Why we should revive this illustrious City institution

Private equity firm 3i, once one of the most illustrious names in Britain’s venture capital industry, could soon disappear. But the role it plays is as crucial as ever, says Matthew Lynn.

It has hardly been the best few months for the private equity firm 3i. After months of pressure from shareholders over its lacklustre performance, last week saw the resignation of its chief executive, Michael Queen. Yet that has done little to placate its shareholders. Some are now reportedly calling for the company to be wound up, its investments liquidated, and the cash returned to its owners. It is now possible that 3i, once one of the most illustrious names in Britain's venture capital industry, could disappear over the next few months.

But if so, that would be the perfect trigger for the Bank of England and the major British banks to launch a new version. 3i was originally set up after World War II to channel money into small companies and the City remains just as bad at doing that as it was more than half a century ago. There was a time when the potential disappearance of 3i would have kicked off a political storm. It was a key bridge between the City and the rest of the economy. It was founded in 1945 as the Industrial and Commercial Finance Corporation by the Bank of England and the main high-street banks, following a series of reports that concluded the financial sector was useless at providing the kind of seed capital and helpful support that small companies need.

It was a great success. Through the 1950s and 1960s it became the largest supplier of venture capital to the unquoted sector, and through its network of offices developed the knack of nurturing young firms that often went on to be very successful. It backed Oxford Instruments, for example, which developed some of the first MRI scanners, and is still a world leader in medical technology. Not everything it invested in was as smart as that, and it had its share of duds. But it managed to channel a fair amount of cash into industry during what was a difficult time for the British economy.

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And now? The sad truth is that if 3i disappears no one will really notice. The firm has long since turned itself into another fairly boring private-equity house and in the last few years not even a very successful one. It makes the same sort of investments that most private-equity firms make, targeting well-established companies and infrastructure projects. There are lots of firms that do that and on the available evidence, do it rather better than 3i seems to have done.

Yet the role that 3i was originally set up to fill is as crucial as it ever was. The City has never been very good at channelling money to small companies it wasn't in 1945 and it isn't in 2012.

True, it is hard work. You have to talk to a lot of entrepreneurs to find a few good ideas, and then put together the teams that will turn those ideas into flourishing businesses. You need to know what sort of industries they should be in, be aware of the potential obstacles they might face, and often you have to get directly involved in managing the company. The failure rate will be high, and you have to devote a lot of manpower to each firm.

There is easier money to be made by chipping in a few hundred million to build a new power station with fairly certain future revenues, and then finding a clever way of securitising the debt.

That said, if it is done right, venture capital in the old-fashioned sense can also be hugely profitable. There is far more money to made in finding growing young firms than in endlessly re-financing old ones, even if it is harder work. They have far more growth potential than established firms, and there is less competition for deals, so the rates that can be charged on loans are usually a lot higher too. There isn't likely to be a shortage of opportunities. Britain remains, despite its over-paid public sector and high level of taxes, an entrepreneurial country. The number of new company start-ups is rising strongly they are now at a record level. According to government figures, 435,856 new companies were registered in 2011, compared to 384,981 in 2010. In January, the number of start-ups grew by 12% on the same period last year.

Despite the image of a country that relies on the City of London, Britain actually has a fairly broadly-based economy. Just take a look at where people are making money. According to a survey last month by the wealth manager Skandia, 21% of British millionaires made their cash in manufacturing and IT, compared to only 17% in finance. That means that in Britain, a higher proportion of wealthy people are making their fortunes from real engineering, as opposed to the financial sort, than in France or Hong Kong or Singapore, for that matter. With the sharp devaluation of the pound, Britain should be developing a lot more technology and manufacturing-based businesses over the next decade.

The trouble is, the banks are not about to start doing the hard graft of lending to those businesses. They don't have the experience or expertise any more. But the Bank of England could step in, and persuade', with a little arm-twisting if necessary, the main high-street banks to chip in a few hundred million to a new fund that would bring together industrial and technical expertise to help new small businesses raise capital. The Bank could put some of the money it is printing into it it would be more useful than just giving it to the government. They could even call it the Industrial and Commercial Finance Corporation and then change the name to 3i when it became available.