Something ventured

Venture capitalists are often held responsible for the lack of investment in high-tech industries. But UK companies’ lack of business expertise can be just as much to blame, finds Brian Davis

High-tech companies are the future of British industry, but all too often they cannot get funding to develop their ideas. Blame is frequently laid at the door of venture capitalists, who, it is said, lack the vision to invest in anything except the latest internet stock. But is it really their fault, or are the companies seeking funding bad at presenting a case for investment?

In June this year St Catherine’s College, Oxford, hosted an event which brought together scientists, researchers and entrepreneurs with potential funders. Venturefest was billed as the first festival of its kind. Several hundred budding entrepreneurs, drawn mainly from Oxford University and its environs, plus a variety of small start-up companies, joined leading venture capitalists who co-sponsored the event. These included Advent, Apax Partners, HSBC, consultancies McKinsey, Grant Thornton, and dozens of private investors. Their experiences offer some interesting lessons.

Dr Peter Johnson, organiser of Venturefest and research fellow and lecturer in management studies at Exeter College, Oxford, says: `The great weakness of many UK companies is the lack of a simple, coherent business model that can be easily explained. People tend to end up with incredibly seductive technology, but can’t present a coherent “business mantra” explaining how the idea will make money. The Americans are far better at articulating the business idea.’

Johnson’s point is underlined by the fact that the £10,000 first prize in a Venturefest competition for the best international business plan went to a US team, from Dartmouth College’s Tuck School of Business in New Hampshire (pictured above).

The value of a good business plan should not be underestimated, says Deborah Kay, former marketing director of high-tech equity investment group Apax Partners, one of the main investors in PPL Therapeutics (creators of Dolly the cloned sheep) and Demon Internet. `The challenge is to translate what is often a very technical idea into commercial terms people can understand. Unfortunately many high-tech entrepreneurs lack the right skills to exploit their concept,’ she says.

David Cheesman, investment director at Advent, a source of private equity capital for industrial and commercial start-up firms, says: `There is no shortage of venture capital for good ideas. The problem in the UK is the lack of good quality business managers.’ He suggests there are several key factors for raising funding (see box, opposite).

Cheesman stresses the importance of holding protectable intellectual property, but admits that patenting know how is a black art. `Alternatively a company must be able to demonstrate that it would be difficult for others to catch up in a reasonable time,’ he says.

The business plan should be fairly brief. Its main message should be: `What is different and why is it worth investing in?’ There must be capacity for rapid growth and profits and a clear exit strategy for the venture capitalist. Cheesman says: `Advent will not invest unless we and the management team have the same exit strategy, typically aiming to sell within five years. IT and electronic firms should anticipate valuation of at least £25m in three to five years, and biotech companies £50m in a similar period.’

Dr George Siemieniuch, partner in Oxford-based high-technology business consultancy and accountant Grant Thornton, publisher of a free High-Tech Start-Up Guide, says there is a simple formula for new high-tech firms to secure funding. `Traditional venture capital companies like 3i insist it’s all down to “management, management, management”. In high-tech business, we consider the formula is “technology, market, management”.’

But Siemieniuch recognises that there are problems in getting funding for new technology companies. Most new businesses will have to go through several rounds of funding from initial start-up, through development and testing to bringing the product to market. `There are considerable difficulties gaining funding to cover the initial innovation stage of the business,’ he admits, `as that’s when things tend to go wrong.’

So the first round of development is likely to be have to be funded by friends, acquaintances and business angels, possibly supported by small seedcorn funds. Typically the large venture capital companies will only get involved after the first round.

But new funds are being created to foster early stage development. MTI Partners, which backed iOra (see panel, right) has invested about £60m in about 30 companies during their early stages. A further £60m has just been raised for new ventures.

MTI investment manager John Melotte says two thirds of its funds go to IT, telecommunications and internet-related companies and the remainder to new materials and life science companies. `We get involved while a product is still a prototype, not yet fully developed and certainly unlikely to have a customer base,’ he says. `Because new firms are unlikely to have a track record, we need to be sure the underlying technology is right. So all our investment managers come from technical backgrounds.’

The European Investment Bank and HSBC recently created a £5m venture capital enterprise called QTP to support small, innovative firms which have previously suffered the `equity gap effect’. The fund primarily serves Oxford and Cambridge University spin-offs and start-ups.

David Gill, head of the Innovation and Growth Unit of the HSBC Bank, says three biomedical-related ventures are undergoing due diligence. The fund is targeted at small technology-based firms, from biomedical projects to IT and innovative engineering. Up to £500,000 will be offered for individual projects, with potential follow-on investments, and the fund is set to grow considerably.

`The technology must be robust, though the idea may not yet have been tested, and may need finance to reach the prototype stage,’ says Gill. He considers the funding climate for new high-tech ventures has become considerably more benign over the past couple of years, `but we still have a long way to go to match the real hot spots such as the US, Israel and Australia.’

Selling your idea to a venture capitalist

David Cheesman, investment director of Advent, lists the key criteria for new ventures trying to raise money:

* The technology must have protectable intellectual property and offer distinct competitive advantages in the target market.

* It must result in a product with real applications and generate decent revenue.

* There must be a well-rounded management team, including marketing, finance and business skills.

* Path and costs to market have to be clearly identified and quantified, with predicted revenues.

* The business plan should be high on data content and no longer than 25 pages.

* There must be capacity for rapid growth in sales and profits once the product reaches the market.

* If there is a manufacturing element, what resources are in place and how much will it cost to get manufacturing running properly?

* There must be a clear exit strategy. New ventures must offer the opportunity for the venture capital company (or business angels) to realise a multiple of the value of its investment by sale of the business, sale of the technology or flotation.