For many years, communication between small, high-tech start- up companies and providers of funding has resembled a dialogue of the deaf.
Engineers and scientists trying to get their new product to market complain of the difficulty in getting banks or venture capitalists interested, and of the maze that is the system of grants available from government. Venture capitalists, for their part, complain that businesses seeking funding do not know how to sell their ideas.
The problem is particularly acute in the start-up phase and in the early years of a new business. A depressing number fail in the first 36 months; improving the survival rate could be a critical factor in boosting the UK’s record of innovation and level of competitiveness.
This is the sort of reasoning behind the idea of Venturefest. It exists to provide a forum where business investors and advisers can meet small firms seeking capital. ‘It brings all the players together in genuine collaboration,’ says Roger Mumby-Croft, director of the Enterprise Centre at Oxford Brookes University Business School and one of Venturefest’s founders.
This year the event, held at Culham Science Centre near Oxford, included seminars on listing and improving your business; clinics offering entrepreneurs one-to-one advice on their business plans; the opportunity for companies seeking funding to present their case to investors; and an exhibition of organisations dedicated to advising or investing in start-ups.
The event was also used as a launch pad for two new initiatives to address the complaints by start-up businesses and financiers about each other.
Mumby-Croft considers these complaints justified. In start-ups, he says, ‘there’s a lack of management skills. Engineers may be very highly qualified in their own discipline but they also need to learn business skills, not pick them up as they go along’.
Then there are funding problems. ‘Banks have no concept of risk capital, a source of good low-interest money. There’s no risk capital culture.’
The government, Mumby-Croft believes, should be pushing the banks to change the way they provide finance to encourage entrepreneurs: ‘I don’t see how else we can change banking culture. Gordon Brown talks about entrepreneurship but I don’t see the positive moves from the government.’
The experience of electronics engineers John Beavis and Peter Gwynne, founders of SeaTrak, one of the companies making a pitch for funding at Venturefest, is typical.
Beavis and Gwynne plan to launch a range of burglar alarms and security systems for privately-owned boats. The basic model is already on sale and has received a good reaction from retailers of marine electronics equipment which the pair approached directly. They intend to produce five models, with the top of the range version including automatic GPS tracking. They are seeking £440,000, in return for a 35% equity stake, to complete the R&D and to set up a sales organisation and production line.
‘It’s been a struggle,’ says Gwynne of the three and a half year development period so far. ‘It would have been impossible if John and I hadn’t had our own businesses and worked without pay.’ Ironically, neither of their existing businesses is related to electronics or manufacturing. Applying for government grants, they say, was ‘a maze’. ‘We always had too many or not enough people,’ adds Beavis – though recently, after many disappointments, they won a £10,000 Smart award.
‘It was hard work. We’re engineers, not marketing experts. But we got the product to the market ourselves.’
An initiative aimed at improving the management skills side of the equation is Business Boffins. It is led by Oxford Brookes Business School’s Enterprise Centre and funded by Seeda, the South-East England Development Agency. Launched at Venturefest, it goes live this autumn.
Putting theory into practice
Managing director Russell Smith is a consultant who has specialised in helping to spin out companies from Oxford University. The aim is to bring the academic expertise of the business school to the aid of entrepreneurs, and to provide a virtual support and advice network. For a monthly subscription, start-ups will receive an information pack every month for three years tailored to what they are likely to need to know that month — how to register for VAT, preparing annual accounts – as well as sector-specific updates and details of changes in the regulations.
‘We reckon the majority of businesses will move along a similar timescale – for example they all have to produce annual accounts,’ says Smith. For those that grow quickly there will be a fast-track pack and also a ‘rescue-track’ for struggling firms.
In addition, business experts will provide advice free of charge to an e-mail problem-solving service. The motto of Business Boffins is to help start-ups ‘avoid the avoidable’ and, by helping them steer clear of pitfalls, minimise the time their founders need to spend on administration.
‘You can be the world’s expert in your field and not have a clue about business,’ says Smith. ‘Academic experience doesn’t equip you for it.’ But he adds: ‘You can’t teach people to be inventors, or to be Richard Branson, but you can teach them to be entrepreneurial.’
He also believes that funding need not be a problem if the fundamentals of the company are right. ‘The most successful company structure is to have the guy with the idea as the chief scientific officer, with another guy as chief executive. If both have the same level of expertise, it’s a winner. If you have a good idea, intellectual property and management capability then raising finance is not a problem.’
Another new scheme unveiled at Venturefest seeks to make the funding side easier, and aims to open up access for investors to a range of firms at the smaller end of the scale. Angel Bourse is being set up as an exchange to deal in shares in smaller unquoted companies. It will make it easy to buy and sell stakes in family firms, or a company set up by an entrepreneur who wants to cash in a small part of the business, without the need to list, even on Ofex, the simplest official Stock Exchange. For investors, it will act as a network for business angels.
It will take advantage of a provision of the Financial Services and Markets Act 2000. This defines categories of investor who are not considered to need the full protection which normally regulates investments. The Act allows investment data to be sent to these ‘high net worth’ and ‘sophisticated’ investors, without having to be vetted by an approved authority.
Angel Bourse financial director Charles Crombie says: ‘For small businesses, bank loans are entirely the wrong way of financing. You have to pay it back with interest. It’s a much greater risk than raising equity, which is the answer in my mind.’But,’ he continues, ‘venture capitalists can’t afford to invest at the lower end of the market. They have very expensive executive teams on which they have to maximise their return, and with smaller deals they can’t do it.’
