Players across Scotland have noted a gradual change in the Scottish private equity market with private equity houses widening their reach across the UK. Scotland is brimming with talented investment professionals and funds for commitment, but as far as deals are concerned, Scottish players are having to export their skills. A recent example is indigenous Scottish player, Scottish Equity Partners, which recently set up an office in Liverpool Street, London. Scottish Equity Partners’ investments are pure technology so the firm has cast its net further afield to create a broader portfolio base. This migration of Scottish players is raising the profile of Scottish houses in the rest of the UK.
The Scottish venture capital market has a long history. The technology sector has ramped up in the last three years and it is the first time Scotland has been on the global map as far as technology investments are concerned. Edinburgh in particular is rife with opportunities largely due to its strong university culture.
Seasoned Scottish venture capital player Hazel Cameron says the Scots are good at coming up with winning ideas, but lack commercial know-how. “In Scotland, there is no shortage of technology opportunities which potentially could be world-beating. So how do we make more global Scottish companies?,” asks Cameron. More of an emphasis on strengthening sales and marketing expertise is needed and people who know how to sell the product fast and in big volumes. “It’s getting past the few hundred turnover that we don’t seem to be great at,” she says.
She adds it would be nice to see some multinationals coming out of Scotland. This is a slow process given that many of the smaller Scottish start-ups are being gobbled up by larger international firms in trade sales. “Given the climate for certain sectors it makes sense for the smaller companies to be acquired by the larger conglomerates, but it would be nice to have a few large independent Scottish companies,” says Cameron.
Cameron gained her experience with 3i and has backed successes such as Orbital, Kymata and Indigo Vision. Most recently she headed the Edinburgh office of Silicon Valley technology investor Bowman Capital, which last year closed its venture capital business worldwide to focus on its core business in the public hedge fund sector. Cameron is currently lending her skills to US-based VC firm Cross Atlantic Capital Partners, which is on the look out for new technology investment opportunities in Scotland. The firm recently set up an office in Edinburgh and will be working closely with Cross Atlantic’s bases in Philadelphia, London and Dublin. Cameron says the firm is looking at opportunities UK-wide and that the new office will give the firm a good insight into what the Scottish market is like.
Edinburgh’s success in spawning start-ups was recently recognised by the European Commission with the Region for Excellence of Innovation Award. It is the first time a Scottish region has won the award, which has previously been given to renowned hubs for tech and biotech start-ups such as Oxford and Cambridge. The award recognises the research undertaken in the city’s universities notably in medicine, life sciences and micro-electronics from institutions such as Edinburgh University and Heriot-Watt University.
Stuart Paterson of Scottish Equity Partners, says: “There is a certain bias towards Cambridge when it comes to technology, but there are also a lot of good ideas elsewhere. What Edinburgh has over Cambridge is a larger local economy and a strong industrial base from which technology companies can benefit. Edinburgh is also a strong financial centre with a lot of good bankers and lawyers.” Robin Marshall of 3i, which has been investing in early stage Scottish start-ups for over 15 years, agrees: “We are blessed with some really top class legal firms who have considerable experience in private equity.” Among those getting a special mention are McGrigor Donald for transaction work and Dickson Minto for fund structuring.
3i is no stranger to the Scottish market. As one of the most well-established VC players in the region, over the last three years the firm has invested around GBP150 million in early to mid stage tech companies. From its 1998 to 2002 Scottish investments, the firm has made significant profit. Among these are the sale of Atlantic to Cisco Systems and Indigo Vision which floated on the main market in 2000. 3i has also backed projects spinning out of Roslin Biomed, the animal biotechnology research centre where Dolly the sheep was cloned. However, last year saw 3i close its Edinburgh office, in line with a general restructuring of the firm’s regional offices nationwide. The firm now operates in Scotland from its offices in Glasgow and Aberdeen.
A boost for the Scottish market this year was Enterprise Minister Wendy Alexander’s announcement to launch a GBP20 million fund-of-funds for Scots firms. The funding will target home-grown companies requiring venture capital investments ranging from GBP50,000 to GBP250,000 and is being managed by professional venture capitalists. “Personally, I think it makes a lot of sense that the government is putting this money out,” says Cameron. She adds Wendy Alexander is open to ideas and is doing a good job in promoting the creation of global leaders from Scotland as she too recognises the need for international success stories from Scotland.
