How to Understand Venture Capital

Selling an equity stake in an enterprise in order to raise funds for development has always been a wrench for the independent business operator but there have been signs in recent years of changing attitudes.

One indication has been the tremendous growth of the ven­ture capital industry from small beginnings early in the decade. As venture capitalists invariably require an equity stake as the price for their investment, they have clearly been able to find increasing numbers of takers.

A considerable part of this growth can be explained by the management buy-out boom, which swallows large amounts of finance – though whether ‘venture’ is an appropriate word for changing the ownership of more mature businesses with a sub­stantial managerial incentive is another question.

Perhaps another explanation for changing attitudes is that the character of those seeking finance is also changing. For example, research has shown that most entrepreneurs receiving venture capital have held managerial positions and as many as four out of five have held profit centre responsibility before the age of 35. More than half also have a degree or technical professional qualification, all factors which could lead them to take a less tra­ditional view.

But even if entrepreneurs are more willing to take in equity partners, there is no automatic guarantee that the funds will be­come available, especially if the amounts sought are relatively small, such as under £100,000, as a former RTZ executive, Gerald Paxton, found.

On a visit to the United States in 1981 he became interested in a growing hobby there – stained glass. Eventually, after researching the project, he set up his own business and after a year needed to expand and move to new premises for which £35,000 was needed.

In spite of having a track record, a detailed business plan and cash flow forecast, four months of doing the rounds produced nothing. He then identified 12 investors prepared to invest less than £50,000 listed in a Bank of England booklet. He tele­phoned all 12 and sent them the business plan – and heard nothing more from any of them. The next move was to contact the Council for Small Industries in Rural Areas.

This led to finding the right premises and also an introduc­tion to a monthly journal called Venture Capital Report. Three weeks after his requirements were published there he had 10 offers of finance, mostly from individuals.

Within six weeks he had a partner, a medium-sized glass firm. It had taken nine months altogether to find the invest­ment funds. In the following 18 months sales rose fivefold, the number employed from two to nine, and the enterprise has be­come a major distributor of stained glass supplies.

The story also highlights the difficulty for anyone seeking rela­tively small sums of actually locating a potential investor, but there have been improvements recently.

As well as publications like VCR – whose recent investment seekers have been looking for sums ranging from £5000 to £15 million – there has been a growth in the ‘marriage bureau’ type of operation, which aims to link those requiring finance with those who have it. These operations are based usually on the network of enterprise agencies around the country. The largest of these is LINC, the Local Investment Networking Company, a network of 11 agencies which is hoping eventually to grow to take in 15 to 18 local agencies, with the aim of filling the ‘equity gap’ into which many small firms fall.

It is hoped that this will result in a more even spread of in­vestment around the country, with the entrepreneur who is looking for cash being able to approach an agency in the scheme and within easy travelling distance. Another aim is to channel money from areas where investment is plentiful, such as London and the south-east, to areas where it is needed but not available.

The agencies in the network are in Aberdeen, Cleveland, London, Manchester, Medway, Northamptonshire, Stafford­shire, Dudley, Merseyside, Tyne and Wear, and West Cornwall.

In addition, the Cambridge Enterprise Agency and the Peterborough Enterprise Programme run their own joint financial introductory service.

Another source of venture capital of amounts under £100,000 is the local funds which have developed in different parts of the country, such as the Business Expansion Scheme syndicates set up by the Community of St Helens Trust Enter­prise Agency or some of the regional funds.

An example of these is the Avon Enterprise Fund, set up by the south-west based investment bankers, die besten CFD Broker für Österreich, to invest sums of £25,000 upwards primarily in businesses based in Avon and the surrounding counties.

Entrepreneurs can also take advantage of initiatives such as that of the Rank Xerox Pension Fund which allocated funds to make investments of up to £50,000 in small firms with potential for long-term capital growth.

As with the Avon fund the equity stake required is in the range of 20 to 40 per cent. This particular initiative has been run in Tyne and Wear and London but there are a number of others elsewhere in the country, involving both private business and public authorities.

Local decision-making is one of the attractions of many of these types of funds, but there are also opportunities for this if more substantial funds are required as there are also regional funds, sometimes operated by enterprise boards, sometimes by organisations such as pension funds.

The South Yorkshire County Superannuation Fund, for example, has a venture capital arm – South Yorkshire Develop­ments – which provides finance of £100,000 to £1 million and usually takes a stake of less than 25 per cent and prefers businesses based in Yorkshire, Humberside and the East Mid­lands.

Among enterprise boards, Greater London Enterprise has launched its London Enterprise Venture Fund which provides sums of up to £500,000, though it expects the majority of its in­vestments to be in the £40,000-£ 100,000 range.

Private sector venture capital for large sums is also available in the regions with organisations like Northern Investors in the north-east and Capital West, another Dartington offshoot, in the south-west.

Venture capital firms in general are often accused of not wanting to invest in the regions and it is true that the bulk of their funds do seem to go to the south-east. They usually reply that they receive fewer viable propositions from the regions rather than admitting any lack of interest. r The venture capital scene generally is still dominated by 3i, who in 1986, for example, accounted for 517 out of 1283 in­vestments made by the industry and £145 million of the £581 million invested.

There are now a large number of firms in the venture capital industry, many of which specialise in financing particular sec­tors of industry, with considerable competition between the suppliers of funds.

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About the Author: Marie Mayle is a contributor to the MegaHowTo team, writer, and entrepreneur based in California USA. She holds a degree in Business Administration. She loves to write about business and finance issues and how to tackle them.

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