Business angels, by contrast, don’t cost their own time, so the economics are different. The new Act removed the stumbling block to spreading information about investment opportunities. ‘In the past a business plan would have to be approved by an authorised person. This could typically cost £30,000. As a result, only quite a small amount of information could be sent to people,’ says Crombie. Under the new Act it will be possible simply to e-mail business plans to sophisticated investors.It will also make it easier for business angels, who typically have a few hundred thousand pounds to invest, to spread this over a range of firms.
Angel Bourse will apply some standards. Companies will have to be introduced through authorised intermediaries such as financial advisers, solicitors, or stockbrokers.
Angel Bourse will not make judgements on the quality of the firm or its management, but will carry out a certain amount of ‘due diligence’ work. It will insist on minimum standards of information supplied, such as the memorandum and articles of association, quarterly trading information, and publication of important information. Directors’ backgrounds will be checked for convictions or disqualifications.The only cost to the firm would be a fee to the official intermediary.
Angel Bourse is also officially launched in the autumn. Meanwhile it is holding events around the UK to publicise itself and seeking letters of intent from companies which want to be included on the database.
One company which was not seeking funds among the crowds at Venturefest, despite having its premises within 100 yards at Culham Innovation Centre, was Reaction Engines.
It was founded by three aerospace engineers who spent the last 10 years working on technology for an engine in a reusable spaceplane, building on the cancelled Hotol project. Alan Bond, John Scott-Scott and Richard Varvill believe their work will guarantee the UK a crucial role in developing a space vehicle that can take off and land like a conventional aircraft, whenever the European Space Agency decides that discarding the launcher every time is not a sensible way to go about carrying satellites or astronauts into space.
Limitations of materials
Reaction Engines has been developing the engine such a craft would need – it would operate as a conventional rocket outside the atmosphere, but for altitudes of up to 26km and speeds of Mach 5, it would have a compressor to feed in atmospheric air, as in a gas turbine. But at Mach 5, the air would need cooling from 1,000ºC to around -130ºC, because of the limitations of materials and because the power needed to drive the compressor is proportional to absolute temperature.
The crucial piece of unproven technology is a heat exchanger able to achieve this level of cooling without being enormously big and heavy. Bond and his team believe they have cracked the problems, and aided by an investment from non-executive director Paul Portelli have put in hand a programme to set up a wind tunnel and verify flow phenomena around the exchanger.
Reaction Engines is looking for investors to put up the funds to enable it to develop the heat exchanger, in return for a stake in the firm. It needs £1m for the next stage, simulating ascent conditions in a cryogenic wind tunnel, and with £10m it could demonstrate it in action in front of a modified conventional gas turbine.
But it’s a long-term project. People expecting an exit strategy in five years’ time need not apply.
Sidebar: Flomerics maintains independence and funding
Even safely through the first three years, when businesses are most likely to fail, funding arrangements can still precipitate unexpected problems.
Flomerics was founded in 1988 by mechanical engineer David Tatchell to produce virtual prototyping software used in such applications as predicting airflow inside electronic equipment so that sensitive components do not overheat. It now employs 140, selling to markets worldwide, and to customers including all the main semiconductor and computer companies.
In January 1989, venture capital funding was arranged through Managed Technology Investors with few strings: ‘They just took a 55% share of the company,’ says chief executive Tatchell.
Problems arose in 1995. MTI had invested from a fixed-term fund and needed to realise its investment. Flomerics was a successful growing business but wanted to remain an independent organisation.
A number of options for the future were considered. The first, a trade sale, got short shrift. ‘The last thing we wanted was to sell the business we’d spent years nurturing,’ says Tatchell. The company was too small for a full stock exchange listing, and it would also have been too expensive. A listing on Nasdaq was considered, since the US is Flomerics’ biggest market, but this would have required restructuring as a US company.
Second stage venture capital to buy out MTI would have given the firm a low valuation and high gearing.
Eventually the company decided to float on Aim, the London Stock Exchange’s then newly-launched market for growing and fledgling companies. This offered MTI the prospect of an exit at a reasonable valuation, while allowing Flomerics to continue independent, with an enhanced public profile and better access to market funding.
The downside was that the process – selecting advisers, putting together an admission document, verification (legal checking of every statement in the prospectus with supporting material provided to the lawyers), and corporate presentations – took six months of management time and cost £132,000. ‘It would cost three times as much now,’ says Tatchell, a view supported by the Stock Exchange which puts the cost at £323,000-£1.4m.
But Tatchell says the company was strengthened by the addition of a non-executive chairman and two other non-executive directors. Aim is more lightly regulated than the main Stock Exchange, but Flomerics has decided to abide by the ‘partial compliance’ code and produces monthly financial reports. Share price volatility can be a problem, but the best way to cope is to set realistic expectations, warn early of any departure from these, and maintain good investor relations, Tatchell says.Tatchell estimates the direct annual cost of being on Aim at £100,000.
But it has maintained its independence, increased its status, and has easier access to funds. A share placing last year raised £1.2m for working capital, and helped it make a strategic acquisition in 1999 for £700,000, of which two-thirds was paid in shares. ‘We went on Aim as a £4m turnover company, we’ve had steady organic growth of 20% a year over the last five years, and we’re profitable,’ says Tatchell.