Credit conditions may be tight, but the venture capital and private equity houses still have billions to invest. Douglas Friedli discovers they are making more of an effort to get out and find prospects.
Catch the early train from Paddington to Cardiff any weekday and you may spot them: suited, laptop out and flipping through a report. The venture capitalists are on the move, and they have Wales in their sights.
A wave of private equity (PE) and venture capital investors from London has been one of the more welcome effects of the credit crunch, according to Adrian Godfrey, managing partner at HW Corporate Finance. He says: “We have had a steady procession of London-based firms coming down the M4 to talk to us. In the past two months I have seen four or five firms I have never met before.
“The PE firms are sitting on substantial funds that they need to invest,” he adds. “But they think we might be heading for recession, so they are hunting around to find recession-proof investments. They are going out from London to the regions and looking for deals with people they haven’t worked with before.”
These investors make an effort to line up their own deals, says Kevin Beevers, head of leveraged finance at HSBC. “They have been visiting the region, meeting businesses and build relationships.”
Trefor Griffith, director of Grant Thornton’s corporate finance division in Cardiff, has also spotted the private equity boys around: “Two years ago the mid-market players were being bombarded with good transactions. It was an unnatural peak. Most have done deals in Wales before, but it seems they are looking outside London more.”
Some are even putting down roots in the area, including Zeus Private Equity, which has just hired former Northern Venture Managers executive Jonny Allatt to run an office in Bristol and find investments in Wales and southern England.
Zeus followed Lloyds Development Capital, which signalled its interest in the region by recruiting corporate financier Paul Oldham from Grant Thornton’s Cardiff office.
The Lloyds TSB arm has £300m to £400m a year to invest across the UK, and Oldham is confident he can do his bit in Wales and the South West. He says: “We can see companies that are just starting the sale process with a view to doing a deal in the autumn.There will be enough at the £10m to £100m deal size.”
Nick Evans, corporate and structured finance director at The Royal Bank of Scotland, says venture capitalists are keen to work with banks still in the game. “There is a wall of money out there. The message you get from the investors is that if you are leveraged finance and still active, they will come looking for you.”
These investors know they can get more for their cash in an economic slowdown.
The best-performing investments have often been picked up at bargain prices. And the ones that survive should perform well when the economy picks up.
But the credit crunch is having other effects.
Calum Paterson, managing director of Scottish Equity Partners, which invested in Welsh battery technology company Atraverda, says: “You have to draw a distinction between private equity and venture capital. With private equity, the mega deals have pretty much ground to a halt.
But mid-market firms such as 3i and Bridgepoint seem to be busy, and there are a lot of deals being done.
“On the venture capital side, debt does not play much of a role in what we do. We tend to take a longer-term view, so what is going on now isn’t as significant.”
In Wales, early stage deals often involve Finance Wales, which is backed by the Welsh Assembly. Investment director Peter Wright expects to put more into each deal to make up for any slack on the part of private sector investors. “There is evidence of banks retrenching, and we are being asked to fill the gap,” he says.
Deals are still being done, but the terms are changing. Griffith says: “The PE houses are more risk averse. In a lot of cases, high prices were paid and not much due diligence was done. That has changed.”
Oldham says valuations are coming down by 10 per cent to 20 per cent, largely because it is harder to obtain debt. In one case, says Wright, a company being touted with a value of £5m in 2007 came back with a price tag of £2m in 2008.
This discounting may have gone too far, according to Frank Holmes, senior partner at Gambit Corporate Finance. “Valuations are cautious,” he says. “One questions the validity of some of the valuations, which seem excessively low.”
But at what point will prices fall so far that vendors will be put off selling? Oldham says: “If prices come down by 10 per cent, most vendors will still sell at that level.
At 20 per cent, some may wait. But corporate vendors selling for strategic reasons will sell regardless.”
In some cases, deals may take longer to arrange, particularly as investors are more likely to club together to spread the risk and change the way they approach investment, says Gambit’s Holmes. “There is uncertainty about how long the slowdown will last. A lot of management teams have not seen a downturn. Different management skills are required in that kind of economy,” he says.
“I understand the PE houses are looking to introduce more operational value – linking the management of public companies with the entrepreneurial drive of private companies.
In the old days, being hands-off was a big selling point, but (PE investors) are now more hands-on.”
This more assertive method includes formulating strategy, identifying customers and suppliers, setting up management teams and monitoring performance. With valuations flat at best, investors will be under pressure to add value to investments, by acquiring rivals, for example.
In this climate, some investments are likely to prove more popular.
Godfrey at HW Corporate Finance says: “PE investors are looking for businesses with a strong public sector client base, such as buildings maintenance – anything that is unlikely to be impacted by the economy.”
SEP’s Paterson adds: “There are signs of a slowdown in some sectors, such as software for financial institutions, but generally market conditions are good.”
And exits are viable. “The merger and acquisition side is quite good,” he says. “There are a lot of big corporates sitting on large amounts of cash and looking to add products to their portfolios.”
The early stage investment market looks healthy, according to Leanna Davies, network manager of the business angel group Xenos: “We have noticed an improvement in the quality of companies coming forward in the past two years. People are more willing to sell equity because they know they are getting the investors’ experience and money.”
She says this is partly down to the efforts made by the likes of Xenos, but adds that TV show Dragons’ Den has also helped: “It may be the X Factor version of what goes on, but it has helped to raise the profile of business angel investing.”
Right now, she says, angel investors are keen on companies with a strong technology focus, their own intellectual property and strong management teams. Just like some of the big PE investors, angels are lubbing together. “There is a trend towards syndication. It means investors can make more investments, spread the risk and join in funding rounds,” she says. “There is an equity gap at the seed-funding level and prototype stage. Once firms have made sales, that takes the risk out.”
For now things do not look too bad. Evans at RBS is optimistic: “Businesses in a range of sectors are doing well,” he says. “There’s a hell of a lot to go for.”