Introduction to Venture Capital and Private Equity was the theme of the second workshop in the research into innovation and enterprise in Greater Manchester hosted by Eversheds.
On the panel were Mike Perls (MC2), Gary Tipper (Zeus Private Equity), Jonathan Diggines (Enterprise Ventures) and Doug Stellman from YFM. Both Doug and Jonathan are VC fund managers as part of the £185m North West Loan Fund. I chaired the session and thoroughly enjoyed every moment and many thanks to Simon Cleaver from YFM also in support.
The introduction was based on the ten things everyone should know about SME’s in Greater Manchester, in itself the subject of another blog post to follow. Of the 11,000 start ups every year in Greater Manchester, the initial funding was secured in the main from three sources, A: the three F’s, founders, family and friends, B: secured bank finance, short loans or credit card, and C: business angels or “Shadow investors”. Government grants accounted for under 10% of all transactions and the formal Venture Capital market is involved in less than 5% of start up situations.
Venture Capital is the provision of early stage funding or seed funding to businesses with high growth potential. The investment may be pre revenue where the business has not started to trade, or pre profit where the business has yet to generate a profit. Venture Capital funds make high risk investments which are unsuitable for bank finance in the leverage funding process. VC’s will invest in high tech and low tech investments. High tech may include some “Proof of Concept” fund provision.
Private Equity on the other hand is the provision of equity to later stage private ie non public companies with an established business model and most importantly profits and cash flow. EBITDA, (Earnings before Interest, Tax, Depreciation and Amortisation) is the key driver to value since it is the one factor that can service debt and provide a return to equity. Private equity funds can provide additional capital to business for an equity stake but are also used in the acquisition of all of the share capital for total control. This can include the acquisition of a public company as the business is taken private.
Since the business has established cash flow and and asset base, bank debt can be engaged in the mix since the interest can be serviced by the cash flow (EBITDA) and debt secured against assets.
Into the acquisition finance package is what is termed as a mezzanine strip where equity and bank debt are blended with some form of preference share carrying a higher dividend coupon.
Investment in start ups is high risk. Research confirms the half life of a new business is 4.5 years. One quarter of all new businesses will fail within two years, half will fail within five years and the mid term survival rate is just 16%. Jonathan Diggines explained the J curve . The phenomena in which over a ten year life, the VC fund value will fall to some 50% of initial value as some businesses fail and are wiped off the asset base. Gradually the value returns to par with a “modest” return to value over the ten year life. This takes “bottle” to stick with the fund as values fall.
Sixty five per cent of SME stock in the UK and in Greater Manchester are micros either sole traders or employing no more than four people. They are predominantly lifestyle businesses with subsistence and sustainability a priority. High growth is not on the agenda. High growth “gazelles”, companies of real interest to VC, are less than four per cent of total stock, hence the limited success rate of investment propositions.
In developing a public sector strategy for SME’s, it is important to realise that Venture Capital is high risk, with limited returns. Not all start ups are suitable for investment. Neither the public or private sector can support every start up any more than we can "catch every raindrop". More included in the formal report into innovation and enterprise.
Questions of the week.
According to the research, the average start up cost of a new business is £10,000 but for a women the average cost is just £7,500. Comments and explanations welcome.
Without the public sector, there would be no formal venture capital funds. So if the private sector cannot produce a return should the public sector be there?
Definitions
BIMBO Management Buy out Buy In
EBITDA Earnings, before Interest Tax, Depreciation and Amortisation
Equity Gap A myth of gigantic proportions
HLT High Leveraged Transaction (those were the days)
IPO Independent Public Offering, we used to call this a “flotation”.
LBO Leveraged Buy Out
Leverage The use of debt alongside equity in the investment
MBI Management Buy In
MBO Management Buy Out
PE Private Equity
Pre IPO A placement with an institutions or group of institutions prior to the IPO
RAMBO Rollover assisted MBO see VAMBO
VAMBO Vendor assisted MBO, the vendor retains a stake
VC Venture Capital
Comments