11/03/2011

Signs Of Big City Strategies Now Appearing In The EIS Fund Market - Venture Capital Case Study

By Modwenna Rees-Mogg Founder and CEO of AngelNews

Did you know that in 2009 (the last year reported on by BVCA - (The British Private Equity & Venture Capital Association) the Technology Sectors absorbed £763m or 26% of the investment made by Private Equity in the UK? Or that this money was invested in 475 companies or 57% of the total? Looking in more detail at the stats you will see that it was only the Venture Capital end of the market (including Expansion Capital) that was investing in these sectors at all.

The devil is always in the detail in statistics of course. The lack of investment at later stages of the Private Equity market will be a reflection of all sorts of factors; not least the potential lack of opportunities, but that is a discussion for another day.

We are interested in Venture Capital most of all, and the BVCA’s useful chart is enlightening. You will see that whilst Technology investment was largely focused on software, investors were much more balanced in their investment in the different types of technology sectors. Despite the Credit Crunch its members still liked biotech, instruments, pharmaceuticals and electronics. And they continued to invest at Expansion Stage though less, I am sure, than anyone will have liked.

These numbers are gleaned from BVCA members, an important point, as they will not include data from the angel market, nor from non-BVCA members so it is hard to assess the total amount of investment across the Technology sectors, but it is probably safe to guestimate that a further £200m or so of investment was made under the EIS scheme.

What should private investors do if they want to take a share of this large part of the Venture market? Of course they can buy quoted stocks such as IP Group & Imperial Innovations, gaining exposure to a load of early stage deals or buy some shares in Beringea’s ProVen Health VCT in the secondary market. Another alternative is to join various private investor groups and take up any opportunities to co-invest in deals that come up, but most of these groups are equally focused on specific types of tech – TMT, Cleantech or Life Sciences these days - so the opportunities will only come up in proportion to the rest.

Trawling around the angel networks, incubators and university innovation centres may also turn up some gems, but this involves serious investment in time and due diligence if you do, like me, think you had found the next big thing, only to discover it didn’t last the course and you were busy reclaiming your losses under EIS (Enterprise Investment Scheme) from the taxman at the time you had thought you would be receiving a fat cheque from an exit.

From my perspective, it was fortuitous therefore, to uncover Parkwalk Advisors at a recent EISA party. Parkwalk Advisors is a gang of ex-blue chip City corporate financiers, equity traders & salesmen and wealth managers. They invest themselves, advise other private investors on investing and also corporates on raising money, M&A and exits. They are a mini-investment bank, in fact. And in terms of investing they have a focus - early stage venture capital in the technology sector, specifically British University Spin-out companies.

Why do they deserve a mention in this EIS issue of Making Life Richer?

It’s because Parkwalk also offers investors the chance to invest in its Technology focused EIS funds. So it seemed a good idea to get them on the phone and get behind the formalities of their published documentation, which people can read for themselves at parkwalk advisors.

I spoke to Alastair Kilgour and Moray Wright last week. As we chatted it became clear that the Parkwalk strategy is rather neat. If anything I think it reflects the history and experience of the individuals in the team rather than the just the market opportunity in either Technology as an investment sector or EIS as a tax break opportunity.

They stressed that their position in the market is underpinned by their genuine passion for enterprise and the fact that they believe that it will be the tech entrepreneurial businesses which will drive the UK out of recession and into long term sustainable growth. James Dyson is their great hero. Although they have had experience of many business sectors over the years, they chose Technology in its widest sense because at the venture end it had a number of characteristics which would help them meet their own objectives of becoming renowned venture investors, namely a thriving source of opportunities regularly being spun-out of the research departments of the UK’s universities and a number of skilled investors already in the market with whom they could co-invest and who would welcome their financial contribution to early stage funding rounds, but not so many that the supply/demand balance was out of kilter. The early venture market itself was attractive because it gives a chance to invest at great valuations, whilst avoiding the seed round stage.

“University research budgets in the UK are still £4.5bn with a further £2bn of private sector R&D done alongside. Did you know the UK invented the contraceptive pill, keyhole surgery, hip replacements, blood & glucose testing, and of course identified DNA?” Wright told me.

“Universities will continue to fund technology innovation or I will eat my hat. Oxford, for example, has 4,200 full time researchers, is the 5th largest filer of patents in the UK (the largest non-commercial filer) and has had 57 Nobel Prize winners. So it’s the obvious pond for us to swim in if we want to find the right tech venture deals.”

