VCs have dotcom goldrush in their sights...again

Talk about being a victim of your own success. Recent figures show that the venture capital market in the US has a particular problem – there are too many venture capitalists with too much money to spend.

Some £54m is committed by US investors, but unspent as they remain desperate to find the next generation of promising young companies to replicate the dotcom success of the nineties. The market, according to these figures, is over-subscribed with venture capital businesses looking for the next big payday.

But by the beginning of 2004, it seems that some funds have already found a way out of the venture capital market in the States. At the start of May, Thomson Venture Economics and the US National Venture Capital Association calculated that any upturn in the market during 2003 was being lost by the beginning of this year. They found that 32 funds closed on $23m, a decline from the previous quarter’s $54m garnered by 50 funds.

Back at home, the situation couldn’t be more different. In fact, companies scrambling for a necessary and much-needed injection of cash still have a good choice of VCs from which to raise capital.

The British Venture Capital Association, which represents most UK-based private equity and venture capital firms, points to its own figures that claim the market is not suffering from a dotcom hangover.

BVCA says that, over the five years to 2002/03, the number of people employed in the UK in private equity-backed companies increased by 19% each year, against a national private sector employment growth rate of 0.5%. These companies grew their staff levels at a rate of just over three times that of FTSE100 and twice that of FTSE mid-250 companies.

BVCA estimates that private equity-backed companies account for the employment of around 2.7 million people in the UK, equivalent to 18% of the current private sector workforce. Certainly this indicates some grounds for optimism in the domestic venture capital market.

Another set of figures, published by PricewaterhouseCoopers and venture capitalists 3i, indicate that worldwide investment in private equity and venture capital grew in 2003 – the first time for two years. In fact, figures were up significantly on 2002 by 43% globally to more than $155bn.

In Europe, funding outstripped investment by more than £5bn.

It seems that the industry inexorably associated with the dotcom era still has some life left in it. Even though the bubble has long burst, 3i director Patrick Dunne says that increased ‘merger and acquisition activity’ in the markets had helped fuel the recovery.

Tracy Lefteroff, global managing partner, private equity and venture capital at PricewaterhouseCoopers, is optimistic about the immediate future.

‘The increase in spending and M&A activity would suggest that we will see a good flow of opportunities for investors,’ she says.

Certainly that optimism is borne out by events. At the very end of April, the Saga Group – the company targeting the ‘grey pound’ – reported a profit increase of 63% to £82m in 2003. Sales until the end of last January increased by 14%.

Not bad news at any time, but especially good considering that the company had put itself up for sale not long before the announcement of its results.

The price fetched could eventually reach as high as £1bn, ensuring a handy retirement for owner Roger de Haan, and banishing any fears he may have about the cost of car insurance for anybody in his age group.

Already venture capitalists are thought to be queuing up to put their money on the table. HG Capital, Candover and Cinven are among the VCs supposedly poised to pounce.

The continued strength of the venture capitalist market may be good news for the bigger companies, but it doesn’t help the smaller companies whose size puts them at a disadvantage in the quest for funds. The BVCA admits that some companies are not big enough to catch the eye of venture capitalists, and have to look elsewhere for capital.

The problem then for such businesses is where? Who will risk funding businesses where even venture capitalists fear to tread?

Admittedly the choices are limited, such as government grants, equity finance or debt financing. In some cases, they are so limited that it can threaten the very existence of the company. But at least there are some new ways for smaller companies to get their hands on some all-important cash.

The launch in February of web-based Single Pathway to Market (www.singlepathway.com) is the latest attempt to find a solution for companies seeking to plug the equity gap. This is a joint venture between OFEX, the stock exchange for tiny firms, AngelBourse, a fund-raising service of private investors that looks to raise between £100,000 and £1.5m and the National Business Angels Network.

Ministers have previously identified a particular funding gap of between £100,000 and £3m for the smallest of companies desperate for cash. With this in mind, Single Pathway aims to get smaller companies access to finance as they grow ‘in manageable stages without the disruption and delay associated with constant fund-raising activity’.

The founders of the pathway lament that many companies, when it began its work, do not know where to go to find finance. OFEX’s Jonathan Jenkins says that part of the point of setting up the Single Pathway is to ‘help remove some of the education gap often mistaken for a funding gap’.

But even if they are educated, it is still the funding gap that will need to be bridged for many companies. Whether it be from venture capitalists or even new organisations, such as the pathway, the eternal search for extra funding will still dominate the thinking of many companies, small or large.

• David Harding is a regular contributor to Accountancy Age.