Unlocking the VCT cash millions

There is over £1 billion of VCT cash just waiting to be invested in fast-growth companies. Oliver Haill speaks to the fund managers who can turn ambition into reality.

‘Smaller companies offer very attractive growth opportunities, even if the economy is slowing,’ observes Stuart Veale, managing director of the private equity firm Beringea. ‘They’re in a different position from larger companies, which rely more on the whole economy. Small, rapidly growing concerns in dynamic markets are showing good growth and we’re investing.’

Veale oversees the firm’s highly successful ProVen series of venture capital trusts (VCTs), two of which won the VCT of the Year award from Business XL’s sister title Growth Company Investor after producing bountiful rewards for investors in the last few years.

At present, ProVen has £36.6 million of available funds and recently pumped £1.25 million into online travel aggregator Isango and £1.75 million into security solutions provider Optic Vision.

The point of these specialist vehicles, which were launched in the 1990s and have lucrative tax incentives for investors, is to bridge the so-called equity gap between banks, government grants and business angels, and more formal venture capital financing.

Riches await

According to research by Business XL, there is currently £1.02 billion of VCT money available for investment in growing UK companies. On top of this figure, even more will soon be accessible from the £116 million – and more – that has been pulled in so far by new and still-open funds.

Once funds have been raised, VCTs are obliged to invest at least 70 per cent of their cash within three years, so VCTs that were launched in 2006 might be closer to parting with their money than others. Furthermore, the trusts can only invest a maximum of £1 million in any one qualifying venture.

As the principle of the scheme is to ensure funding exists for ambitious but high-risk British ventures, the government has chopped and changed the rules regarding the size of company it sees as the ideal recipient.

Originally, no business could receive investment if its gross assets exceeded £15 million. This provided a large swathe of options in the smaller company space for VCT investment. In 2006 then-Chancellor Gordon Brown revised this rule so that any money raised by VCTs before 6 April 2006 had to be invested in firms with gross assets of no more than £7 million before investment (and no more than £8 million thereafter). Last year’s Budget saw further alterations, with the stipulation that newly raised money must be poured into companies with fewer than 50 employees – and that the ceiling of new VCT funds invested in any one venture must not exceed £2 million.

Critical criteria

The reason for the changes is to keep VCTs focused on backing entrepreneurial companies engaged in ‘qualifying business activities’. While some market observers believe that any alterations to the investment criteria might hamstring longer-term activity, our research indicates that entrepreneurs have no need to worry about this for now. This is because the majority of the pool of VCT cash was raised prior to 6 April 2006 and so can be invested in ventures with up to £15 million of gross assets.

So, if your business has gross assets of £7 million or less – regardless of how many people you employ – you can make a bid for the money, as well as the £116 million that has so far been drummed up by 2008’s funds.

Fitting the bill exactly for Beringea is Oxfordshire-based Path Group. It backed the £7 million management buy-out of the distributor of consumer electronic accessories through two of the ProVen VCTs and added a couple of new non-executive directors to the board.

However, despite this recent incursion, Veale says the ProVen funds’ focus is now on growth capital investments rather than management buy-outs and buy-ins: ‘The companies we’re looking at are relatively small, operating in a good market and are either growing particularly fast or occupying a niche. We are interested in all sectors, but a common theme of our investments is that they have strong management teams and a good competitive advantage.’

There are a number of other VCTs with plenty of cash to invest. Octopus Protected VCT is third in our list of cash-swamped trusts. Simon Rogerson, chief executive, can boast that Octopus’s many arms of VCT funds represent a whopping £250 million, in which Business XL calculates there remains £97.9 million available for further investment.

However, Rogerson says he’s in no hurry to splurge. ‘Yes, we’re sitting on a lot of cash, but we’re happy to keep doing that. The economic situation has caused values to come down a little, but we think they will come down more so we’re being patient.’

He and his team divide their strategy and VCTs in three ways. The ventures team, via the Titan 1 and 2 VCTs, is focused on small, early-stage, unquoted companies, investing up to £2 million. Then three Eclipse VCTs back management buy-out deals of between £5 million and £20 million, and the Protected and Apollo VCTs provide mezzanine finance of around £1 million to £4 million. A recent deal saw Octopus back the MBO of Hydrobolt, which makes fasteners for the gas industry.

This had a lot going for it, explains Rogerson, as the company was well established and profitable, with good turnover. ‘Its exposure to oil and gas means it’s well protected from potential economic woes. We invest in things that we think will become big businesses. In these economic times people have a natural scepticism of businesses that are very focused on consumers.’

Getting your hands on the cash

Some firms are more open to offers than others if you are aiming to stake a claim for this bulging cash kitty, and methods vary slightly between firms. One of the largest in terms of available funds is TriplePoint, whose second fund, in association with hedge fund specialist GAM TP70, has just shy of £30 million, and whose third, brand-new TP70 2008 VCT, which only just closed in April, has raised a whopping £44 million. However, TriplePoint intends to keep around 15 per cent of each VCT’s assets invested in a hedge fund, and for the remaining amount that must be invested in qualifying companies, it ‘does not accept direct applications’. Rather, TriplePoint targets companies it thinks would benefit from the funding.

For Patrick Reeve, managing director at Close Ventures, a variety of methods are used to cast the net as far and wide as possible to find great companies. It uses a network of corporate finance introducers, lawyers and accountants to source companies, as well as a personal internal referral system. Then there are the direct applications too.

A cold wind blows

The wider landscape is, of course, a concern for fund managers. Reeve, whose Close Technology & General VCT is the fourth most cash-rich, says values at the smaller end of the market are not falling, but ‘we’re beginning to see a little bit of distress in the current economic climate’.

And so in some sectors this is beginning to affect how companies are priced: ‘Valuations are starting to be a little more aggressive, particularly in certain areas – small management buy-outs, technology less so I think, but consumer-facing companies are being viewed more critically, obviously.’

Beringea’s Veale has a slightly different view: ‘Businesses get an idea of what they’re worth, so even when the cold winds of an economic slowdown start to blow they are reluctant to change their valuation.’

While some VCTs may be playing a waiting game, one thing is clear: there are literally millions of pounds that have to be invested over the next 18 months.

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