and not just local investment.

“Economically, Scotland has to be very careful that it continues to send a message to the outside world that it’s open for business and that it is particularly open to entrepreneurs and those investors that wish to embrace risk and back entrepreneurs,” adds Dunlop. “That obviously touches on tax, it touches on research funding. It’s important Scotland keeps that at the foremost of its mind as it begins to gain control of more of its fiscal tax levers.”

Holyrood has had the ability to vary income tax ever since it was created in 1999. Since April 2016, the Scottish Government has been required to set a Scottish rate of income tax, with the ability to vary the final 10 percentage points of the UK rate across the basic, higher and additional bands, building on existing powers with the land and buildings transaction tax, which replaced stamp duty and MSPs will soon gain additional tax powers.

It’s not just the level of tax about which Dunlop is concerned. He chose to base Epidarex in Scotland – and he’s adamant that was a business decision and nothing to do with an emotional attachment to home – because of its world-class universities.

“Scotland needs to look very closely at how we sustain the global competitiveness of our universities because unless we allow our universities to resource themselves competitively then over time there’s a possibility that the quality of the research and the amount of fundable, commercialise-able research coming out of our universities could be at risk,” he warns. “The funding of post-doctoral posts is as much an issue as anything. Scotland needs to recognise that the top talent, particularly in the life sciences, is extremely mobile – so we’re trying to attract the very best researchers from any country. We have to acknowledge that our universities are competing with, frankly, much better-funded institutions, not just in North America but in some cases south of the Border.

“Our top universities have people based overseas whose job it is to recruit top talent, and I’m not talking about undergraduates here – I’m talking about the next generation of potential Noble prize winners. Are we asking our universities to fight to attract that talent with one arm tied behind their backs?”

When it comes to attracting venture capital to Scotland, Dunlop thinks further reforms are needed to the enterprise investment scheme (EIS) and the seed enterprise investment scheme (SEIS). At the moment, he recognises that it’s hard for venture capital funds to invest alongside business angels in the same funding round due to the some of the “structural complexities” surrounding SEIS and EIS.

Accessing scalable funding in Scotland may be tricky, but it’s not a unique problem. “It remains a Europe-wide challenge,” admits Dunlop. “If you’re raising anything north of €10m in the life sciences for an early-stage company for example in the therapeutics area then other, than in the UK – or one or two sources in France and Germany and a few pockets in Scandinavia – then it’s going to be a much bigger challenge than in Massachusetts or California.

“The other big challenge is sector-specific experienced entrepreneurs. In many parts of Europe, including Scotland, we don’t have in the life sciences an abundance of experienced entrepreneurs who have built life science companies, exited life science companies and are then in the business of recycling their knowledge and indeed their capital in some cases back into the next wave.”

Sinclair 03While Dunlop is “absolutely” convinced Scotland can create a bio-tech ‘unicorn’, he warns: “The creation of that $1bn market cap Scottish biotech should not be our number one measure of success. Too often we fall into the trap of thinking we need to have really big companies employing a lot of people on the ground in Scotland. While that is a very attractive and a very desirable goal, it shouldn’t be the only measure of success.

“On occasions in the past when we’ve seen an acquisition of a Scottish company, we are sometimes too quick to see that as a ‘glass half-empty’ result, when actually it could be a ‘glass half-full’ result. If we were in California or Massachusetts then there would be much less angst around those types of transactions. In fact, what we could do is see that as a ‘half-full’ outcome because it is in fact a validation of the quality of the fundamental, underlying research from which we’re building these companies and it’s a validation of our ability to build those companies to a point at which you can generate a positive return – in every sense – for all concerned. If you can’t demonstrate to the outside world – and in particular to those very same big institutional investors whose capital we need in Scotland – that you can make a profit by investing in Scottish companies then we’re not going to break out of this cycle of under-realising our immense potential.

“In the most-active hubs of technology and innovation, companies are changing hands and there’s merger and acquisition (M&A) activity every day of the week. That’s seen as a sign of success. The two aren’t mutually exclusive. The key is to get more private sector activity and specifically more venture-backed, technology-driven small and medium-sized enterprise (SME) private sector activity. That’s the key. From that, the broader economic benefits will flow.”

Dunlop points to the success of ProStrakan, the Galashiels-based and London-listed drug company that was bought by Japanese giant Kyowa Hakko Kirin in 2011, which has since grown its headcount by 55 staff to 516 workers. “Now everyone in the life science sector in Japan and many of their shareholders will know that Scotland is capable of building and growing very successful companies in their sector,” he says.

Since returning to Scotland, Dunlop has become involved with Inspiring Scotland – an organisation that helps charities and other third-sector outfits to become more professional in the way they measure their impact in order to help them raise funding – and with Reform Scotland, an Edinburgh-based public policy think tank that sits independent from any political party. His work with Reform builds on his previous experience in public policy in the US before he became an investment manager.

Although he’s clearly passionate about his day job, Dunlop has been making the most of another perk of being back in Scotland. “I’ve really enjoyed hosting friends and visitors from around the world,” he says. “My partner and I have had lots of visitors from the States since moving here and the best time is in August. To be able to invite friends from around the world to come to Edinburgh in August is such a treat.

“I don’t think there’s anywhere in the world I’d rather be than Edinburgh in August. The pleasure of the last three summers of introducing people to an amazing city that hosts a globally-significant cultural event – the Edinburgh festivals – is the best part of being here outside of work.”