Venture capital activity is booming once more, with management buy-out and buy-in deals flavour of the month. The build-up of funds on the part of players such as Schroders and Candover is driving this trend but, while the number of deals is probably static, their value is increasing almost to levels last seen in the late 1980s.
The Big Six enjoy a well established position in the MBO market. Out of 50 deals of more than #10m in the first quarter of 1998, Coopers & Lybrand have worked on nine, Deloitte & Touche on five and Ernst & Young, three.
According to Chris Ward, partner at Deloitte & Touche Corporate Finance, the Big Six advise on 75% of all deals in a typical year, and act for one party or another on almost every large deal. Consequently, the top-tier firms are a big draw for accountants who want to develop careers in venture capital as well as other financial professionals. ‘Our first senior hire from the investment banking community was in 1985 – a policy which we have built upon since then.
We now have a large number of partners and staff in our corporate finance division who have worked in investment banks, clearers, brokers, venture capital houses and industry,’ Ward says.
With greater use of auctions and an increase in publicly quoted companies being taken private, emphasis is shifting within the market – and with it the role played by accountancy firms. As well as traditionally advising the buy-out team there is the possibility of advising the venture capital provider. According to Peter Jacobs, partner in charge of national MBO advisory services at Coopers, the firm may give advice to a venture capital provider, offering project management as it would to a buy-out team.
It could also provide tax and pensions advice as well as assistance in raising debt finance.
So with obvious attractions in advisory work around MBOs and MBIs, which business and industry sectors show the most activity and which appeal most to investors?
Investment by UK venture capital firms increased by 29% from #3.2bn in 1996 to #4.1bn in 1997, according to the British Venture Capital Association’s ‘1997 Report on Investment Activity’. The number of companies which received investment rose from 1,200 to 1,272.
MBOs and MBIs accounted for less than a third of the total number of companies backed, but the finance they received amounted to some #2bn. There were more expanding companies backed than any other type; 451 businesses received #678m of venture capital.
Hi-tech companies received more capital than any other industry grouping, as investors were attracted by that particular sector’s current growth. A record #690m was invested in 295 computer, medical, health, biotech and communications-related businesses.
That is 15 times the amount invested in 1984.
Engineering proved to be one of the strongest industry sectors with some 163 companies receiving a combined total of #378m, while 41 companies in the leisure and hotels sector received #333m.
The maturity of a company will be a big factor in its attractiveness to investors.
Early-stage companies and those businesses going for only two or three years have proved comparatively unpopular. While the amount invested in early-stage companies was the highest for seven years at #159m, it still accounts for only 3.8% of total investment.
‘Some niche players will look at early-stage companies, but the majority of venture capital houses won’t look at them,’ says Alex Firth, director of BDO Stoy Hayward’s corporate finance division.
‘It’s a shame, as the majority of calls I receive are from just this type of company. But it is understandable. More businesses go bust at this end of the market, as they can’t easily withstand trends or movements in the economy. Would you want your pension invested in a company that is making a time-machine? I’m being a bit flippant – but the answer is no, you wouldn’t,’ comments Firth.
An adviser’s evaluation of the MBO or MBI team is crucial. So what does a venture capitalist look for in a company or an MBO team? ‘Successful MBOs are achieved by management teams, not by individuals. And a good team reflects a proper balance of a number of factors,’ says Ross Dawkins, director on the private equity team of Stoys’ Corporate Finance division.
‘Clear leadership is essential to drive the business forward – a divided team is an absolute deal-breaker. The core team needs the right mix of strengths and skills to run all aspects of the business in the post-MBO environment.
‘An MBO should not be viewed as a reward for past endeavours. Agreed strategy is important. The team will need to review the existing business model and develop a vision of how it might change in the future.
‘The chemistry of the team is also important, but a successful team is unlikely to consist of homogenous characters. A successful team needs the correct balance of managerial and entrepreneurial spirits,’ says Dawkins.
Evidence of growth, or growth potential, is a huge draw. ‘If there’s an expanding business in a clear growth sector, such as technology, then obviously we’ll be interested in it. But there are many other situations where a growth business can present itself,’ says Mark Wignall, managing director of venture capital company GLE Development Capital.
