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Articles on Venture Capital
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Private Equity Money Available
No one can doubt that we are now in recession and it’s fair to say that given the unprecedented worldwide financial turmoil - normal rules do not apply – according to Graham Mold, director of Catapult Venture Managers.
First the bad news. Yes, it’s going to be tough and, unlike the recession of the 1990s, we are not going to be led out of this downturn by consumer expenditure. A combination of worldwide turbulence on the stock market, credit card debt, falling house values, rising energy prices and general inflationary pressures are undermining confidence and, as the banks tighten credit lines, even those wanting to continue spending will find it more difficult.
Whilst I may be painting a rather gloomy picture, it has to be said that times are extremely tough, but unlike the last recession, companies are generally in far better shape to ride out the storm.
My best guess is that we will hit the bottom of this economic quagmire towards the end of 2009, but recovery is likely to be a long slow process which will be business-led.
Who can dispute the maxim ‘cash is king’ in such economic circumstances. So is there any good news on the horizon? Well, as I mentioned earlier, companies are generally fitter and leaner than in the past and, well run enterprises will continue to move forward.
And there is still a substantial bank of private equity money available for the right business opportunities. Here at Catapult - we are still open for business and being approached by increasing numbers of enterprises looking for funding. Some of these opportunities would not normally come our way but, with the banks generally not doing deals at the moment, we are benefiting from the situation.
And it’s not just the banks pulling away from investment. Private investors are also turning their back – wanting to find a safer haven for their money.
But, private equity investors know that even in recessional times there is money to be made and, sometimes such circumstances provide a buying opportunity. However, owner managers need to recognise that the value of their businesses have inevitably fallen from the highs of even just six months ago. Now is the time for a dose of ‘realism’ when it comes to prices (but then I would say that).
For those businesses seeking funding, it is more vital than ever to present a well structured business plan with the right strategy to take the business forward. Catapult and other private equity players, are certainly not looking to provide short term funding to new businesses to help see them through a difficult patch. We are looking for companies with good management teams, competitive products and that are hungry to develop their market.
Whilst sectors such as retailing and house building are to be avoided, there are others arenas that look relatively strong including healthcare and hi-tech.
Certainly, companies need to keep a close rein on their expenditure and keep on top of collecting debts. Avoid ‘tying up’ money in working capital – quite simply work hard at both collecting and generating cash.
Good management teams will look at the current situation and evaluate what the threats and opportunities are for their businesses: not only in the coming months but over the next two to three years. Cost cutting measures undertaken early on are likely to reduce the need for drastic ’surgery’ later on.
The Government clearly recognises the problems that businesses are facing and are very definitely in listening ‘mode.’ At the time of writing this article, the Government was due to announce a series of measures aimed at helping SMEs – we will have to wait and see if there is any real benefit to be had from these, or whether it will be a matter of ‘window dressing.’
At this time, management teams need to be pro-active and be on the lookout to strengthen their business base – times may be tough but competitive enterprises will usually find a way to return a profit!
For further information contact Graham Mold at Catapult Venture Managers on 0121 616 0180 or 07768 148187 or Paul Shrimpton at PSPR Ltd on 0121 354 7311 or 07979 505322.
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The Credit Crunch - One VC’s Perspective on how equity investment is replacing debt
John White, Founder and Director
East Midlands Early Growth Fund
E-Synergy Ltd
Introduction:
The “Credit Crunch” has seen at least £40k wiped off every British adults wealth on average. Since July 2007 the value of their property and equities has slumped by 28%. For high net worth individuals and those lucky to have £500k of free assets at their disposal to invest in speculative start ups - the effect of the credit crunch would be expected to be much worse with a consequent reduction of start up capital being available in the market place. The recession is only in the first stages and it is likely to be the world’s first global depression.
This article will look at the initial effects of the credit crunch and where companies can still obtain early stage start up cash; firstly though some further information on how the crunch has effected overall wealth in the UK.
The affect on Average Wealth:
PWC estimate that the £1.9 trillion fall in UK wealth could reduce annual spending by around £45 billion, or around 3 per cent of GDP. The world now has 30% less billionaires than 18 months ago and countries, such as Iceland & the Ukraine, that have encouraged heavy borrowing have effectively gone or are on the brink of becoming bankrupt. Closer to home and of more immediate interest, interest rates have been cut to a record low of 0.5 per cent in this economic cycle and the Bank of England is now embarking on a process known as ‘quantitative easing’, whereby it buys up gilts from institutions such as banks in the hope that the extra cash will get the economy moving again. Yet if you are small company wanting an overdraft or a loan to support your business you can’t get it from a bank!
