Q&A: What sparks the interest of venture capitalists?

What sparks the interest of venture capitalists and what are their main pet hates?

Growing firms in many science and technology sectors can find it tough to get funding in the current climate. So what sparks the interest of venture capitalists and attracts them to invest in innovative tech companies?

The UK’s private equity community is currently focusing much of its investment firepower on supporting management buyouts of established businesses, so early-stage technology firms are facing a struggle to find funding.

Fortunately, all is not lost, as tech companies can attract a plethora of venture capitalists that specialise in providing development capital to hi-tech hopefuls. Of course, hundreds of companies apply for this type of funding and only a lucky few are chosen. Venture capitalists must, therefore, carefully sort the wheat from the chaff and decide which firms are the ones to back. So, what key attributes do they look for in potential investment opportunities, and how can you encourage them to part with their cash?

Name: David Mott
Oxford Capital Partners
Typical initial investment: £0.5m-£1m
Hot sectors: Mobile/wireless communication & environmental technology

Headed by father-and-son team Ted and David Mott, Oxford Capital Partners (OCP) bills itself as an investor in science and technology. The group’s strategy is to invest in funding rounds of up to £3 million, with OCP itself typically providing between £500,000 and £1 million of this, though it will go as low as £250,000 for businesses matching its investment criteria.

‘We will back a range of enterprises, from seed opportunities through to companies looking to float,’ says David Mott, ‘though most of the businesses we back are at the development stage.’ Having said that, he adds, ‘We look to support businesses at a point of inflexion and try to avoid those with long-term development work still ahead of them.’ The company’s goal is therefore to become a minority investor in businesses at the appropriate point of development, where management are left free to drive strategy itself.

OCP looks to divide its portfolio equally between three broad areas. These are IT (including software, hardware and communications), healthcare and medical, and security and environmental technologies. Advances in mobile/reless devices, as well as networks and environmental technologies, are, Mott says, ‘particularly high-profile at present’.

In fundraising terms, however, he believes times are now far tougher for those engaged in drug discovery. ‘It’s a sector the really deep-pocketed investors have moved away from and the smaller investors simply can’t fill that gap.’

In terms of what attracts OCP to a deal, he explains, ‘We always look at management because bad managers can make good technology fail. That said, we don’t have a policy of not investing in first-time management.’

One thing to bear in mind is that to secure investment from the likes of Oxford Capital Partners it is important to think long-term. ‘One of the biggest turn-offs is a team that hasn’t thought about its eventual exits,’ argues Mott, ‘as that raises all sorts of questions about management. And when a team is overpaying itself, that’s another worry. Just keep things in perspective.’

Name: Ernie Richardson
MTI Partners
Typical initial investment: £1m-£5m
Hot sectors: Materials science & medical technology

To Ernie Richardson, chief executive of MTI Partners, the venture capital market has evolved considerably in recent times. ‘I think what’s interesting is that technology venture capital has a much broader emphasis today. Five years ago when people spoke about it they were only referring to software and communications. Now material science and medical technology (med-tech) are just as important.

‘We like material science in particular,’ he elaborates, a comment reflected by recent investments like antenna-maker Sarantel and Screen Technology, the producer of large-scale video displays. ‘Med-tech is also appealing. For us the emphasis is not on drug discovery, but rather the use of IT and innovative materials in monitoring systems, patient care programmes and the like.’

At the other end of the spectrum, Richardson believes that, ‘Enterprise software is one area in which it is difficult to do much at present. There are lots of companies developing systems and that makes it hard to get the deal structures right. It’s the “vanilla” customer relationship management and enterprise software systems that are particularly tough to back, and there are exits issues too.

‘The thing we emphasise is “market, market, market”. You can never find out too much about the market you are trying to address in advance [of meeting a potential investor] because you need to know who your customers will be. The most common weaknesses in business plans relate to this point.’

Like Oxford Capital Partners, MTI also tends to invest at the first round of institutional investment, although it looks to take larger stakes of between £1 and £3 million initially. This figure will often double over the course of an investment’s life.

‘We see several hundred possible deals each year, of which we might do eight,’ says Richardson. ‘But the great thing at the moment is that there are so many opportunities to choose from.’

Name: Richard Anton
Amadeus Capital Partners
Typical initial investment: £1m-£5m
Hot sectors: Wireless technology, semiconductors, security & clean energy

Pan-European technology company backer Amadeus has established a strong reputation in recent years. Director Richard Anton attributes this to his firm’s empathy for what is a very different investment discipline.

