Robin Klein’s open letter to the UK government about how to stimulate startups got a lot of response from TechCrunch Europe readers. We’ve decided to run two responses to his letter, making their own case for how government intervention should take place. The below is by Jens Lapinski (@jenslapinski), the CEO and Co-Founder of aiHit, a London-based business information company with VC backing. He was previously VP Analysis & Consulting at Library House, where he advised organizations on innovation programs and investment policy. The other response is here.

What the UK needs is a large and sustainable investment ecosystem that covers seed, early, and expansion stage. For the last 50 years, various UK governments have experimented with a mixture of programs and initiatives. I suggest we build future initiatives based on the past’s success, not by repeating the many mistakes that have been made.

1) Seed Phase – Seed new companies by bringing back a modified SMART Award
By far the most successful program that the UK has ever run in terms of giving early stage money was the £45k SMART Award program. The program required founders to invest £15k in their company and, if qualifying conditions were met, they received a £45k grant. This program invested in both startups and product ideas of established companies. The former worked well, the latter not. Later on, the program’s responsibility was given over to the regions and the brand was abolished.

I would suggest revitalizing the SMART program with the following criteria: £15k own investment, £45 grant by government, provided following criteria are met:

- Company younger than 18 months
- Company less than five employees
- This is grant money, not equity investment, not a loan

The grant should be centrally administered. There should be no regional focus. All government loan or equity investment programs at this stage that I am aware of don’t work well. I would therefore make this a grant. This program’s aim is to help early stage companies get off the ground that then grow to employ many people. I would rate a success any company receiving money that lasts for longer than three years and that employs more than ten people at this stage.

2) Early Phase – Seed new VC Firms by creating seed funds in cooperation with established VC firms
The key problem in Europe’s investment ecosystem is the slow birth of new VC fund management companies. Looking around, I largely see fund managers that have been around since before 2000. These fund managers have progressively raised larger and larger funds, moving later and later stage. What any healthy investment ecosystem needs is a continuous supply of new VC companies ‘bubbling up’ from the bottom. These new VC fund managers naturally start out with smaller funds, investing smaller amounts of money per company. Eventually, they will mature, raise larger funds, and move later stage themselves. In order to get VCs to invest early stage, you need young VC firms. So I suggest we create a system that results in a continuous ‘supply’ of new, small VC firms, which invest early stage.

I would suggest expanding and making permanent a program to ’seed’ Seed VC Funds in cooperation with established VC management companies.

Specifically, I suggest doing the following:

- Offer a seed fund to all VC fund management companies that have closed a VC fund larger than £75 within the last year (maybe two years initially) and do this continually.
- The seed fund should have a size of £10-20m
- These funds should be equity investment vehicles, not loan or grants.
- They should have no co-investment limitations
- The funds should be fixed term funds of 12 years
- Ask the VC firm to invest half of the money (at least say £5m), the remainder should be from government
- Ask the VC firm to have the fund managed/run by somebody who is NOT a General Partners at the VC firm’s main fund. This should be somebody from the middle management of the VC firm.

The principle is to establish a program that enables the next generation of managers at VC firms to run ‘their’ own shop. Over time, I estimate that some 30%-50% of these emerging seed fund managers to be successful. This means they will start raising the next fund, eventually separating from the ‘mother ship’, setting up their own VC firm, and thus growing the ecosystem of VC fund managers. The reason why I would establish these funds in collaboration with established VC funds are manifold. In short they are: By sharing the cost of people, offices, etc, the seed fund can work with a smaller amount of money than would be necessary, if it operated on its own. The operations would share deal flow. The seed fund managers could ’soak up’ lessons learned from the more established fund. By aligning the vintage date of the main, larger funds, with the smaller seed fund, the seed fund can have the larger funds invest in follow-on rounds. This means that the seed fund invests in early companies, not so much in small companies. By only offering the seed funds to VC firms with recently closed funds, the government can choose fund managers easily, as closing a new fund means that the VC firm is good at what they do. I would rate as a success that the seed fund returns a positive return over the fund’s life time, and the spin-off the of the seed fund into a new VC firm.

3) Expansion Phase – Ensure that the government remains an active LP/ fund of funds investor
In a time when many LPs have problem honoring the capital calls of their GPs, I strongly suggest the government not waiver. In addition, I would suggest that the government aggressively support European institutions as an LP investor. All of this is already happening, don’t take the foot of the gas pedal!

Summary
Grants at Seed Phase. Collaborative equity investment at Early Phase. Cash as a fund of funds investor at Expansion Phase.

Investing £100,000 in 10,000 start-ups sounds good, but investing it via equity is hard. By making it a grant program, you remove many of the problems associated with the cost of making an investment work at this size. I further suggest investing larger sums of money intelligently in collaboration with existing VCs, and to continue investing even larger sums as an LP at expansion stage.

All of the above has been shown to work. There is real data and real evidence for this. SMART Awards worked in the UK. The support of new VC funds worked all over Europe and specifically in Israel. The European Investment Fund is a heavy LP investor in many VC funds, some of which have done extremely well.

I suggest we do what works first. We can improve from there.