The world financial system effectively froze up for at least a year as every financial institution tried to improve it’s capital adequacy i.e. the amount of “real” money and solid assets it possessed as opposed to borrowed. Although interest rates have now been reduced dramatically the Banks remain loath to lend as they slowly build back their “real capital” base.
Ironically through all this maelstrom, and value destruction, it is the likes of Sir Fred Goodwin ex RBS who has certainly benefited, although in many ways overseeing if not responsible for the excessive lending spree. And on the other side those who took out excessive loans or who spent excessively now have the luxury of some of the lowest mortgage rates in history. Whilst the government has previously encouraged saving; it is those pensioners and cautious savers who now suffer with asset value destroyed and low interest on those monies the banks haven’t lost for them.
But this is probably getting too serious and instead for a fuller picture and further biased explanations I would direct you to the following :
http://www.youtube.com/watch?v=wGxmgwUWNr0
http://www.youtube.com/watch?v=s_iMS31mqmU
http://www.youtube.com/watch?v=kQdNLFVdwfQ
How we got there
Years of lax lending inflated a huge debt bubble as people borrowed cheap money and ploughed it into property. And of course this seemed a good idea when Central Bank interest rates were low; the trouble was it just couldn’t last. Interest rates hit rock bottom in America in the early part of 2004 at just 1 per cent, but in June that year they began to rise. As interest rates jumped, US house prices started to fall and borrowers began to default on their mortgage payments but unfortunately for us in the UK the US banking sector had packaged sub-prime home loans into mortgage-backed securities known as CDOs (collateralised debt obligations) and sold on as obscure debt packages to hedge funds and investment banks who generated high returns without understanding the risk. (Jon Moulton, a shareholder of E-Synergy is quoted as having said on television before the crunch started that a large number of the heads of major banks in the UK did not understand a CDO! )
When borrowers started to default on their loans, the value of these investments plummeted resulting in huge losses for banks globally. But no one really knew where the losses were because they had been packaged up!
But the CDO debacle shouldn’t have come as a surprise – those who remember the 1987 Wall Street crash – made famous by the Oliver Stone film with Charlie Sheen – will be aware that a similar obscrurification had been employed then by striping off the dividend from a quoted share and then subsequent packaging up with others to produce a “pure” dividend product sold on to others. Again the risk element was not understood correctly.
The affect for small businesses: Finance Availability
To get back to the main point of small company investment finance, irrespective of how we all got here the current situation for small companies is very difficult. Even small companies with good turnover and strong orders are not easily able to get bank overdrafts renewed. One small company in the North East successfully running for 19 years , with £1m turnover, had both its bank overdraft of £50k and its mortgage of £750k refused, even though it had been trading successfully. This inability to obtain a bank loan is becoming fairly common now and those of us who interface directly with businesses in the East Midlands can tell of many similar stories.
The recently announced Enterprise Finance Guarantee scheme, a successor to the Small Firms Loan Guarantee (SFLG) scheme just hasn’t worked. This £1.3 billion scheme is designed to support bank lending, of three months to ten year maturity, to UK businesses with a turnover of up to £25m who are currently not easily able to access the finance they need. It should enable them to secure loans of between £1k and £1m through a Government guarantee and is available up to 31 March 2010. The problem highlighted by recent publicity in the papers and media is that the banks are still demanding guarantees from the Directors. Consequently as with the previous SFLG scheme very few applications are proving successful. I’m afraid there are a lot of arguments for banks to return to simple old fashion lending where the banks did proper due diligence on individuals and companies and understood what and who they were lending to!
Co-investment funding : Public and Angel investment
That really only leaves VCs or Angels to step into the funding breech.
At E-Synergy we initially thought that everyone would put on hold investing in new start-ups and if they did invest would only invest in the equity gap, higher up the food chain, in established companies with reasonable turnover and approaching breakeven.
