A capital injection for R&D

Over the past few years, small start-up companies have sprung up from nowhere to become the success story of the 90s economy. It is not something lost on the UK government. From chancellor Gordon Brown’s promotion of financial incentives to encourage capital-hungry start-ups to IT minister Michael Wills’ steering of the electronic commerce bill through parliament, ministers are falling over each other to put themselves at the forefront of the information revolution.

Finance directors at these cutting-edge companies, however, still face the daunting challenge of where they can raise the capital to steer the business through a long period of non-profit making.

David Bloom, FD at Keystone Software, which specialises in accountancy software for running a practice, is wary of government incentives. ‘There’s an old saying in industry which goes: don’t let the taxman wag the commercial dog,’ he says.

Instead, the New Zealand-based company, which established itself four years ago in the UK, chose to float on the Alternative Investment Market in 1997, rather than go down the venture capital route.

Bloom, a former Big Five corporate financier, says one advantage of floating on AIM is that it is easier to raise capital, bypassing the otherwise lengthy due-diligence process. In the past year, it has raised a further #1.8m through existing and new shareholders.

But he warns: ‘A small company on the stock exchange puts itself under significant pressure and you have an audience watching you.’

Despite boasting clients such as Kidsons Impey, Keystone has yet to break into profit. He attributes much of this to the heavy research and development costs in the software industry.

Not surprisingly, the Big Five consultancies are keen to muscle in on the market.

Both KPMG and PricewaterhouseCoopers have established new solution centres to meet the needs of fast-growing start-up companies.

Last month, PwC unveiled a global technology industry group to provide consulting for up-and-coming, as well as established, clients.

Based in Thames Valley and Cambridge – the UK’s answers to Silicon Valley – it has a special division for fast-growing companies, called ‘companies with extraordinary potential’.

Keith Evans, who heads the UK CWEP, provides financial and IT advice to a variety of IT and non-IT based companies during their initial five-year growth period.

‘The companies lack money, but that’s part of our strategic investment,’ says Evans. ‘If we advise them at an early enough stage, then they’ll stick with us forever.’

Not surprisingly, IT start-ups feature heavily at the new PwC consulting centre. According to Evans, a quarter of the Virgin Fast Track 100 companies are IT start-ups. But not all the companies Evans works with are newcomers. ‘Some entrepreneurs are in their forties and setting up a company for the third or fourth time,’ he explains.

Much of the advice focuses on financing the business through three main sources of investment – venture capitalists, the stock market, and business angels and rich investors keen to plough money into start-ups.

Evans urges companies looking to float on the AIM to plan ahead. ‘My advice for companies is not to put it on the back burner. They need to encourage their staff through share options,’ he says.

The need to draw together business consulting has also prompted KPMG to establish a string of solution centres in Reading, Watford and the US to advise start-ups as well as more traditional blue-chip clients.

And in a break from the past, it also produces hardware and software products.

The main benefit for clients, according to Richard Ingleton, director of consulting at KPMG’s Reading solutions centre, is that KPMG shoulders the R&D costs and is able to implement the products more quickly. ‘The solutions centre sounds abstract, but what we are doing is more pro-active,’ he explains.

It is also important for the government to support the start-up sector through mechanisms such as tax relief for R&D. ‘For small start-up technology companies one of the easiest things to drop is R&D,’ says Ingleton.

Over the past few years, venture capitalists have been criticised for not paying enough attention to Britain’s entrepreneurial start-ups.

But the British Venture Capital Association argues that investment in start-ups rose by 41% on 1997.

BVCA council member David Thorp links this investment surge to the trend for venture capitalists to specialise in specific markets, such as bio-technology and the hi-tech sectors.

He adds that although the Big Five consultancies are keen to break into the start-up market, their fees will be too high for many fledgling companies. ‘Venture capitalists will pick up a deal if a company wants to raise more than #0.5m,’ he says. ‘Anything less, and it will be picked up by a business angel.’

If there is a complaint, Thorp says start-ups frequently underestimate the amount of investment they need in the early years of the business.

‘You need to throw a lot more money into R&D than start-ups think,’ he says. For those that are more realistic about their financing, the first casualty is often the finance director. Although the FD plays an important part in keeping a company’s feet on the ground, says Thorp, smaller start-ups often cannot afford an FD.

At the end of the day, the venture capitalist is in it for the reward. The ultimate investment is in a company like the now-huge mobile phone company Vodafone, which received venture capital funds in its formative years.

For the FDs of more mature start-ups, another financing option is through EASDAQ, the Brussels-based pan-European stock exchange for growth companies. There is also, of course, NASDAQ across the Atlantic – the US market which can offer a significantly higher stockmarket capitalisation for trailblazing young businesses. That, however, is still quite a daunting step for fledgling companies.

Founded in 1995 after a management buy-in, AFA Systems sells risk management and banking software to financial markets.

‘We considered floating on NASDAQ but worked out it would be more expensive with quarterly reporting for more sophisticated investors,’ says AFA FD Henry Sallitt. Instead, it floated on AIM in 1996.

And just as the winds of government are blowing in favour of technology-based companies, so is finance. ‘With investors,’ says Sallitt, ‘it’s a lot easier if you’re a technology company than if you’re a commercial company.’


It’s not just government rhetoric and the markets that have combined to support the exponential growth of small hi-tech businesses in recent years. Sometimes it seems that everyone wants to climb on the bandwagon.

Last week, British Steel entered the fray. In a move backed by the trade and industry department through the small firms loans guarantees scheme, British Steel (Industry) will provide funding for technology-led businesses operating in a number of hi-tech sectors. BSI already supports 40 to 50 businesses a year in traditional steel industry areas with about #2m in finance through loans and share capital.

Now under the DTI agreement – the first of its kind in this area – BSI says it will be able to support more technology-led businesses in traditional steel areas.

‘We always aim to provide our finance in ways which strengthen the businesses and help them achieve their full growth potential,’ says BSI investment manager Keith Williams. ‘This scheme will enable us to extend that support to a greater number of companies in the technology sectors.’

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