Deals at the higher end of the corporate finance market have all but dried up since the meltdown in financial markets began to bite during 2008. Despite the banking crisis and consequential tough economic conditions, VC players in the sub £2m equity market continue to invest in companies. Ben Bolt, Investment Director with Catapult Venture Managers, explains why.

Traditionally, private equity companies operating in the larger deals space have made a return on their investment through one or a combination of approaches. These include growth in underlying profitability, financial engineering and arbitrage (buying a business for a low multiple of profits and selling for a higher one). In recent times financial engineering has become increasingly prevalent as the driver of equity returns. This involves a company taking on bank debt which is subsequently paid back in order to gear returns to equity holders when the business is sold on.

There is nothing inherently wrong with this strategy as long as management teams understand that it introduces a new layer of financial risk to their business on top of existing operational risk. Banks are, of course, a critical component in financial engineering so there is little surprise that the drying up of bank lending has resulted in a significant slow down in the volume of larger transactions.

Venture Capital investors have traditionally been heavily focused on growth in profitability as the main driver of healthy investment returns. This is because smaller businesses often have higher levels of inherent operational risk so it is not prudent to introduce new risk in the form of debt.

Catapult is no exception; we are focused on understanding and assessing growth opportunities and this forms a critical part of our due diligence. Any company seeking funding from us should highlight and articulate their growth potential. This focus on growth has borne dividends with Catapult completing a record breaking 30 deals during 2008 in spite of the banking crisis. This is clear evidence that VCs have been sheltered from the full impact of the financial crisis. Catapult certainly remain open for business and our business model remains focused on businesses with a tangible growth story.

A businesses ability to deliver attractive growth is a function of its position in its chosen markets and the quality of the management team.

Focusing first on market position, whilst current global and UK economic statistics make dismal reading it would be a big mistake to be swayed into inactivity by them. In the UK there are niche businesses and markets with fantastic growth opportunities both at home and overseas. Furthermore innovation and new product development are constantly creating new technologies and, as a consequence, new markets. Mobile telecoms did not exist as a market two decades ago but now is a multi-billion pound global market.

A strong growth story will deliver additional benefits as growth is often synonymous with diversification. Whether it is launching new products into an existing market, moving into new geographical territories or creating new markets, the net result of a successful strategy is often decreased operational risk as a business diversifies its revenue streams and reduces reliance on key customers or suppliers.

Finally, acquisitions can be a very effective way of delivering both attractive growth and diversification. In the current climate there are plenty of opportunities for ambitious owner managers and management teams to deliver step changes within their businesses via acquisitions, often at attractive prices. Of course acquisitions are not without risk but proper advice and due diligence can minimize this and the benefits can certainly be significant.

Moving on to the management team who are charged with delivering the growth strategy, we would expect to see a business plan that sets out both short term tactical steps and longer term strategic steps to achieve their plans. Just as important in the current changeable economic conditions are contingency plans and ‘what if’ scenario planning. A management team that can anticipate market changes and can demonstrate flexibility in the business model is an attractive proposition.

In summary, Venture Capital can help management teams to accelerate their growth plans by providing financial resource and hand on expertise, both internally and via non-executive directors. Whilst there is inevitably a cost of this assistance, in the current climate maintaining the status quo is a dangerous strategy, particularly for smaller businesses that have not yet diversified their business models.

For businesses with strong management teams and a well articulated growth story finance is available. Whilst cost is always a major influencer there is a strong argument that it is access to finance in order to deliver growth and diversification rather than the cost of finance that will really differentiate the winners from the also rans.

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For further information please contact Ben Bolt at Catapult Venture Managers on 0121 616 0180 or 07837 036795; or Paul Shrimpton at PSPR Ltd on 0121 354 7311 or 07979 595322




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