UK: Nanny goes to market - 3i prepares to go public.

UK: Nanny goes to market - 3i prepares to go public. - For decades 3i was the source of venture capital, is still by far the largest, and sniffs rather at newcomers as it prepares to go public. Peter Wilsher reports.

Last Updated: 31 Aug 2010

For decades 3i was the source of venture capital, is still by far the largest, and sniffs rather at newcomers as it prepares to go public. Peter Wilsher reports.

Real men, they say, don't eat quiche; but real quiche-makers are voracious and enthusiastic consumers of expansion capital. Cavenham and Simms, the fast-growing Carlisle-based food manufacturers who are Marks and Spencer's biggest supplier of such delicacies, concluded their first deal with 3i back in 1957 when they were still just a small, family-controlled bacon-curing concern. Now, 10 rounds of financing later, they have a string of production plants, a widely-admired distribution network and well-advanced plans to start exploiting the export potential in a set-up which includes Europe's most modern sausage and pepperoni factory.

This is one of the longest-standing clients in 3i's constantly changing portfolio. Altogether some 11,000 companies have passed through its books in the 46 years since it was founded as the Industrial and Commercial Finance Corporation (the 3i trademark came from a later title, Investors in Industry) to help kickstart the post World War II recovery programme. A few of its changes have foundered, but the great majority have survived and prospered in one way or another - even though many, over time, have inevitably merged, been taken over, gone public, or just found other backers. The current stable runs at something over 4,000 names, each backed with its own judicious mixture of loan, preference and equity funding, and, naturally, most are relatively recent arrivals. The main point, after all, is to encourage new forms of enterprise. But there is a hard core of old faithfuls, also. When David Marlow, the chief executive, decided recently to hold a dinner for customers who had been around for quarter of a century or more, he found it was necessary to send out 110 invitations.

ICFC was born in an attempt to solve a problem first highlighted in the 1930s: the difficulty supposedly faced by fledgling businesses, under the British banking system, in finding medium to long-term capital during the period when they are getting too big to rely on retained earnings and the owners' private resources but still too small to go public and launch themselves effectively into the equity market. This became popularly known as "the Macmillan gap", after the chairman of the parliamentary enquiry which originally indentified it, and in the initial phase of post-war reconstruction the Bank of England, with the main English and Scottish clearing banks as its partners, agreed to make available the necessary funds and institutional arrangements to ensure that it could be filled.

These have remained the controlling shareholders, through nearly five decades of often spectacular growth (during the second half of the 1980s the compound return from dividends, loan repayments and disposals was running at 22% a year). But the decision has now been made that it is time for a parting of the ways. In the course of 1992 (but probably now not until after the general election) the stock market will be faced with a challenging new valuation-exercise: putting a price on a vast cupboardful of assorted assets which collectively reflects the past performance and future prospects of Britain's middle-range industry.

At the most basic level 3i does much the same as any other capital-provider. It looks for attractive situations, weighs up the people involved, provides the finance needed to carry out their plans, and ultimately aims to be well rewarded for its pains. But three things differentiate it sharply from its peers: its sheer size, the unequalled range of its experience and above all the extended time-scale within which it is prepared to work.

In money terms its £3-billion portfolio will make it the giant of the investment trust sector: three times the size of Foreign and Colonial, the current leader and still further ahead of the more specialised groups like Candover and Electra, which were created explicitly to cash in on the 1980s venture capital and management buy-out boom. By the time they were born, 3i had already been in business for more than three decades, and had pioneered, if not invented most of the tricks of that particular trade. But the characteristic which most clearly marks it out is the patience with which it is prepared to nuture the fledglings which prefer to stay under its wing. Characteristically, the newer groups seek to be in and out of the situations they have nutured within three, or at most four years, and in many cases have become notorious for the pressure they exert to achieve a remunerative exit. The 3i philosophy, however, cheerfully accepts that some relationships, like the best marriages "may be for years, and may be for ever". Which is the attitude which leaves Howard Simms, chief executive of those Carlisle quiche makers, happy that he turned down a proposal to go public in the 1980s and remain instead in the 3i play-pen. "They have been with us every step of the way. They encouraged us when we wanted to float, but then were equally understanding when we decided to pull out - and during the period immediately after when we were hit with the listeria scare. We get quick answers, lending terms as keen as anyone's and no pressure to change anything we don't want to change for ourselves."

To reinforce, and indeed to capitalised on such perceptions, the present 3i chairman, Sir John Cuckney, and his chief executive, David Marlow, have decreed a fundamental revision of the way the group sees its role.

They have developed a growing distaste for the values that have lately attached themselves to the term "venture capital". They dislike intensely the notion, fostered by some of their more recently-arrived competitors, that the main objective is to extract the maximum profit as quickly as possible with the minimum concern for the beneficiary's on-going health. And they cringe at the phrases currently being bandied around by some of their industry's more disenchanted customers. "We know them all," says their marketing director, Chris Woodward. "Vulture capital. Rip-off capital. We don't want any of that, or the damaging confusion it engenders."

Two years ago revulsion reached such a pitch that they agreed to drop the phrase entirely from the group vocabulary and substitute instead the more neutral expression "investment capital". As Cuckney himself defines it: "Investment capital implies long-term, non-interfering loan and share capital, which is what we provide; whereas venture capital has tended to be a description often applied to shorter-term funds where a more rapid portfolio turnover is sought." The distinction is now emphasised in every speech, seminar and piece of publicity material that originates from the 3i headquarters in London's Waterloo Road. And the resulting re-think is not only a matter of semantics: it has triggered some extensive pruning, including the elimination of the group's once-flourishing property development and management-consultancy arms and the institution of a fairly sweeping redundancy programme. As a result, the staff has been trimmed back from 1,000 to 750, and several very senior people have disappeared, most notably the MD in charge of UK investment, Derek Sach. "We are now pursuing a policy of concentrating on our core business: the provision of long-term investment capital to companies of all sizes without access to the capital markets," David Marlow crisply explains.