At a conference on Scotland’s economic future earlier this year Alexander said: “Our research shows that Scottish firms continue to face difficulties in obtaining small scale, early stage equity in the current market. This reflects a number of factors including the high risk nature of many early stage proposals particularly in high technology fields and the high costs of due diligence for such investments.” She added that the Executive’s proposed GBP20 million funding will address the current equity gap, by investing in a number of new private sector equity funds making small scale investments.
Stuart Paterson says Scotland is pretty well-funded when it comes to early stage. “In terms of level of support for the sector, I would say that government grants are more accessible here than down south.” He adds the GBP20 million fund-of-funds might be the catalyst for some of the many angel investors that populate Scotland to formalise themselves and create a new wave of seed investors.
There is a healthy community of angel and seed investors in Scotland. Serving both the business angel community and seed investors, Gap Fund Managers is an investment manager of a number of funds targeted at investing in high growth small- and medium-sized companies in Scotland. Among its funds under management are Eastern Scotland Investments and the Strathclyde Investment Fund, both GBP7 million regional funds able to invest from GBP30,000 to GBP250,000 in each deal. In addition to the formal funds under its management, Gap has a network of informal angel investors to whom appropriate opportunities may be presented.
Some incubator models are still active in Scotland in spite of their general demise. Axiomlab and far blue are two such examples. Axiomlab has offices in Glasgow, Manchester and London and provides business building expertise and capital to early stage regional technology and software businesses. Equity funding for each investment ranges from GBP250,000 to GBP1 million. far blue, an independent technology investment and management group with offices in London and Cambridge and Glasgow, recently set up an Edinburgh office to cash in on the technology opportunities spinning out of the region. Expansion into the Scottish capital will add considerably to the breadth of scientific and technological knowledge within the company, said Lynne Cadenhead, director and head of far blue in Scotland.
Funds outweigh deal flow?
“There’s a lot of money looking for homes,” says Craig McDermid, investment director, Aberdeen Murray Johnstone Private Equity. According to many players there is a mismatch of funds raised and invested in the Scottish market. Excluding 3i, which has its own pan-European fund, there are approximately GBP0.5 billion funds raised by private equity houses domiciled in Scotland and nowhere near that much has been invested over the past year.
And yet many houses are still on the fund raising trail. Albany Ventures, like Scottish Equity Partners, is another team of venture capital players at the early stage end of the spectrum that has emerged from a buyout. The team was formerly known as British Linen Equity, part of the Bank of Scotland and invested directly from its parent’s balance sheet. Albany Ventures is anticipating a first close on its first independent fund at EURO35 million, looking towards a final target of EURO80 million.
The firm is treading carefully in the current climate. The fund made two investments last year and has been concentrating on fund raising and its existing portfolio of five investments. Raymond Abbott, managing director, says Albany is still getting its feet off the ground and in this respect he is able to empathise with his portfolio companies. “We had a lot of infrastructure to build for Albany so we can appreciate what these start-up companies are going through. We are growing up and definitely have an empathy with some of those entrepreneurs out there who have milestones to meet.”
Mid-market player Penta Capital, with its new technology fund, Pentech Ventures, set up last year has widened its horizons and is now more akin to the 3i investment model in the region. Pentech Ventures expects to close shortly north of GBP20 million and will have completed fund raising in less than a year since its launch. Mark Phillips of Penta said: “We got to GBP17 million very quickly and were thinking of closing last year, but demand was high and there were more investors who wanted to commit to the fund.” Pentech Ventures recently secured a GBP5 million investment from Scottish Widows Investment Partnership.
The collective experience of the team at Penta is mainly in buyouts. The strategy behind the venture fund is that there seemed relatively few people focusing on this sector after the demise of the dot.com and a funding gap had formed. There are certainly opportunities out there. Since the fund was launched, it has received over 100 proposals from businesses throughout the UK. To date it has completed two investments in Applied Generics, the Edinburgh-based telematics company and Rhetorical Systems, a developer and provider of text-to-speech software.
