Venture capital's land of plenty
Article Date: May 26 2006
Venture capital investment in the UK is second only to the US in terms of size and sophistication. This lively domestic market is great news for growing firms that seek funding and many UK enterprises are now attracting significant levels of overseas cash.
Beyond a shadow of a doubt, British enterprise is of vital importance to overseas investors. Statistics from the British Venture Capital Association (BVCA) suggest that the UK currently accounts for some 52 per cent of the entire European private equity and venture capital industries by value. Moreover, investment firms in Germany, Southern Europe and the Benelux regions all channel more than 20 per cent of their reserves into the UK. Add to that interest from the US – the largest venture capital/private equity market in the world by some distance – and the foreign cash available to UK businesses is phenomenal.
This becomes even more evident when you consider further figures from the BVCA, which suggest that of the £3.3 billion raised by UK venture capital and private equity funds in 2004, a staggering 41 per cent came from North America.
Meanwhile, according to a recent survey from accountancy group Deloitte, only 11 per cent of US investors currently invest outside of America, but 20 per cent plan to increase their level of overseas investment over the next five years. The emerging markets of China, which 20 per cent of these firms identify as their main focus, and India (18 per cent) will be the major beneficiaries. However, some 11 per cent cite the UK as their key focus, placing it more or less on a par with Continental Europe as a whole (13 per cent).
‘Previously, fund rules would have prevented US firms from investing too much of their portfolios overseas but that’s changing now,’ explains Jeremy Furniss, partner at corporate finance house Livingstone Guarantee. ‘Five years ago I’d have said US funds were investing 90 per cent of their money at home and ten per cent overseas – these days I suspect the split is edging closer to 60/40.’
Why the interest?
‘One of the biggest things that changed perceptions of Europe was the success of Skype, says Chris Grew of US-based law firm WilmerHale, a significant player in the UK investment market. ‘Bessemer, a US venture capital company that didn’t really have a presence in Europe up until that point, achieved a phenomenal return.’ Though Skype was based in Luxemburg, Grew adds, ‘I think that deal opened up significant US interest in European markets, including the UK.’
What stands Britain in particularly good stead with investors in the US is its way of life. ‘There may be more competition for deals in the UK than in other European markets,’ notes Furniss, ‘but as a culturally similar, English-speaking country, it’s also a familiar market for them to operate in.’
It’s for this reason that the UK, and London in particular, has become a launch point for many of the US venture capital houses operating in Europe, through local offices. However, there are other factors at work.
‘There are two main issues relating to the UK Government that play a vital role,’ says Grew. ‘The first – and I have to say that I have no particular political leanings – is that it’s truly remarkable what the UK Government has managed to achieve in terms of making the tax environment favourable for entrepreneurs. Capital gains tax is lower than in the US when it comes to selling shares, and awarding options in the UK is more favourable as well. The DTI and UK Trade & Investment, meanwhile, have played a big role in both bringing US investors over here and taking UK companies overseas to raise awareness.’
‘I don’t think there are any fiscal enticements to invest in UK companies, but there are things relating to CGT and options which are big draws,’ concurs David Carratt of pan-European venture capital house Kennet Capital. ‘Certainly, the UK is better than anywhere in continental Europe in that respect.’
Lost in translation
While the general familiarity of the UK market coupled with these Government initiatives have greatly increased levels of inward investment, it must be noted that there are major differences in perspectives across trade borders.
‘US venture capital firms are far more focused on the upside associated with transactions than UK investors,’ says Grew, referring principally to the high-tech venture capital markets. ‘This in turn often sees them take on higher-risk deals and focus a greater deal of attention on making money.’
As Carratt puts it, ‘when it comes to returns they tend to be far more interested in really shooting the lights out than European funds.’ Those seeking investment from the overseas markets, in particular the US, therefore need be aware of what’s expected of them in terms of performance.
Grew points out that, ‘some big firms like Accel Partners and Benchmark have established UK offices. They understand there are differences in both sets of market forces and issues of valuation in both territories, so they are able to back the best businesses in each market as a result.’
The differences don’t end there either. Deal structures can vary hugely. ‘Our experience is that there tends to be a higher degree of gearing involved,’ says Furniss, who worked on the £300 million institutional buy-in of building supplies group Polypipe last summer. This transaction saw New York investment group Castle Harlan assume control of the UK-based business. ‘In that instance,’ he continues, ‘it was more of a US-style deal with probably £7 of debt for every £3 of equity put in, although that debt does tend to come from UK lenders.’
There are even some cases in which businesses will be requested to re-establish themselves as US-based entities post-transaction.
In-game advertising group IGA is one firm to have gone through this process, with Ed Bartlett (who heads up the UK-founded company’s European operations) explaining that, ‘we’ve now set ourselves up as a Delaware incorporated company and our chief executive and chief strategy officer have both relocated to New York. That was part of the deal when we secured funds. We were aware that this would be the case, but I’d advise other people that you do have to go into this kind of deal with your eyes wide open.’