Simon Calver, partner at BGF Ventures, explores the growing long-term investment model, patient capital.
Why is it that some companies find it easier to raise £500,000 when they barely have a business plan and one employee and yet can struggle to raise £5m three years from launch, having built strong revenue streams, won loyal customers and broken into new markets?
It’s a problem that has blighted the British startup world for years but it is finally getting attention, with both the prime minister and the chancellor recognising that companies find it hard to make the leap from startup to scaleup. Now Sir Damon Buffini, governor of the Wellcome Trust and a former head of private equity group Permira, will chair a Patient Capital Review for the Treasury.
Patient capital – or long-term investing – was the main reason that I decided to join with Harry Briggs and Rory Stirling, as founding partners at BGF Ventures, part of the Business Growth Fund.
At BGF Ventures, our role is to focus on companies at an earlier stage in their development, but we still intend to be long-term investors. We think that patient capital could really change the nature of venture capital and, more than ever, flexibility in how we source investment has to be a good thing.
To understand what we are up against, it’s necessary to consider the current model of venture capital. Funds raise money to invest in early stage companies over a pre-defined period, usually three to four years. The aim is to generate enough success to go through the whole process again and raise a second fund, which will often be larger than the first.
The problem with this business model is that the rush to raise a second fund can be a massive distraction for the partners away from the day job of helping to turn businesses with potential into something that can produce returns. VCs can be so busy demonstrating a few steep increases in company valuations that other investments – companies with employees – suffer.
If you can’t raise a second fund you are toast. Seven years down the line from fundraising, questions from investors about how they will get their money and returns back will become increasingly loud. Exits need to be found. Things can get uncomfortable.
This model ignores the fact that it takes time to build global companies. If a fund is driven purely by shorter term return needs, then the desire to supply one investor with liquidity may trigger unintended consequences such as a sale to a private equity house, or selling to a multinational strategic buyer. This is probably the backdrop to Edinburgh company Skyscanner’s sale to Chinese travel giant Ctrip.com last month. Access to capital markets – as we have seen at key points over the last decade – is not always possible or desirable.
To make sure companies and investors have other options, we need more patient capital throughout the different stages of growth.
In the US the attitude to larger fundraising at a later stage in a company’s growth cycle is hugely different from here in the UK. It is often quite common for companies worth over $1bn to use their position to raise significant further funds. This gives them a significant advantage when investing in innovation and in research and development, the expenditure that drives growth in productivity and market share.
At the same time, founders may take a bit off the table. This isn’t just so that they can buy the house on Waikiki beach: by spreading their own financial risks around, and realising some reward after years of hard work and basic salaries, they can renew their enthusiasm for the company they are leading.
We need to help achieve longer term funding options for companies in the UK, so that there isn’t a chasm between the money available to startups and the financing routes for established companies that are ready for the next stage in their growth. If we get this right, the reward will be creating even more globally successful companies to support our economy and create the next wave of entrepreneurs.
So how does patient capital differ?
Firstly, there’s no frantic fundraising in the first place. In VC you can often be investing alongside competitors as well as against them. It is good to see other funds now emerging with patient structures, such as Draper Esprit and Woodford Patient Capital.
Secondly, patient capital gives you flexibility to invest in a measured way. At BGF Ventures we are looking to invest £40-£50m a year in a dozen UK tech companies. If we only find eight this year, we will only invest in eight. There is no rush to deploy money in a certain time-frame.
If an investment takes more than ten years to realise, then so be it. Given the recent shocks in the market, frankly, the greater flexibility that founders and investors can get, the better.
All capital needs to generate a return and patient capital is no different. However, if after seven years, the value of the company is still rising, it makes sense for both the company and the investor to stick together. With the patient capital model this can happen easily, for an LP fund it is much harder.
When Sir Damon looks at patient capital I hope he finds that it is more founder-friendly and that it can give companies a real competitive advantage. We need to bridge the gap between our academic success in ground-breaking technologies and our track record in developing successful businesses from that cutting-edge research.
The Government has already created many incentive schemes such as EIS to encourage private investors to put money into early stage companies, but it would be great if more investors were encouraged to take a “patient” longer-term view.
2016 has been a year of shocks and surprises. Public markets have actually born this volatility pretty well, but that might not have been the case. In this new era of economic uncertainty, there is no better time to advocate the virtues of long-term investing.
We think rewards will come to those who are prepared to wait and we hope that the Treasury will see the long-term advantage to the country in supporting them.