VC does it

Source: Stock Market Digital

Date :17/07/2007 14:52:40

What is the difference between venture capital and private equity – is it just a matter of scale?

You should be very sure of your ground before sharing some of it with a potential predator

By Terry Carroll

The terms venture capital (VC) and private equity are sometimes interchanged but the latter has come to be generally connoted with the investment of private capital through a range of media. Private equity sometimes gets a bad press as aggressive and predatory. Venture capital is much more about involvement, often in the early growth stages of a business, where the risks are greater

Whilst Venture Capital Trusts (VCTs) only came into being in 1995 in the UK, the origins of venture capital as a source of funds for company investment can be traced back more than 60 years in the US. Venture capital has traditionally had a strong association with technology companies and innovation.

Latterly, the phenomenal success of the Alternative Investment Market (AIM) has allowed some companies to skip straight over the venture capital avenue to access market funds direct, at the same time releasing the individual entrepreneur’s debt burden. Quoted markets are also a proven exit route for venture capitalists.

Venture capital is more formalised through business, financial and fiscal structures and incentives than business angels, who are usually well-heeled individuals. The TV programme ‘Dragon’s Den’ has given a wider and simpler insight into how angels engage in young enterprises. In real life however angel funding is not a 5 minute casino where ‘Grandma’s sauce’ gets start-up capital and a supermarket order in minutes!

Having a supportive government, fiscal and regulatory environment helps enormously. Venture capital firms face minimal regulation, unlike stock markets which now fall under FSA, as well as Stock Exchange regulation. The government has also helped with the establishment of Regional Venture Capital Funds to fill a need for SMEs up to £500,000.

Venture capital funding is unsecured and usually advanced in return for a share stake in the company. Accordingly it is higher risk and expects a higher return, which can be generated by capital growth. It is not unusual for venture capitalists to have a portfolio of investments with maybe a 20 percent success rate.

What should you consider?

Before seek venture capital, make sure you have access to sound financial and legal advice. You could also access the British Venture Capital Association (BVCA) website.

Ask yourself if you’re prepared to cede a share in the business and some control? Of course you have a competitive product or service, but what’s your USP? Do you have the skills and/or experience to back this up?

Venture capital is usually looking for high growth businesses needing capital who want an early exit strategy. Consider all the possible funding sources, not just VC. While venture capitalists may typically invest £2 million or more, you may find sources for as little as £50,000.

What will they want from you?

Venture capitalists don’t stay for the long run and will typically invest for as little as three years. They want a clear exit strategy from the outset, whether through a trade sale, refinancing elsewhere, flotation, earnout or buyout.

They look at the track record of a business, its management team and business plans; often want a place on the Board; and would expect to put in key personnel if the skills aren’t there, for example CEO, Finance Director or IT Director.

Opportunities for investors

Investors who want the best of both worlds can invest in Venture Capital Trusts. Quoted on the Stock Exchange, these offer a spread of risk and professional fund management, income and capital gains tax reliefs. They invest in unquoted companies seeking capital.

An alternative avenue would be by investing in 3i, arguably the best known venture capital investment company in the UK, with global coverage and its shares being a FTSE100 constituent. For investors or companies seeking capital, its private equity portfolio extends from 1m to 1bn euros per opportunity.

A brighter future?

The venture capital investment sector was savaged after the dot.com bubble burst. In 2006, however, it recovered to the highest level since that era. Indeed, private equity as a whole boomed, from VC to buyouts, with Britain as the main destination outside the US. One of the major drivers is the growing interest in ‘green’ funds and businesses by, for example, The Carbon Trust.

With echoes of 2000, however, there are warning noises from the US about the VC funds chasing green fuel and technology ideas. If this bubble bursts, it may well impact the availability of funds across the whole VC sector.

In the meantime, on the wider markets, concerns about CDOs (collateralised debt obligations) sound ominously similar to the junk bond market collapse that preceded the 1987 global crash. This may make private equity capital scarcer and more selective but whatever the state of the markets, venture capital will probably be around for at least another 60 years.

Terry Carroll is Finance Director of Eatonfield Group plc, and author of several books including The Role of the Finance Director (Prentice-Hall; 3rd edition 2003)