Venture capitalists (VCs) have challenged the government to increase support for technology startups, if it is to succeed in its plan to create a knowledge-based economy.

The UK is falling behind on provision of public funding for new technology companies, said Dr Chas Sims, director at VC firm TTP Group. Regional development agencies (RDAs) are not developing software services at the prototype stage, instead choosing safer investment targets.

“If the government believes we are to become a knowledge-based economy, why is funding still targeted at widgets?” said Sims, speaking at last week’s Microsoft Innovation Day conference.

“The Innovation Nation white paper is aimed at improving consistency and working with RDAs to align their funds, but is this the right model? Can we really leave funding new technology businesses to people operating on a local level?”

Sims said the government should move away from localised funds and instead copy the US model of the Small Business Innovation Research (SBIR) scheme.

“In the US, under SBIR, you can get 100 per cent funding at several million dollars over a few years, keep the intellectual property and keep the government as a captive customer,” said Sims.

Stewart Davies, board member at private VC firm New Venture Partners, agreed that the government has the potential to transform new technology firms.

“Why can’t the government hold equity stakes in startups?” said Davies. “It already has a 100 per cent stake in Northern Rock, so why not other businesses?”

A barrier to such plans has been a reluctance to spend tax-payer’s money, said Davies. Yet correct use of this funding could prove extremely productive.

“If we had a government-backed venture pool, as projects became successful the funds would become evergreen,” he said. “The resulting money could go back into the cabinet or be re-invested in other projects.”

Aside from a lack of government support, Davies said that technology startups are being hampered further by the changing attitudes of public venture capital groups. He cited as an example 3i, a long-established firm that ceased dealing with startup IT companies last month.

“You cannot get through the door now unless you are talking about a £500m buyout,” said Davies.

Changing market conditions have discouraged VC groups from looking to new companies, said George O’Connor, technology investment analyst at stockbroker Panmure Gordon.

“Among the short-term issues is the fact that it is hard for investors to find an exit,” he said. “At least temporarily, the IPO market is closed. Not many stock market floats are planned.”

Investors have also been discouraged by changes to the capital gains tax system introduced by Chancellor Alistair Darling in this year’s Budget. The reforms effectively cut the amount of profit that entrepreneurs will make on their investments.

“In the public sector the question is all around capital gains tax, which has almost doubled from 10 per cent to 18 per cent if you want to sell the business,” said O’Connor.

“The government has promised to invest money but where is this money going? If anything the development agencies should be investing in low-cost startups in areas such as Web 2.0, but it does not appear to happen,” he said.

The Department for Business, Enterprise and Regulatory Reform said: “The recently-released enterprise strategy contains a range of measures to increase the number of new UK businesses. The government-funded Small Firms Loan Guarantee and Enterprise Capital Funds are available to businesses that would otherwise struggle to secure finance.