Between the summer and Christmas we did indeed notice a hold in investments but others have not seen this, which is initially surprising: In 2008 Ascendant (http://www.ascendant.co.uk/) reported the highest level of investment (2008: £1,001m, 2007: £872m) since the technology bubble of 2001, with 253 deals done ( 242: 2007) of over £0.5m. In particular in the last quarter of 2008 (when the crunch was hitting hard) £229m of funds was invested in 55 companies - an indicator that the crunch was neither putting off institutional investors nor private/angel investors who represented 19% (last year 13%) of the total funds committed. These figures represent UK/Irish tech companies only and some of the biggest investors were Scottish Enterprise, Enterprise Ireland, NorthStar Equity and others with a considerable proportion of their funds derived from the Public Sector.
Of note also is the report from Nesta with information supplied by Library House titled Shifting Sands (September 2008) unfortunately written before the main crunch impacted but nevertheless with useful pointers. Of key importance is that between 2000 and 2008 the public sector has become considerably more important as an investor in both absolute and relative terms rising from 18% of all VC deals at the beginning of this period to 43% in 2007. Together with a notable increase in business angel funding doubling from 15% to 30 % , this has resulted in co investment deals being the dominant form of funding (62%) in early stage company finance.
On the face of it this information is all consistent and in a downturn one might expect, given both the public sector leverage and past history of Business Angel cyclical investment (low sensitivity) should hold up well in a downturn.
Further on hindsight perhaps this is not as surprising as one might initially think. As a high net worth individual in an environment with “safe” banks crashing all about you one’s perception of risk changes: a risky seed start-up becomes relatively less risky compared with a bank or building society particularly as the hi net worth individual can do his own due diligence and “get his head around” the investment; better than a CDO!
So to date the VC investment area has held up reasonable well, Business Angel and Co investment funding, such as the East Midlands Early Growth Fund (EMEGF), is critical to this early stage financing and co investment funding appears to be the best source of funding new company start ups. And in turn one of the better ways of “recycling” jobs and employment into dynamic new growth companies required by the region.
The Future
Well I wouldn’t like to openly predict the future for investment in this sector: but a few things can be said together with the fact that there is starting to be some overall consensus emerging;
Firstly: Inflation is currently zero or negative and the Government is doing everything it can to get people to spend; to encourage the same people who borrowed too much before to do the same again. Quantitative easing is another way for saying the government is printing money – yet they argue it is not printing money for the likes of me and you but for institutions and therefore won’t produce inflation.
Secondly: In all previous histories of recessions and large debts being incurred, the Government has always inflated its way out of debt. Which would you prefer as a Government – any government? A debt approaching £30k on every man women or child in the country to be paid off over the next generation or a quick dose of inflation to reduce the debt to low values over the course of a few years? So my guess would be that the government fails to react quickly enough to all the spending measures it has introduced and we move rapidly from zero to high inflation in a couple of year thus solving the debt problem in one go!
Thirdly: If you are a VC, on this scenario– it is a buyers market! Lots of new company start-ups from newly unemployed people. Lots of previously well run companies looking for cash to replace bank loans. Which means in turn companies must lower their valuations to attract any chance of investment funding.
Lastly: As a company seeking finance, get as much money as you possible can now – it’s going to get harder first before it gets better or inflation starts to kick in and the economy rebounds. Do not worry about giving away too much equity – if you are confident in your company negotiate performance related options. No VC worth his salt will mind giving away a proportion of equity as a strong incentive if the company does well. Remember also, that if you are lucky enough to get funding from a public/private co investment fund such as the EMEGF you also will be able to tap into a databank of expertise that can facilitate your company to grow and successfully exit.
copyright© john White 2009
Disclaimer : This article does not nor is intended to constitute investment advice and represents personal views of the author who accepts no responsibility for any loss or otherwise of any actions taken as a consequence of reading the article etc.
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Venture Capital/ Private Equity - What is it ?
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Venture Capital/Private Equity - What is it?
Venture Capitalist/Business Angel/Dragon - What/Who are they?
The Jargon explained
Having become involved with Turning Point Investments LLP in 2008, people often ask me what I am up to.
The answer - 'Venture Capital' - often leads to further questions such as 'What exactly is it?, How does it work?' - and the same applies to the alternative answer - 'Private Equity'
This document is designed for those who may or may not have heard of it, and who are not exactly sure what it is.
Most people are familiar with the London Stock Exchange where both corporations e.g. Pension Funds and the general public can buy and sell shares in 'Public Quoted Companies' many of which are household names such as Marks & Spencer, Sainsbury's, BP, Shell and so on. Less well known is the AIM market which is for smaller growing companies, and still regulated and run by the London Stock Exchange.