‘If, say, a sector were in the process of undergoing legislative change, then certain companies may be well positioned to take advantage of the rules shake-up. When the dental sector was moving towards more private healthcare and NHS funding was being reduced, some companies were in the right place to take advantage of the increase in paying customers.
‘GLE invested #575,000 in Whitecross, which became the first high street chain of dentists, in 1994. Whitecross was an established but small company at the time, with an annual turnover in the region of #1m. It was sold last month for #7.5m,’ says Wignall.
Markets undergoing consolidation are popular targets for a venture capitalist, as there is increased scope for companies to acquire other businesses.
And venture capitalists are always looking to back businesses that have a competitive advantage in their marketplace, according to Wignall.
Initial venture capital investment is by no means the end of the story.
Companies accepting an injection of cash will have to give up a degree of equity in return and the venture capitalist, like any other shareholder, will want a say in the running of the company.
‘We back management teams on the basis that they are responsible for the day-to-day running of the business. We do not want them to see us as interfering, but we will appoint a non-executive director to the board from our team members,’ says Wignall.
The non-executive will attend monthly board meetings, although his or her level of involvement may vary immensely, from very little to a highly active role.
‘I wouldn’t say that we have seen it all before, but we do have a wealth of past experience on which we can draw. The non-executive can act as a sounding board for key commercial contracts, assist the company with its relationships with other financiers – such as the bank, or become involved in important strategic decisions,’ adds Wignall.
The BVCA claims this non-executive approach is successful. ‘Past research by experts such as Coopers has shown companies with non-executives tend to perform better than those without. They are better prepared for business and a non-executive is considered an addition to the board, rather than an intrusion,’ says Charlotte Morrison, head of communications at the BVCA.
But not all companies wish to give up an equity share, and early-stage companies may not even get the chance, as many never get past the starting post.
Venture capitalists can provide much-needed finance and additional management guidance for some companies, but they are still reluctant to look at the smaller and less established end of the market.
The English ICA launched its faculty of Corporate Finance in April 1997.
The move, says Peter Mayatt, the faculty’s head, was driven by members.
‘We’d like chartered accountants to be at the forefront of corporate finance, be that within merchant banks, venture capital houses or within accountancy practices.’ The faculty aims to provide representation for chartered accountants working in corporate finance in order that they speak as one body in dealings with the Department of Trade and Industry or Brussels.
Its executive committee reflects a cross-section of firms from Big Six partners, smaller firms, merchant bankers and businesses. Chris Ward, partner at Deloitte & Touche Corporate Finance, says the faculty is already providing effective promotion of firms’ interests.
Mayatt says the faculty is also addressing the need for a recognised qualification in corporate finance. This will take the form of a diploma which would prove to employers that a candidate has good working knowledge of corporate finance.
Oxford Asymmetry has travelled the tried-and-tested route of venture capital on more than one occasion.
But the company found that start-ups do not have an easy ride when it comes to raising finance.
The Abingdon-based business, a provider of specialist services to the pharmaceutical and biotech industries, used venture capitalist 3i in 1994 and 1996 to raise a total of #10m in investment funding. OA was a young company just beginning its third year of operations when it made its original approach to 3i. The company successfully launched on the London Stock Exchange earlier this year and posted a 1997 turnover of #10.1m.
‘When we approached 3i, we needed additional equity capital. Borrowing was not appropriate for us in view of the risk attached to the company, so we approached a venture capitalist as we needed a large amount of risk money,’ said Nick Cross, OA’s finance director at the time.
‘We found that for early-stage companies, the sources of finance were limited. Not many venture capitalists were willing to support young companies. And of those that did, only a small proportion had any serious money to invest.
‘We selected 3i, which proved to be an excellent investor. The company encouraged us to appoint two non-executive directors, which reaped considerable benefits. We recruited two individuals with experience relevant to our company. They brought a broader perspective to the business than we had internally,’ said Cross.
Venture capitalist 3i was attracted to OA as a young, ambitious company within an interesting and expanding field, said Patrick Sheehan, 3i’s director of technology.
‘But that in itself is not enough. What attracted us was the quality of the people and the clarity and realism of their plans. They conveyed a sensible approach that we felt would drive the business,’ he added. Joanna Offer is a freelance journalist
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