It is a truly exciting time for Britain’s aspiring businesses. The appetite for backing entrepreneurs and their fresh and innovative ideas has never been greater, with alternative finance now a £3.2 billion UK industry and London currently ranked 7th globally for venture capital investment per capita.
Supporting this, the Government has taken some steps to make investing in both listed and non-listed young firms more simple, including abolishing stamp duty on shares invested in AIM companies and introducing EIS and SEIS schemes offering investors tax incentives.
In another recent wave of legislation, the 2015 Finance Bill introduced changes to the rules governing VCT investments, including the requirement that investee companies are no more than seven years old. As a result, VCTs have had a marked change of focus during 2016, away from later-stage and acquisition-type transactions that have been a staple for VCT private equity (PE) investment for the past 20 years.
Many growth businesses are still unaware of the changes and they do not fully appreciate the opportunity they now have to tap into the expertise and financial resources of VCT managers with huge experience of backing SMEs who can help take them to their next stage of development. Equally, it is an exciting prospect for firms such as Maven to support Britain’s brightest entrepreneurial companies.
But how can early-stage businesses make the most of this opportunity and secure the funding they need to evolve and grow? Below I outline the new rules on VCT funding and what PE houses such as Maven look for from companies and management teams seeking investment.
New seven-year rule but there are exceptions
While the changes to the VCT investment rules require investee companies to have been trading for no more than seven years at the point at which the investment is made, there are certain exceptions. VCTs are still able to invest in a business which has traded for up to ten years if that business is deemed to be a ‘knowledge-intensive’ company and where that funding is being raised to take the business into new product areas or geographical markets.
In order for an investment in a company, which has been trading for over seven years, to qualify for VCT support on the basis of launching a new product and/or entering a new geographic market, all of the money raised must be spent on those activities. The level of investment must also equate to at least 50 per cent of the company’s average annual turnover over the previous five years.
Investment must be used for a company’s organic growth
Any money raised from investments must fund a company’s organic growth and development, and cannot be used for acquiring all or part of an existing business or replacing an existing loan.
Given the increased risks associated with investing in earlier stage businesses and the restrictions on how new funds can be spent, it has never been more important for VCTs to scrutinise the entire investment landscape of companies that qualify for VCT support and select the best on behalf of shareholders.
An entrepreneurial, balanced and dedicated management team
VCT fund managers need to have confidence in a business model and trust the management team of a business they back. As VCTs will now focus on earlier-stage investments, the quality of the management team is an increasingly important requirement. Each team raising money for their business will have to demonstrate that they have the relevant combined skills and experience to make the venture a success, as well as the vision and passion to drive the business forward.
A credible plan to achieve growth
For early-stage companies it is critical that they can convey to investors a credible business plan capable of delivering strong growth and additional shareholder value. Any potential investee must demonstrate their investment case which includes realistic, objective projections of future revenues and overheads, knowledge of their sector and a strategy to exploit a defined market opportunity.
An understanding of the competitive positioning
An immediate priority for investors when assessing any business is to understand its USP, i.e. what sets a company apart in its target market. This means the management team being able to articulate the market dynamics and the opportunity to investors, as well as how its business can prosper in its niche sector.
A strong defensible IP
As well as understanding the competition, any business seeking funding will need to demonstrate to investors that it has strong defensive characteristics and is capable of protecting its market position. Early stage or technology businesses can be at risk from disruptive or new market entrants. Without strong defensible IP, ideas and strategies can be replicated or even surpassed by newer, more innovative products and services.
Clear exit potential
Fundamental to any investor, is the potential to see a positive return through a future value event. This means having a clear strategy for delivering strong, sustainable sales and earnings growth, and being able to present a credible assessment of where the company will be in three to five years’ time, alongside an analysis of who might acquire the business at that time.
The new changes to the VCT rules present an exceptional opportunity for entrepreneurial businesses to secure investment and drive growth. To capitalise fully on these changes, it is vital that potential investee businesses not only demonstrate their ability to grow, but also have a healthy capital base to help achieve that plan. VCT firms with well-resourced investment teams across the country, sector expertise and a proven track record in supporting growth business, such as Maven, offer the stars of tomorrow the greatest chance to seize this new opportunity and achieve their full potential.
Bill Nixon is the managing partner of Maven Capital Partners.