EIS Funds were chosen as their preferred vehicle because they remove the risks of broking every deal to individual investors separately, but did not have the costs of VCTs (Venture Capital Trusts) and, because they are unquoted, are not subject to the vagaries of market makers and forced sellers in an illiquid market. And, not surprisingly given the background of the Parkwalk team, they liked the fact that an aggressive investor cannot effect a hostile takeover of a fund – something that is always a risk for a VCT.

“We also think that the Government will continue to incentivise people to invest in early stage technology, so believe that the EIS will be around for a long time to come”, Kilgour said. “We were pleased that the Dyson report emphasised its importance to the UK economy and even suggested that the Government should make the tax breaks even more generous. We agree that this would be a healthy thing to do.”

The Parkwalk strategy does not just have elements of Venture Capital in it; it also combines something more sophisticated, namely leveraging the risk taken by others. Whilst the Parkwalk EIS funds retain the ability to invest alone or to lead an investment, for now they will only invest as a passive co-investor in what they perceive to be the best of the deals offered to them by IP Group, Imperial Innovations and a small number of other expert venture Tech fund managers or experts e.g. Fusion IP or Anglo Scientific. Parkwalk openly relies on these fund managers to represent them post deal.

Kilgour told me that the beauty of this strategy is that they do not have to do every deal that these higher volume investors inevitably have to do, but can cherry pick the most suitable ones. This means they can offer their own EIS investors a fund with a very different risk profile to an investment in, say, the quoted shares of IP Group. Meanwhile an extra £250,000 or so from a Parkwalk Fund helps the other investor/s disseminate their own risk position. It all smacks of deals done in the “Big City” where risk-sharing is at the core of any quoted company fundraising and would stand ahead of many other more obvious factors.

And it explains why Parkwalk’s co-investor watch fills a large part of each of its newsletters (see Parkway Newsletters). It’s from these co-investors, that most of the deals will come from and it makes sense to allow the investors in Parkwalk’s EIS funds to keep an eye on what they are up to. Clearly there is also a PR benefit for Parkwalk in showcasing their partners too.

It’s the passive nature of the Parkwalk involvement that makes the risk sharing strategy work, but this does not mean that Parkwalk does not monitor its investees. Typically one of the other investors will represent their interests at board level and they still receive monthly reports etc, so they can see for themselves what is going on. And Wright told me that they will not be backwards at coming forwards if something arises that they think needs dealing with. The difference is that they will revert to the lead investor rather than taking it up directly with the management team. (Moray did admit also that the entrepreneurs in whom they have invested also find them to be a useful sounding board and a channel through whom to communicate the other way around from time to time!)

The one disadvantage of being a passive investor might be that Parkwalk gets worse investment terms, but I was assured that the Parkwalk EIS funds usually get the same terms excepting only that they are not allowed any preference on liquidation. That means they get the same upside as the more active investors and EIS loss relief on a winding-up.

Kilgour referred to their strategy as bringing an institutional approach to investing in the Venture market. It is certainly attracting attention from others. Its investment in Eykona, which addresses diagnostic challenges in the £4 bn per annum wound care market, was made alongside Technikos, MTI and H2O Venture Partners and interestingly some angel investors.

Their other investment so far particularly tickled me (Ed: I wonder why?!). Xeros is developing a technology which should, all things being equal, create the “(Almost) waterless washing machine” according to Time Magazine and which the latter cited as one of the 50 best inventions of 2010. Forgetting the obvious sustainable world theme of saving water, the commercial rewards of developing a new Consumer Product that all social groups in the UK, nay Europe, nay the World might adopt and use on a weekly, nay daily basis, makes my brain reel.(For those interested, the market for clothes washing products was £1.2bn in 2005 in the UK alone. A rough guess suggests this could be £120bn worldwide). Even more importantly, the market is largely static or slightly declining, even in some of the BRICs, making this a priority area for the largest FMCG companies such as P&G. So you can see Xeros either being snapped up in a deal reminiscent of Google’s purchase of YouTube or ending up with an eye-watering top line revenue.

Wright and Kilgour told me that when they founded Parkwalk – in a restaurant off the King’s Road near to Park Walk, hence the name - they were genuinely inspired to help tech companies to succeed by giving them the capital they need to grow. They also identified that there was an opportunity for them to bring Big City expertise and approaches to what is still really a cottage industry. Focusing on a sector within that industry which, in relative terms, is thriving, is a sensible place to start, and at a time when access to capital for the investees is sparse, will help them to prove their model more easily than might otherwise have been the case. It will be interesting to watch them as they undoubtedly grow. Meanwhile, they are out on the road fundraising for their second EIS Fund. We wish them luck.

If you would like to learn more about Parkwalk and its EIS funds, including its current UK Technology Fund II, please call Alastair Kilgour on +44 (0) 207 947 4017 or email akilgour@parkwalkadvisors.com

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