A reasonable proportion of Pentech’s investments are in Scotland. But on the buyout side, most investment is south of the border. Phillips says around 80 per cent of deal flow is sourced outside Scotland. “There’s a healthy, vibrant level of deal flow at early stage, but as you get to the more mature businesses, there’s less high quality in Scotland. There isn’t the industrial base in Scotland that there is in the Midlands you get very few manufacturing deals.” Of its GBP130 million buyout fund Penta has committed GBP55 million to six deals. Of these only one is Scottish and that spread will pretty much stay as it is, says Phillips.
Also buyout-focused, Dunedin Capital Partners has achieved a first close of GBP45 million on its first fund for ten years and is looking towards a final close of around GBP75 million towards the end of this year, although the fund raising market is still tough, says Ross Marshall, managing director. Dunedin is another product of a management buyout. It was incorporated in 1983 as British Linen Fund Managers Limited and in 1989 was acquired by Dunedin Fund Managers Limited and its name was changed to Dunedin Ventures Limited. In 1996, the directors of the company carried out their own management buyout and the name was changed to Dunedin Capital Partners Limited. At the time of the buyout the team comprised seven investment professionals. The group is now a 16-strong team with GBP200 million under management with a deal size that has increased from a GBP2 million to GBP5 million range to between GBP10 million and GBP15 million today. Last year Dunedin launched a successful bid via the Dunedin Enterprise Investment Trust, to take over Group Trust. This acquisition says Marshall created a bigger vehicle to make bigger investments. “That was the first portfolio acquisition we’ve done for a while we are looking to do more,” he said.
Following the opening of its London office last year, the firm is active UK-wide and will be looking to continental Europe in due course. Dunedin would look to forge relationships with European VCs of a similar size to give them exposure to UK and Scottish deals and vice versa. “We will be looking at that route over the next five years or so, but there are no plans at the moment to open offices in Europe,” says Marshall.
Marshall says there are over 200 players in Scotland with commitments to private equity including the big names such as Standard Life and Scottish Widows that have exposure to private equity funds through their portfolios. For this reason, many of the indigenous Scottish buyout players are looking outside their home turf. “The Scottish market just isn’t big enough,” says Marshall. “A few years ago, the Scottish industry was very parochial. It is now more outward-facing. Most players are active UK-wide. We see ourselves as a UK business based in Edinburgh, rather than a Scottish business.”
Bank of Scotland is a prime example of a UK business based in Scotland. The bank spreads its investment across various areas and surprisingly allocates around five per cent to technology investments, although the bulk of private equity commitments are in industrial deals reflecting the predominance of old economy businesses in Scotland. Mike Wooderson, managing director, structured finance explains the bank’s technology investments are an important factor in terms of the food chain, and are a good indication of where the opportunities for later stage deals are going to be three to five years down the line. Graham Sturrock, head of investments and mezzanine, agrees: “There is a good grouping of technology VC investors in Scotland and therefore a bigger accent on early stage deals than later stage and buyouts.” For this reason Bank of Scotland Structured Finance and Sigma Technology Venture Fund last year joined forces to launch the Sigma Technology Venture Fund. With a target of up to GBP50 million, the fund has just announced a first close of GBP17 million.
Wooderson notes there is still nervousness in the market and many transactions last year and in the first quarter this year were either delayed in completing or the vendor pulled out. “The levels of completion don’t match the levels of activity,” he says. However, for the bank it is not a bad thing that private equity houses are concentrating on their portfolios rather than making new investments. Many are looking at releveraging their companies and this presents some good opportunities for the bank in terms of refinancing. “We don’t get phased by VCs looking at their portfolio companies,” says Wooderson.
Most players are realistic when it comes to doing Scottish deals. “Scottish-based deals are firmly entrenched in the core mid-market. You don’t find mega deals in Scotland,” says Wooderson. For the moment, the funding is there and is pretty strong. The biggest issue for Scottish houses is whether the proposals are good enough and what the management is like. Raymond Abbott of Albany Ventures sums up the main factor holding back the Scottish market: “There are some good ideas in Scotland, but the problem is how to take the company from that stage through to commercialisation of the products.” He adds it would be nice to see more experienced companies in Scotland that have developed from small to large with a flotation on Nasdaq, for example. There are high hopes for Dundee-based biotech company Cyclacel. “What we need to raise the profile of the Scottish private equity market are some more of these success stories,” he says.