If statistics from the private equity industry are anything to go by, then the outlook is now brighter for companies seeking small amounts of growth funding and early-stage finance.
A May 2004 report from the British Venture Capital Association (BVCA) showed that UK private equity firms continued to increase investment activity throughout 2003, with an increase of seven per cent in the number of companies financed at the early and start-up stages.
Meanwhile, whilst all of this has been going on, the Blair Government has been doing its bit by throwing its weight behind measures designed to assist young enterprises. At the centre of its strategy is the “Bridging the finance gap” initiative, a programme designed to improve access to growth capital for small businesses.
Other initiatives, such as Regional Venture Capital Funds (RVCF) and Community Development Venture Funds (CDVF) have enabled a number of growing businesses to tap into private equity, while the Enterprise Capital Funds are also in the pipeline.
Overcoming economies of scale
Historically, it’s been prohibitive (from a cost point of view) for growing businesses to raise smaller sums. It has also made more sense (for the same reasons) for venture capitalists to complete fewer, high-value deals. But things are changing.
London Fund Managers, which runs The Capital Fund (the Greater London RVCF programme), has made 15 investments in the two years since it launched, and is looking to complete up to 80 over the next four years. As Geoff Sankey, managing director at London Fund Managers acknowledges, ‘there still aren’t enough players at the lower end of the market because of the economies of scale. But the RVCF programme has been successful so far and it could help to blaze a trail.
‘The maximum we can invest is £250,000, a sensible sum for both us and the investee company. The arrangement fee for such an amount would be about three per cent. Therefore, to make money, we have to strip out as much cost as we can,’ he explains.
Tim Levett, of Northern Venture Managers, which specialises in making equity investments of between £500,000 and £5 million, is another who believes the tide is turning.
‘Ten years ago, there was a smaller population of advisers – nowadays, the market is more sophisticated, with a good number of advisers who, for smaller deals, can keep the fees to between five to seven per cent of the money raised. For example, if the total deal size was £5 million, I’d be disappointed if the fees were more than £300,000,’ he comments.
Seize the moment
For David Williams, director at Sand Aire Private Equity (whose average deal size is £5 million), there is a rapidly improving number of options available.
‘The business angel market has matured rapidly and there is the option of venture capital trusts and the soon-to-launch enterprise capital funds,’ he acknowledges.
This is a view shared by Nigel Guy, deputy managing director at private equity player Granville Baird, who believes that ‘those looking to raise between £2 million to £10 million are able to access funds from a reasonable group of people.
‘There is lots of money out there and it’s a competitive market. With the creation of venture capital trusts and enterprise investment schemes, there are more and more incentives for individuals to invest in companies and benefit from tax breaks,’ he believes.
VCs with deep pockets
Raising sums of money at different stages from the same investor and/or completing a two-track approach (where companies raise money from, for example, a business angel first and a venture capitalist after) are two methods proving popular.
Granville Baird, for example, last year backed a company, Public Recruitment Group, with £5.5 million and then invested a subsequent £700,000. The company floated on AIM earlier this year.
The Capital Fund followed its original investment in two companies – Avanti Screenmedia Group and Touch Clarity – by joining a syndicate of institutional players in subsequent investment rounds. In total, these two ventures ended up attracting no less than £6.6 million. Avanti floated on AIM in July.
Northern Venture Managers’ Levett expects to complete seven deals in the £2 million to £5 million space this year (three have already been completed) and has also backed several companies more than once.
Private investors are back
In amongst all of this, a number of regional investor networks have been flourishing. Typical examples are the Oxfordshire Investment Opportunity Network (OION) and the Great Eastern Investment Forum (GEIF). OION, which claims to be Europe’s most successful technology business angel network, links investors with entrepreneurs seeking business development funds of between £50,000 and £2 million. In the last four years it has raised £14.8 million for 61 companies. Alongside GEIF is GEIF Ventures, a £5 million co-investment fund which exists to match investments made by GEIF business angels.
Manish Madhvani, director at GP Capital, which specialises in matching private companies seeking to raise between £1 million and £20 million with sources of capital tailored to their individual characteristics, believes that there is now a healthy outlook for companies seeking to raise up to £10 million.
‘The tail end of 1999 and the year 2000 were crazy days, where companies had very high valuations. Then the pendulum swung too far the other way, resulting in harsh valuations, and terms that weren’t conducive to growing companies. There is now more capital available on better terms because of the number of exits venture capitalists are achieving,’ comments Madhvani.
Over 75 per cent of GP Capital’s clients raised money in the last year and Madhvani is confident that this trend will continue.
