UK: SME - How to seduce a venture capitalist.

UK: SME - How to seduce a venture capitalist. - How can you persuade venture capitalists that you are going to be a plum and not a lemon? Preparation is everything - not just a glossy business plan.

by Sarah Gracie.
Last Updated: 31 Aug 2010

How can you persuade venture capitalists that you are going to be a plum and not a lemon? Preparation is everything - not just a glossy business plan.

It has often been said that it is easier in this country for a business to raise £5 million than £5,000. The notorious 'equity gap' does still exist, with venture capital companies contributing the majority of their funds to large-scale and 'safer bet' operations such as management buyouts. But the venture capitalists are beginning to invest in earlier-stage, higher-risk companies, following changes in the laws governing requirements for listing on a stock market (which have implications for how quickly a venture capital company can realise its investment) and some spectacular successes.

As Norman Murray, chairman of the BVCA, the trade association for the industry, and chief executive of Morgan Grenfell Development Capital, puts it: 'The climate for SMEs is good. The number of venture capital transactions done for amounts of £1 million or less has increased dramatically.

Venture capital companies will go lower now but only if a business offers serious growth potential.'

Growth potential is the first article of faith for a venture capital company, which usually invests for between two and seven years in unlisted companies in return for an equity stake. Their investment (known as the 'exit route') is realised when the company has grown to such a level that it is sold to a larger player or listed on a stock market. They expect a better return than on standard stock-market investments. As the latter have recently exceeded 20%, clearly the money in a venture capital investment has to work hard.

Because of the nature of the risk, venture capital companies calculate on losing a substantial proportion of their investments in companies that go belly up or underperform. The remaining companies must therefore do better to compensate. The art - and survival - of a good venture capital fund manager depends on building a portfolio with more 'plums' than 'lemons' or one with a plum of such spectacular size and quality that it outweighs the lemons.

So when you go cap in hand to venture capital fund managers, you are trying to convince them that you are a plum.

This means you should have ruthlessly researched your product or service and you need to convince them that you, and only you, are the person to drive the project forward. In the words of Martin Gagen, director of 3i, the UK's largest venture capital company: 'The old saying is true - only three things matter when you decide whether to put money in a business: people, people and people.'

You must have answers to all the questions that investors could ask you.

In particular, what is the unique selling point of your product and service?

Can you demonstrate demand? How does your quality exceed that of your competitors? Have you made realistic assessments of cash flow requirements?

Are you capable of setting up and managing financial controls? And how much capital do you need?

The answers to these questions usually take the form of a business plan (and glossy productions written by accountants will have no impact whatsoever if you, the entrepreneur, show yourself to be unfamiliar with the hard details of cash-flow or your market). Indeed, 30 pages of well-reasoned summary in the entrepreneur's own words is often better than a 100-page tome with sensitivity analyses put together by an accountant. At interview, you will obviously need to show a lucid grasp of the business and strategic vision. The arrival of the business plan is sometimes helped by a preparatory phone call from a sponsor, someone respected in your sector, who is able to put in a good word.

CVs are also crucial. They should not be vague and woolly ('I spent several years in the pharmaceuticals industry and then went on to do consultancy for a variety of firms.') They should give precise reference points: company names, dates, titles, and a record of relevant achievement. A word of warning: it is better at all stages to be honest, even when this may seem to you to jeopardise your chances of success. 'One of the worst things is when a history of insolvency or the equivalent unravels at a late stage,' says Steve Clarke, director of investment at 3i's Reading office. 'It usually means the end of the deal, not because of the fact itself, but because of what it implies about the way that someone does business.'

Finally, the search for venture capital should be targeted. Venture capital companies are not like high street banks, with a standard set of services.

They vary, depending on the sectors in which they invest, the stage at which they invest and the amounts invested. There is no point going to a company which invests an average of £50 million almost exclusively in management buyouts if you are a small fashion retail company seeking start-up capital of £50,000.

Equally, there is no point going to a fund that specialises in giving seed capital to biotech companies within the Thames Valley region if you are a property company in Edinburgh with a profitable trading history seeking £10 million for a strategic acquisition.

As for professional advice, accountants can do all this for you, but it is not strictly necessary. There are a number of sound DIY solutions.

You can approach the British Venture Capital Association (BVCA), which provides information and contacts and publishes a variety of useful (and free) booklets on the industry. You might also seek preliminary free advice from your local Business Link service. Richard Sharper of Business Link Wolverhampton, specialises in SME finance: 'Many of the people I encounter are extremely good at making widgets and no good at all at managing finance.

Their only idea of how to raise money is to increase the bank overdraft.

It is my job to encourage them to think more broadly.'

The cash-flow and investment advantages of venture capital can far outweigh a perceived loss of control that many SMEs dread, states Sharper. And the process can often bring in much needed (and otherwise too expensive) expertise because venture capital companies will often commit a member of staff as non-executive director.

Seeking venture capital requires patience and dedication. You may face repeated rejection and, if you are successful, it may take anything between a couple of weeks and 10 months for an investment to come through. As a result, set aside plenty of time and plan ahead. Budgeting for some professional advice in the later deal-making stage may also make sense.

START-UP TO STOCK MARKET IN SEVEN YEARS

Oxford Asymmetry was founded by Stephen Davies in 1991 to exploit the commercial potential of research done while he was professor of chemistry at Oxford University. The company was to supply chemicals services to pharmaceuticals, biotechnology and agrochemical companies.

Its first round of investment came from two 'business angels', who invested several hundred thousand pounds in return for an equity stake of just under 50%. They also introduced a crucial new member to the team, Edwin Moses, to add commercial ballast. Moses had top-level scientific and business experience and was ideally suited for the role of chief executive. He sought larger-scale investment for an ambitious expansion plan from venture capitalists 3i, which invested a total of £5.5 million in two separate rounds and took a minority holding in the business.

To date, Oxford Asymmetry has made profits of £2 million on a turnover of £10 million in 1997 (highly unusual for a biotechnology company at this stage). And Moses believes the company has only just scratched the surface of its potential market.

The company will shortly be listing on the London Stock Exchange and it hopes to raise £20 million, giving it - analysts estimate - a valuation of £100 million. Not bad for a company that is only seven years old.

WHERE TO GO FOR HELP

Independent bodies

British Venture Capital Association: 0171 240 3846

European Venture Capital Association: 00 32 2 715 0020

Business Links: 0345 567 765

Venture capital companies

Apax Partners: 0171 872 6300

Baring Private Equity Partners (more international): 0171 290 5000

ECI Ventures: 0171 606 1000

HSBC Private Equity: 0171 336 9955

Midland Growth Capital

(offers smaller amounts): 0171 260 8091

3i Group: 0171 928 3131

Accountants to SMEs

BDO Stoy Hayward: 0171 486 5888

Grant Thornton: 0171 383 5100

Reference

BVCA Directory - lists venture capital companies and contacts: 0171 240 3846 Venture Capital Report Guide - breakdown of investments by sector: 01865 784411.

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