INTRODUCTION

The Royal Society of Edinburgh is pleased to respond to HM Treasury and the DTI in connection with their consultation document "Innovating for the Future". Although Scotland is a world leader in academic scientific research it has a poor record for exploiting these advances in Scotland. As a result, the Royal Society of Edinburgh has been actively engaged in the national Technology Ventures initiative to promote the commercialisation of the Scottish science base. In partnership with Scottish Enterprise and the Scottish Higher Education Funding Council, the RSE has been delivering a programme of activities over the past two years to promote a better understanding of the issues involved in innovation and commercialisation.

Most of the questions on which this consultation paper seeks views, at least as far as Scotland is concerned, are to be found in our joint publication with Scottish Enterprise entitled Technology Ventures – Commercialising Scotland’s Science and Technology, copies of which are enclosed with this response. This document contains many of the answers to the questions posed in Chapters 2, 6 and 7 of the consultation document. Copies of the Final Research Report and video can be provided on request.

As this study shows, there are no political "quick-fixes" for the improvement of our record in R&D innovation. We still face the ingrained, but improving, cultural issue that somehow commercialisation of academic research is "not quite the done thing". Innovation requires a long-term stable and simple fiscal environment. Recent press reports of speeches by the Chancellor of the Exchequer suggest that he could be thinking of tax breaks to encourage investment in commercially significant R&D. Scottish Office Minister Brian Wilson has also recently been talking about the importance of encouraging an R&D function in companies who are locating to Scotland. The arrival of Cadence in Scotland is a good example.

This response has been compiled with the assistance of a number of Fellows, many of whom have been involved with the RSE’s work on Technology Ventures and Foresight and who come from a range of backgrounds including universities, SMEs and multi-national companies.

(i) Sources of finance for innovation and R&D (Chapter 2)

UK financial institutions (with a few exceptions) have viewed start-up companies in science or R&D as high risk ventures compared with conventional investments. Venture capitalists will invest if they think the benefit/risk ratio is advantageous but each side needs to understand the requirements of the other. Clear statements in annual reports of the level of, and benefits deriving from, R&D investment, plus communication via site visits of financial analysts to R&D facilities for presentations by the scientists/marketing staff involved, would help to improve knowledge and understanding of R&D related investments among finance providers, pension fund trustees and institutional fund managers. Networking for SMEs and financiers via seminars and other events organised by such bodies as CONNECT and the RSE as part of the Technology Ventures programme should be encouraged. Similarly, networking via TECs and LECs and private companies such as Seraphim will help to bring together business angels and SMEs.

The Government could help in the following ways:

• allow SMEs to sell tax losses related to R&D. This would encourage venture capitalists to invest and would level the playing field vis a vis large profitable companies which can write off investment against tax in the year the R&D (and other capital expenditure) is incurred. Loss making SMEs cannot take advantage of this.
• give a tax break to venture capital investments held for more than 3 years in loss making companies
• rationalise, simplify and improve information about the plethora of investment grants available for R&D
• provide SMEs with support to reduce the cost of due diligence (presently the costs involved in providing small sums of money will defeat many projects)
• give US-style personal tax-breaks for investment
• relax the 5% ownership rule to benefit from reduced capital gains tax if shares are held for longer periods. This rule adds to the reluctance of SME founders (owners) to raise further capital if that would dilute ownership below 5%.

(ii) Accounting treatment of R&D expenditure (Chapter 3):

The SME sector is where the growth must come from, but small firms have fewer resources to deal with such externalities. Providing clear fiscal advantage to encourage involvement in such procedures will send the proper signals to both management and shareholders. Long-term stability of the fiscal system is a key. The current accounting methods for R&D are counter productive. FRS 10’s suggestion for treatment of intangible assets does provide advantages for incentivisation to a degree but it all depends on promises that might not be fulfilled. Research is always uncertain. The ICAS proposals would improve matters and should be adopted as an initial attempt to deal with the underlying problem.

(iii) Tax treatment of R&D expenditure and intellectual property (IP) (Chapter 4):

Although the tax treatment of IP-related transactions is currently adequate, there is a role for further tax incentives to R&D at a personal "business angel" level for high technology, speculative ventures. Tax credits of any form do not help loss making, early stage, high technology companies and this is the group that needs most help.