‘As well as private equity investments picking up, we are also seeing private investor networks completing pretty large rounds, some up to £2 million. Bonuses are being driven back to the city and more entrepreneurs who have sold their businesses are investing some of their worth into other companies,’ he says .
10 funding options
1. Venture capital
Several VC firms will invest sums of £10 million and under. Check out the BVCA directory at www.bvca.co.uk and the European Venture Capital Association (www.evca.com) for a list of VCs who operate in this area. It’s worth noting though that VCs will only invest in a solid business that is expanding, or a fast-growth company that has the ability to deliver profits quickly and you must be prepared to give up some equity. And remember, most VCs will be looking for an exit within three to five years.
2. Regional Venture Capital Funds (RVCFs)
RVCFs are an England-wide programme supported by the Department of Trade and Industry. RVCFs can invest up to £250,000 in equity or debt into any qualifying business. RVCFs are also allowed to make ‘follow-on’ investments of up to a further £250,000, and in exceptional circumstances, more than that. For your business to qualify, it must have less than 250 employees and a turnover of less than £24 million or balance sheet assets of less than £16 million. To find out more, go to www.sbs.gov.uk.
3. University Challenge Funds
University Challenge Funds were created in 1998. The aim was to allow universities access to seed fund capital to turn the results of cutting edge research into businesses and products, and to encourage entrepreneurial activities in the university sector generally. To find out more, visit the Office of Science and Technology at www.ost.gov.uk.
4. Enterprise capital funds (ECFs)
These soon-to-be-launched vehicles are privately managed commercial funds investing a combination of private and public money in small, growth-oriented businesses seeking up to £2 million of equity finance. They are based on a scheme that has been running in the US for the past 45 years. At present, the detailed proposals are still under discussion, although everything should progress within the next six months. For more information go to www.sbs.gov.uk/financegap.
5. Venture capital trusts (VCTs)
Set up in 1995, VCTs invest in unquoted or AIM companies with gross assets of less than £15 million, and can invest up to £1 million in any one company. There is a substantial amount of cash available for businesses with growth ambitions, and many VCT managers are sitting on money waiting for decent investments to back. There are generous tax breaks attached to VCTs, as long as certain rules are met. Principal amongst these is that 70 per cent of subscribed money must be invested in qualifying companies within three years.
6. Private investors
These individuals are often referred to as business angels. They are basically high net worth individuals who either invest on their own or through a network. Most do so to benefit from tax breaks under the Enterprise Investment Scheme (EIS). According to the National Business Angels Network (NBAN), business angels invest between £10,000 and £250,000 in any one investment. Where larger amounts are invested in a business, this may be as part of a syndicate organised through personal contacts or a business angel network. To find out more, go to the NBAN Gateway at www.bestmatch.co.uk. There are several regional business angel networks, such as London Business Angels (www.lbangels.co.uk), Beer and Partners (www.beerandpartners.com), OION (www.oion.co.uk) and GEIF (www.geif.co.uk).
7. Community development venture funds (CDVFs)
CDVFs were launched on the back of findings from a report by the Department of Trade and Industry’s (DTI) Social Investment Task Force. They are funded by the DTI and the private sector with the aim of increasing investment in deprived areas. Bridges Community Ventures (www.bridgesventures.com) was the first CDVF to launch in May 2002, with a fund of £40 million. Funds are provided to a maximum of £2 million in exchange for a stake in the business. Thus far, Bridges has invested in ten companies.
8. Matched funding
This programme was launched as part of the Government’s Early Growth Funding initiative, and is designed to encourage risk funding for start-ups and growth firms. The funds will be able to make maximum initial investments of up to £100,000. Most funds will require matched private sector investment to at least the same amount as Early Growth Fund investment. The funds are a mixture of regional and national funds. Further information can be found at www.sbs.gov.uk/finance/earlygrowth.php.
9. Investment syndicates
Private investors tend to invest small sums of money – but there are those involved in investment syndicates, where a number of private investors will look at larger deals. According to the BVCA, there are many advantages a business can gain from choosing such an investment route. It avoids any one investor having a major equity share, the combined business experience of all the private equity partners can benefit the company, there is a relatively greater amount of financing than with a single investor and a syndicate can offer more sources of additional future financing.
10. Seed funding
Most seed funds are focused on areas like technology innovation, and many are linked to R&D at universities. The National Endowment for Science Technology and the Arts (NESTA) fills a funding gap by investing in ideas at a much earlier stage than other funders would. It can provide up to £250,000. www.nesta.org.uk.
