Select Committee on European Union Written Evidence


Memorandum by Alan Bates, Venture Capitalist, on Early Investment in UK Companies

Background

These notes are the result of experiences over the last 15 years. During that period I have been involved with a number of early stage high tech companies in the UK. They have all required finance and this has in most instances been obtained from private individuals, venture capital companies and trading companies in the UK, the USA and Europe.

The UK

  Initial funding normally comes from private individuals. This is difficult for most start-up companies. How do you find potential investors and how do you persuade them to invest? This is high risk for investors—how does one undertake due diligence? In rough terms sums of up to £250,000 may be raised privately. High wealth ("business angels") often find the work load created by multiple investments such that they create early stage Venture Capital companies and recruit professional managers for the task.

Early stage VCs

  There are very few such VC companies in the UK. Three are identified because they provide important services that early stage companies require (see "What early stage companies require" below). Celtic House has been set up by Terry Matthews, the founder of Newbridge. It invests small amounts in very early stage high tech companies and offers a "club" link with other Newbridge affiliates. Herman Hauser has recently set up Amadeus to invest in early stage high tech companies and recruited professional managers for the task. Herman offers links to other related companies. Finally, MTI, where I am a non-executive director, has, for a number of years, invested in early stage high tech companies involved in various industries. Almost uniquely they offer hands-on advice and counsel to companies.

Main stream VCs

  There are a large number of these and whilst it is unfair to basket them all together they are, broadly speaking:

    —  risk averse; and

    —  much taken with Management Buy Ins (MBIs) and Management Buy Outs (MBOs) which are, in the main, not providing finance for early stage companies.

  These VCs will invest upwards of £500,000 but their overheads tend to push them to larger investments and their obvious potential failure rate makes them very expensive in equity terms.

  Banks are, in my experience, useless for early stage companies. They will normally only lend money when you do not need it—never when you do. They, understandably, believe that risk is an equity play.

USA

  Here the VC industry is much more developed and prepared to risk in investing in early stage companies. The market is very large. For a UK early stage high tech company to raise funds from a US VC is very difficult. The US VC has sufficient opportunities in the US so why bother to extend to the UK? The US VC that are investing in the UK often exact a commitment to at least open a US office and in some instances to recruit a US CEO.

  The USA does have another funding mechanism that has been successfully used in the UK but only raising funds in the USA. That is the Limited Partnership that, through tax breaks, enables doctors, dentists and other US citizens with some capital to invest in early stage companies. Unfortunately, in the UK whilst Limited Partnership law exists it is so out of date as to be unusable.

Mainland Europe

  The European VC scene is some way behind the UK. In 1998 the amount invested by UK VCs equalled the total amount invested by mainland European VCs. However, European VC money is becoming available to UK early stage companies and a few are opening offices in London.

Trading Companies

  For some time established companies have invested in early stage companies. Mostly, as might be expected, they invest in companies that are active in areas broadly in line with their own strategic development. Intel of the US is very active in this regard and Reuters in the UK have invested in a number of early stage companies.

What do early stage companies want?

  Simply put they all need finance but in practice they almost always could benefit from advice on marketing, partnering, manufacturing, accounting and taxation. This is where most UK financing is sadly lacking and where something could be done.

  Most VCs will place someone from their investment team on the Board of a company. However, very few of them possess hands-on company management skills. As an alternative an external non-executive Director could be appointed. The legal burden of this role in the UK is becoming intolerably heavy. Furthermore the UK has a label of "failure" attached to Directors involved with companies that fail. Early stage high tech companies are high risk but one is still seen in a negative way. In the USA a failure, particularly of an early stage company, is seen as a learning experience. Much could be done here.

What can be done to benefit companies and encourage investment?

  Recent tax changes have done quite a lot for business angels, AIM and OFEX investors and Founders and senior staff of start-up companies. In addition to the action suggested for non-executive Directors it would also be very helpful if the Government were to find a way to encourage Pension Funds and Insurance companies to invest in private companies.

  One final point: I understand that the British Venture Capital Association recently commissioned a report by the London Business School and that its contents could be of some interest to you. I have not seen a copy at this time.

1 May 2000


 
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