But although that remains technically true there is no doubt that 3i's essential strength lies in its commitment to middle-sized business. "Germany's economic success stems very largely from the breadth and depth of its Mittelstand - the group of medium-weight companies, mainly still private-or family-controlled, which bridges the gap between the small and struggling and the bureaucratically vast," says Woodward. And he, like both Cuckney and Marlow remains convinced that cultivating this constituency is the best service they can provide, both to the UK economy and their own financial health.

To carry out that function effectively, however, requires one overriding skill - the ability to recognise the ideas and people that are worth backing for the long haul, and weed out as many as possible of the fly-by-nights and foredoomed duds. That is currently the job of John Kirkpatrick, who heads the group's modestly-titled engineering department. This is 3i's secret weapon (not to mention its Unique Selling Proposition) and possibly the key ingredient that marks it out from the opposition and accounts for its continuing success.

The team that Kirkpatrick heads, based in Birmingham, consists of 25 "executives" who between them can boast an almost unrivalled knowledge and understanding of Britain's economic landscape. Typically they are blue-chip trained engineers or accountants, with a few years in consultancy, and then a period running their own company or at least a large subsidiary.

Kirkpatrick himself fills almost exactly that bill. He started as an electrical engineer with ASEA and Canadian Westinghouse, spent a short time with Sir William Halcrow, the civil-engineering consultant, stepped sideways into Unilever's management development group, got on the food-production ladder, picked up an MBA at Cranfield, jetted all over the world as a Shell troubleshooter, and then fell out with Normand Electrical when the management there decided not to give him the top job. "That's when 3i said "Walk this way" and I thought I'd give it a try," he remembers. That was 11 years ago, and now he commands a team-of-all-the-talents which embraces every kind of expertise, he reckons, from a veterinary surgeon now looking after pharmaceuticals and exotic chemicals to a couple of surveyors who check up on the value of the factories that get offered as collateral.

The routine is to receive recommendation, usually from one of 3i's 29 regional offices, and then dispatch the relevant sector expert to give it the once over. He distils his findings into a 5,000 word report, and if that is favourable, one of the eight accountants is unleashed. Decisive brevity is the requirement - "Not quite four-letter words, but pretty close" - and the result is a swift thumbs-up or thumbs down. In a typical year, 900 visits are made, and another 500 reports made on proposals by existing clients to expand or go into new areas of activity.

There is no attempt in Waterloo Road, or the 29 regional offices which provide the bulk of the propositions it considers, to claim that there are no mistakes. Indeed Marlow openly admits to 3% of deals going sour in their first year. But overall, the record is consistently positive. Roger Alford, the Cassell Reader at the London School of Economics, has carried out a careful survey, and he reckons that, year in, year out, the score is 60:40 in their favour, "and that is pretty good". Just how good is underlined by a recent survey from Searchline, the banking research group, which nominated the group as "top performing bank of 1991" with its subsidiary 3i plc as number 10. Not one of its high-street-name shareholders managed even to scrape into the top dozen.

The string of successes on which that record is based has embraced a plethora of industrial and commercial organisations over the years. The most spectacular winner was British Caledonian, once written down in the 3i books, during its more troubled years, to just £1, and finally sold to British Airways for a profit of just on £100 million. But the list of those grateful for Waterloo Road's patient support also embraces such well-known performers as Wickes, the hardware and do-it-yourself chain, Weetabix and Iceland Frozen Foods in the household larder sector, and a varied list of past and present top-notchers ranging from Laura Ashley and Oxford Instruments to Geest bananas, English Country Cottages and the Carron Phoenix heavy engineering concern.

The most prevalent criticism of 3i is that, despite Kirkpatrick's protestations, it is insufficiently imaginative, especially at the smaller end. Paul Lammer, who runs a high-tech security firm called Saphos in Abingdon (and only got off the ground with the help of wealthy private individual who agreed to back him) speaks for many when he says: "They didn't want to talk to us about £200,000 for a high risk venture. They would have much preferred to discuss £1 million for a low risk sure thing."

Marlow dismisses this. The tiny high-risk start-ups, he points out, will never account for more than a minor proportion of the investment fund, but they will always be crucial in earning the occasional really spectacular return. He proudly recalls one gamble, 20 years ago, when £2,000 bought a 20% stake that "paid off enormously". But unfortunately the enthusiasm of the people who think up a particular idea is no guarantee that it will work - and certainly no reason for rejecting the judgment of experienced experts who find it flawed.

He himself goes back to the ICFC days, 31 years ago, when he threw up an accountancy career with Peat Marwick, to join the Leicester office which had just opened for business. "I liked its strong sense of service, combined with sensitivity to the market - at the same time commercial and ethical," he says, and that is the flavour he expects to survive when the group strikes out on its own.

He therefore shrugs off fears that "going public" will force any serious change of style. Thanks to an agreement recently concluded with the Inland Revenue, the group is now formally recognised as an investment trust, which both shields it from capital gains tax and bars it from distributing capital profits - thus alleviating any pressure for premature asset-realisation. Barclays and NatWest have agreed to retain a substantial shareholding (probably 25% between them) which should effectively deter any possible predator. And the earnings record (despite some setback during the current recession period) will speak for itself, he believes, when it is spelled out in the prospectus. Honour and profit will be shown to be perfectly compatible. And let the vultures fly where they choose.

Peter Wilsher is a freelance consultant and writer.

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