However the vast majority of companies in the UK are private limited companies whose shares cannot be offered to the general public, and it is the purchase of theses shares which is generally falls in to 'Venture Capital' or 'Private Equity'.
Private limited companies have two main ways of raising cash - obviously there are the normal sources through banks and other finance houses for leasing, mortgages, etc. and there is also the personal cash of the directors.
Sometimes businesses need more cash than they can source from the conventional routes - and one method of raising this cash is by the company selling some shares to a third party individual or company - or Private Equity, where equity in this case refers to 'a legal interest in a company or enterprise' or 'stocks and shares which carry no fixed interest'.
For example - a company requiring £10,000 where the owner currently owns 50 shares
The owner issues and sells 50 shares to an investor for which an investor pays the company £10,000
The company will now have a total of 100 shares (50 owned by the original owner, and 50 owned by an Investor)
An investor would now own 50% of the equity for which he paid £10,000 therefore valuing the company at £20,000.
Venture Capitalist?
Venture Capitalists are people who invest in companies in the hope that they will grow and become more valuable - 'capital invested in a project in which there is a substantial element of risk'. The venture relates to the risk whilst the capital related to the acquisition of shares such that the Venture Capitalist can only make any money if a) the company makes good profits and pays a dividend, and/or b) the company is sold for more money than it was worth when the shares were purchased - in other words if he sells his shares.
There are many other descriptions of a Venture Capitalist - to include 'Private Equity Investor'. 'Business Angel', and 'Dragon' - all of which fundamentally are the same.
Normally Venture Capitalists are wealthy 'High Nett Worth' individuals who have sufficient cash resource to make higher risk investments. Statistically it can probably be shown that for every 10 companies which have sold shares to Venture Capitalists, 1 will achieve great things and may be worth 10 times what the investor paid, 2 or 3 will do reasonably well but with a relatively modest return, 3 or 4 will continue in business at an overall break even, and 3 or 4 will go bust and the investor will lose all of their money invested in them. The challenge for the Venture Capitalist is to find the 1!
In short - Venture Capital/ Private Equity is a means of a company raising money through the issue and sale of shares as an alternative to other methods ( Bank Loans, Invoice Finance, Overdraft etc.) to an investor who believes the business can develop and make them a return of significantly greater than their original cash stake.
For further information please contact
Tom Mawhood
T:01949 869110
M:07710 083283
E:tom@turningpointuk.org
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Access to finance is the key to an entrepreneurial culture
With the backdrop of the current economic climate few would argue that it is an important time to be building an entrepreneurial culture in our region. However, the inter-dependence of an entrepreneurial culture and our ability to raise finance is often poorly understood.
Entrepreneurship seems to be the zeitgeist of our day but what does it actually mean?
In its most simple terms entrepreneurship is the process of conceiving, realising, growing and exiting a business. The final stage is key to making the process repeatable and financially sustainable.
But what role does finance have along the way? Well, moving from concept to reality requires money. Turning reality into growth requires money. A lucky few businesses are in the right place and the right time to experience rapid growth organically, but most will require some investment to help them successfully complete all four stages.
Conversely, there are few obstacles that are faced by entrepreneurs that can’t be removed by money.
Therefore to have a truly entrepreneurial culture requires an openness to and understanding of why, when and how to raise finance. It is part of our role at the Growth Investment network to promote that understanding. If you are in business because you have a passion and you want to see your business grow then you are somewhere on the four stage path. This path will lead you inexorably to exiting your business at some stage, be it for profit or loss. If somebody offered you a huge sum of money for your business tomorrow, would you accept it?
Probably. So if you understand where you are heading and you are happy for it to happen sooner rather than later, why not start working towards it now?
Start the process early, not when you are desperate for the money. Negotiating equity stakes when you are desperate for money puts you at a distinct disadvantage.
Understand what the investors are looking for. Investors think differently about your business. Try to put yourself in their shoes. Imagine if you were giving away a large chunk of money and only getting it back if the business is successful, what questions would you want to ask?
Treat raising investment like making a big sale to a new customer:
o Research all your potential ‘customers’
o Start networking with them first without trying the hard sell
o Find out what they are looking for
o Make sure your offering is tailored to their requirements
o Try the soft sell first i.e. ‘if I could offer you XYZ, would you be interested?’
o Make the pitch when and only when you have maximised your chances of being successful
And finally, do as much research and reading around the subject as possible and the Growth Investment website, www.ginem.co.uk, is a pretty good place to start!