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Venturing into growth capital market

With bank lending volumes slashed since the global economic crisis, businesses are sourcing other means of funding growth.

For small and medium-sized enterprises (SMEs), availability of affordable finance is often the difference between success and failure. A recent European Union report found that around 50 per cent of new businesses fail during their first five years due to a lack of “an appropriate ecosystem” to help them to grow.

So with traditional avenues often exhausted, businesses are increasingly looking to venture capital (VC) investment. Traditionally overlooked by many, VC investment is a source which is witnessing something of a renaissance with government initiatives raising the profile of the VC investor.

A VC investment allows a business to access cash from a high-net-worth individual or a VC fund which pools investors’ cash.

In return for investing in a business, the VC investor will typically be seeking a high percentage return from the company’s profits and, in many instances, will look to play an active part in the management of the company.

And business owners may be surprised to learn of some of the brands which have benefitted from growth as a direct result of this form of investment. Among the success stories is internet calls and conferencing business Skype, and software company Autonomy which was recently acquired by HP.

There are numerous VC funds in the UK looking to invest in different types of businesses in a wide variety of sectors

According to statistics released in February by the British Venture Capital Association (BVCA), UK-managed VC funds currently back around 3,800 companies and are responsible for employing more than 500,000 people across the country. What’s more, 90 per cent of the businesses backed in 2011 were SMEs and funds from this type of investment have channelled £40 billion into British businesses over the past five years.

Paul Latham, managing director of Octopus Investments, says the support offered by the venture capital industry to UK smaller companies should not be underestimated.

He says: “With access to funding still a challenge for most small businesses, venture capital trusts [VCTs] can continue to play a vital role in helping UK businesses grow to become market leaders and world beaters.

“A recent survey we conducted demonstrated our investors like to feel like they’re playing a role in the recovery of the UK economy, thanks in no small part to their VCT investment.”

For those looking at VC funds as a potential avenue to raise finance, there is good news.  There are numerous VC funds in the UK looking to invest in different types of businesses in a wide variety of sectors.  The bad news, however, is that competition for financing is tough, albeit not impossible.

The recent BVCA Growth Initiative report found that proprietors may find VC investment better-suited to where their companies are in the growth cycle.

The report notes that bank lending – in whatever economic environment, but certainly the current one – can be limited because businesses may be pre-profit or even pre-revenue and unlikely to suit the risk appetite of a bank’s regional loan manager.

In these cases, the risk profiling tools employed by banks and commercial finance providers can be quite rigid, unlike the private equity and VC market.

Private equity and venture capital is a leading provider of patient capital and half of all Europe’s activity comes from the UK. So if a business is genuinely innovative, VC investment may offer more options that your local high street bank.

Companies such as Albion Ventures, Maven and Downing all have long track records in VCT investment and also have decent figures for the returns they have secured for their investors.

There are also other, more specialist investors, such as EC1 Capital, which invites applications from those operating in the tech start-up space.

Andrew Ferguson, a partner at Maven, explains why competition is so fierce in the VC market at the moment. “The UK is full of good quality SMEs, with strong management teams that warrant investment and support,” he says. “We focus on backing those teams which run market-leading or market-influencing companies and have a clear strategy for continued good performance.”

Mr Ferguson says that Maven prefers to work on a local level in order to get involved with the businesses in which they invest. “Our regional presence allows us to develop strong relationships with both company management teams and their advisers, and then to provide the ongoing support, both financial and strategic, that companies need in order to deliver their business goals,” he says.

Like any type of investor, VC investors seek areas which they believe are ripe to flourish over the coming years. This means that SMEs in certain areas may find it easier to secure backing than others.

Chris Allner, a partner at Downing, says there are certain areas which are more appealing in the current climate. “We see particular opportunities for investment in the leisure and education sectors, and have undertaken a number of buy-and-build strategies in health clubs, schools and children’s play areas,” he says.

“With the recent focus in the media on childcare provision, we are also investors in children’s nurseries and see this as an area of future investment, working alongside established reputable operators.

“VC Trusts continue to be a prime source of equity funding for SME companies, which the government recognises offer growth prospects for the economy and employment opportunities to mitigate the impact of the reducing public sector.”

In January, EU policymakers recognised that small and growing businesses are hungry for more VC investment and laid down the first draft of the Entrepreneurship Action Plan (EAP). This is a Europe-wide project which aims to improve SMEs’ access to finance.

Specifically, the aim is to develop financing programmes with the VC industry to establish a credible new finance mechanism. It is hoped that SMEs will then be able to use the capital markets more easily with a new trading platform exclusively for SME shares and bonds.

However, the plan is still in its early stages and may take some time to come to fruition as EU member governments are now looking at areas of their own financial legislation which need to be adjusted for this to happen. That said, the initiative has been earmarked as a priority.