‘The businesses we back are at an earlier stage [than those targeted by most private equity firms], so it’s a very different process and risk profile we have to come to terms with,’ he remarks. ‘We have to look for businesses that are very, very ambitious. It’s about firms with the desire to be real global players.

‘Cambridge Silicon Radio is a classic example,’ he continues. Amadeus first backed the Bluetooth solutions provider as an early-stage technology spin-out in 1998 and has supported it all the way through to its £240 million London flotation and beyond.

‘We look for under-served customer need and some sort of latent demand; something there’s a real need for, but which can’t be done today. We also like a star individual to build the business around. Often, this will be the chief technology officer, and we have to be realistic as these individuals tend not to have much experience in business.’

Anton says that Amadeus continues to have a broad focus and assesses opportunities on their merits, though he notes that, ‘wireless technology, semiconductors, security and, in particular, clean energy development,’ deserve attention at present.

‘We invest in companies either at the pre-revenue stage or through to around £5 million in revenue. We look to make a typical investment of between £1 and £5 million – though we don’t think about it that way,’ he adds. ‘We think about the size of the business we can build.’

Name: Bernard Fairman
Foresight Venture Partners
Typical initial investment: £2.5m
Hot sectors: Clean energy, nanotechnology & homeland security

Bernard Fairman, managing partner of technology venture capital trust (VCT) operator Foresight, believes there have been considerable changes to the technology markets in recent years.

‘One new and very exciting area that has emerged of late is clean energy,’ he propounds. ‘For a long time there’s been demand but the technology hasn’t been there. Now, the number of opportunities has increased and we’re witnessing one of those rare instances in which Government action is leading to a commercial response. My guess is that we’re now about two years away from some major breakthroughs in the likes of wave technology and biodiesel, and the economics are starting to come right, too.’

Other areas of current interest for Foresight include nanotechnology and homeland security. ‘There’s been a broad technology upswing recently,’ Fairman explains, ‘and while a few years ago communications and semiconductors were the major focus, interests are now more diverse.’

That said, Fairman is quick to point out that even companies in these burgeoning sectors face stiff competition to find funding, and must be prepared to face a thorough grilling from potential backers.

‘We’ll see 500-600 opportunities a year and invest in around ten. We back people not technologies, and one of the biggest turn-offs for us is uncertainty. If you don’t know whether you’ll be generating revenues two or five years away, it becomes difficult for us to invest. There is no visibility and that was the major reason why so many businesses went bust in 2001.’

Foresight normally acts as a second-round investor, following business angels, challenge funds and the like, and it looks to invest around £2.5 million across its four funds. ‘This year we’re on course to invest about £26 million,’ says Fairman, ‘and we’re looking to raise £50 million of new VCT money for Foresight 3 and 4.’

Q: What are the main pet hates I should know about when approaching venture capitalists for funding?

Answered by Phil Verity, Mazars

Persuading investors to part with their cash requires guts, gall and a bit of good luck, but it’s all too easy to misjudge your audience and fall flat. The top five pet hates venture capitalists experience include;

  • Bluff and pretence – venture capitalists hate it when you start to use technical language, but it’s clear that you don’t understand what you are talking about.
  • Crazy claims – when someone comes into a meeting and insists their business can cure cancer or AIDS, they immediately think you are a crackpot.
  • Poor presentation – don’t try and put too much information on each slide of your presentation and don’t have too many slides. Investors won’t concentrate if the presentation is too long – around 20 to 30 minutes is more than enough to explain most businesses. Make sure the font is clear and legible.
  • Ridiculous valuations – be realistic about the value of your business. It’s common for business owners to believe their company is worth more than investors think it is. The danger is that if you have an inflated view of your company’s value, it could deter potential investors before they have even looked at the business properly. Make sure you justify your valuation to the investors and show good financial information in your presentation.
  • Unworkable ideas – when approaching venture capitalists make sure your idea is realistic and you are approaching the right backer. Many venture capitalists are sector specialists, so don’t try to raise money from a technology fund when you run a food business. Also it’s no good approaching a venture capitalist for £10 million investment when they never invest more than £2 million.

Phil Verity is a partner at Mazars, the international accounting and business advisory firm, and head of the mid corporate market business line. Phil works with a wide variety of entrepreneurial and owner-managed businesses, helping them tackle the challenges of growth and development. He frequently advises companies on issues such as business strategy, financial management and control, mergers and acquisitions, succession and overseas expansion.

Leslie Copeland

Leslie Copeland

Leslie was made Editor for Growth Company Investor magazine in 2000, then headed up the launch of Business XL magazine, and then became Editorial Director in 2007 for the online and print publication portfolio...

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