(iv) Management issues (Chapter 5):

Until quite recently, Government funded scientific research placed too little emphasis upon technology transfer or application in business. This has improved somewhat since the publication of "Realising our Potential" and the setting up of OST. However, the preferred mode of business expansion in the UK has been acquisitions/rationalisation rather than organic development of major industrial companies. This, together with the emphasis on financial services, is a characteristic of the UK whereas Germany, Japan and SE Asia countries have continued to emphasise industrial as opposed to commercial activity. The business culture in the UK has emphasised financial skills at the expense of operational, engineering or scientific competency.

The following steps might help to change this culture:

• Government could play its part in promoting the benefits of R&D and innovation by increasing the its profile, highlighting success and by updating the Queen’s Awards system
• Government could encourage businesses to identify and exploit future technological and marketing opportunities by publishing success stories and by providing wider publicity for Foresight (particularly among SMEs)
• businesses could anticipate customer needs better by improved marketing (i.e. identifying what the customer really wants rather than what is available) and by participating in customer focus groups and Foresight exercises
• schools, universities and colleges could contribute to a generation change by including relevant modules in courses on economics, accountancy, science and engineering courses
• we could learn from other countries such as the US - where the tax system for personal investment in speculative R&D-based businesses has been accepted as a major driver of success - or Japan which takes a 20-year view on key sectors for R&D investment. Spreading the lower tax on longer held investments more widely, including institutional shareholders, might encourage the longer-term view.

(v) Access to technology (Chapter 6):

Government could improve access to technology in the following ways:

• consider improvements to the research grant system and research assessment exercises which do not always adequately reward university researchers who want to set up businesses to exploit their ideas. It should be recognised that future revenues from exploiting the science would flow back to the HEIs, thus ultimately reducing the amount of government funding required (or alternatively achieving a greater volume of research for the same government contribution)
• encourage the recruitment of graduates into SMEs with the co-operation of University Careers Services and possible funding from government agencies
• actively promote the take up of Teaching Company Schemes, CASE awards, LINK projects, and SMART awards between universities and SMEs
• encourage SMEs to promote staff development by allowing staff, who have proved their ability by taking HNC/HNDs by day release, to undertake full time study for a degree with the guarantee that their job would be held open for their return as a graduate. Some support funding would be required
• encourage inward investment agencies to use as a favourable indicator the willingness of the company to include an R&D function in their UK operation, when considering a grant for an incoming multi-national
• encourage contact between leading researchers and senior R&D directors of multi-national companies by seminars, appropriate publications or by personal contact either in the UK or overseas. In Scotland the RSE are organising a series of seminars for this purpose
• promote the extension of industry sector fora (such as Oil & Gas and Electronics) to other industry sectors and encourage academics to join in. Networking is one of the keys and is strongly recommended in Technology Ventures. (The CONNECT programme - which started in Edinburgh and is now being expanded to the Glasgow area and in the North East - is a good example of how this type of networking can succeed.)
• provide courses in entrepreneurship for graduates in science and engineering. (The Scottish Enterprise/RSE Enterprise Fellowships are a good example of innovative schemes to encourage graduates to explore the commercial potential of their research.)
• encourage larger firms and supply chains to make wider use of formal quality systems such as ISO 9000 and thereby lead by example by being more demanding customers
• provide universities with objective advice on whether commercialisation should be via the spin-out route or by licensing
• provide funding for the "Development Gap" either by grant to the university from a government agency (where the licensee has not yet been identified) or by tax break to the industrial partner (where he has been identified)

(vi) Intellectual property (IP) (Chapter 7):

SMEs have a serious problem with intellectual property rights and competitive advantage, when such funding is designated pre-competitive and has to be carried out jointly with potential competitors. This fear of loss of competitive advantage inhibits SMEs from seeking support for R&D in situations where they have good ideas but cannot afford to risk all of the cost. A sound IP position is a fundamental requirement for high technology early stage companies obtaining venture capital investment. The current balance between protection and diffusion of IP seems about right and more IP options would add complexity.

User-friendly guidance to science and engineering academic staff on the protection of IPR is needed to encourage universities to share best practice in the management of intellectual property rights, so that university research can be better exploited. Teaching the basic principles of patent protection in all science courses and at all business schools is recommended. The issue of compatibility of patenting with publication of research in learned journals must also be addressed.

The major cost in protecting IP relates to protection outside the UK, over which the UK government has limited influence. The UK should work through the diplomatic route for a single world wide patent. It would help if patent applications were granted (or finally rejected) faster. The 5-10 year current time scales should be nearer 2-3 years. The long period of uncertainty is especially damaging to SMEs.
June 1998

Further information is available from the Research Officer, Dr Marc Rands