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Friday, October 24, 2008

Looking for Foreign Investment

Is there not just a hint of xenophobia in the way the British press has set against US private equity house TPG Capital, the key investor in a restructuring plan for troubled Bradford & Bingley?

This week, as B&B’s UK Shareholders Association advised retail investors to consider voting against the TPG offer at B&B’s upcoming general meeting, TPG has been on a charm offensive in the City of London to win round investors. With its wide experience of turning round struggling financial institutions, it proposes to parachute in two senior executives to head the rescue bid. But with several major institutional investors unimpressed by the terms, British financial entrepreneur Clive Cowdery has been lined up behind a rival offer – giving newspapers a chance for “Plucky Brit versus US Giant” headlines.

The world of private equity is a very different place to venture capital, of course. PE firms typically look to buy out established companies in need of a cash injection, and take them on to the next stage of growth before splitting them up or selling them on. VCs, meanwhile, look for medium- to long-term equity positions in high-growth companies. But in both areas, US money is still readily available – and US buyout firms are thought to be circling UK companies en mass. So why is the prospect of US investment so often seen as a bad thing?

Research from Library House shows how the investment picture is changing. Last year’s report, “Funding Growth in a Changing World: The UBS UK Venture Backed Report 2007”, found 1,668 venture-backed businesses in the UK, which had raised a total of £1.4bn in 2006. According to its preliminary figures for 2007, Library House estimates that the total investment fell to around £1bn, still a sizeable chunk of money but back to the levels experienced in 2003. It also found that outside the UK, US-based investors were the principal source of finance for these UK venture-backed companies. And although China is overtaking the UK as a recipient for US finance with India soon to follow suit, the UK still leads the rest of Europe.

These findings were reinforced by new research from the BVCA (now known as the British Venture Capital and Private Equity Association). It found that investments by UK-based VCs fell by almost half last year from £1.3bn to £683m. The total number of early stage deals completed by its 214 members remained pretty constant at 584, however, indicating that average deal size is falling. These figures were no doubt influenced by the much-publicised exit of 3i and Panmure Ventures from the early stage investment sector.

Overall – including private equity – the BVCA recorded a 45% rise in 2007 investment activity to £31.6bn. So clearly it’s the buyout sector that’s most buoyant for UK investors, particularly for AIM-listed companies.

So what should entrepreneurs make of the continuing interest from US firms, whether private equity or VC? Firstly, US firms are particularly excited about the UK’s mobile sector, seeing it as a gateway into Europe – but interest across the whole of the technology sector is strong, as well as certain areas of life science and of course, our much-vaunted creative industries. One company founder at a recent Library House event professed to be taken aback at the level of interest from US funds, while UK investors were noticeable by their absence. “There were wall-to-wall VCs and many were American,” he told me. “They said they were coming over to get the deals because we are more innovative.”

Although he was in the market for angel rather than VC investment, he was positive about his experiences with US investors. “UK investors tend to look at your business and ask: ‘What are the risks involved?’ whereas the US investors are much more concerned with the opportunities.”

Buoyed by this kind of attitude, the US route has been taken by several UK start-ups over the past few years. As Toby Strauss, chairman and co-founder of IT skills marketplace Orderwork, told g2i, the difference in attitude between the two countries is marked. “We found that the UK continues to be averse to investing in start-ups, whereas in the US, leading financiers are prepared to put seed money into ideas and see what happens. That difference in philosophy became apparent early on.”

There are of course some challenges to dealing with US money. There’s the small matter of the large pool of water that separates you from your investor, although many US VCs with a strategic interest in the UK either have offices in London or work with partners. Entrepreneurs and advisors who’ve dealt with US investors also advise you to set realistic expectations and keep on communicating your delivery against pre-agreed goals – which is good practice with any investor.

Most importantly, entrepreneurs need to ask what they’re getting out of the relationship, whether it’s strategic advice from a top US investor who’s been through the process of helping establish other start-ups, or a longer-term opportunity to access the US market. Whatever the value proposition, if the deal works for you at a strategic level, the colour of the money probably shouldn’t matter.

By David Longworth, Webster Buchanan Research