Technology is a sector well suited to venture capital investment, as it offers the potential for high growth and high returns, writes Albion Ventures partner Ed Lascelles.
Technology is a sector well suited to venture capital investment, as it offers the potential for high growth and high returns, writes Ed Lascelles, a partner at Albion Ventures.
However, the sector is not suited to the faint-hearted, the inexperienced or those with a short term view, as early-on tech companies are fragile and need considerable support, both financial and otherwise.
The financial returns, if you manage to back a successful enterprise, are further enhanced by the high valuation multiples that can be achieved upon an exit: unique intellectual property can protect a valuable competitive position, the business models are often underpinned by recurring revenues, with strong margins and predictable growth, and if a business positions itself well it can become a strategic, must-have asset.
Given the many dynamic sub-sectors, there is huge opportunity to unearth the next Autonomy or Net-a-Porter. It is possible for a new enterprise with no track record and inexperienced but talented management at the helm to establish itself and grow rapidly. There is often little in the way of regulation, and by avoiding a head-to-head confrontation with the obvious corporate gorillas new ideas can flourish rapidly.
Of course, this sector is not without risk. Many good ideas don’t succeed – often for reasons that can’t be predicted – but fail only after significant time, effort and resource have been spent. Even the successful companies will have to navigate between Scylla and Charybdis.
At Albion we attempt to reduce the inherent risks by focusing on particular sub-sectors (and avoiding others) and by choosing investments that are at the right stage in their evolution for our risk appetite. While we will look at every opportunity, to date our preference has been to focus on vertical sectors that we like and understand, rather than horizontal technology platforms.
‘There are sectors that suffer excessive hype’
So for example we can see that the transport and logistics sector will benefit from mobile technologies that can help an enterprise utilise its remote assets more efficiently. A topical example would be software than can improve safety within the oil and gas industry – a theme which will clearly drive senior decision-making for many years to come. There are so many attractive themes within the technology sector, but to give a few highlights, I would point to security (especially online security), compliance, payments and data management. However, of greatest interest will be the continuing impact of smartphones; the numbers around the iPhone are truly staggering – there were one billion downloads from the iPhone app store within nine months of launch. This is just the start as we finally see mobile telephony and broadband internet combine – two technologies that have independently made a huge impact on consumer behaviour over the past decade.
On the other hand there are sectors that suffer excessive hype and so valuations escalate. In these circumstances there is still money to be made, but the odds are stacked against you and related less to business fundamentals, although companies and investors have learnt from the mistakes of focusing solely on unique visitors or number of downloads. Online retail and social networking are two areas that command high premiums, as does the broader cleantech sector. To invest in these companies you really have to focus on a niche or have a particular expertise.
As for the company itself, it’s essential to understand the business profile. How far has the business evolved and how much further does it need to go? Is this a fuel-cell technology that will require another ten years of research and development before it makes its first commercial sale, or is it an enterprise software business that is still loss-making but has a proven product, referenceable paying customers and a clear pipeline underpinning its growth? And what is the cash requirement to get the company to profitability and cash-generation? Is this a semiconductor business that will need over £20 million before it generates its first revenues, or is this a software business that can cover its overheads with its first blue-chip licence sale?
As ever there is a trade-off between the company’s stage of development and its valuation, but there is also a link to the level of expertise required. In the early days a technology may need heavy technical input at a senior level, but as the business matures the company will transition to a standard commercial infrastructure. This is easier said than done, but it’s important that as investors we know what it is that we can add to a business.
Having found your great business in a sector you like, at the right stage of development, as an investor you inevitably get drawn into a difficult valuation discussion. At Albion Ventures we would concur with Warren Buffett, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price’.