Still searching

Closure of a fifth Venture Capital Trust (VCT) and finalising documentation on its first institutional fund raising exercise in ten years has ensured a busy 2002 so far for Quester Capital Management.

Quester VCT 5 raised just GBP18.6 million, a seemingly disappointing amount given its first VCT in 1995/6 tax years raised some GBP32 million and this figure was steadily improved upon – up to GBP53 million by the time Quester VCT4 was raised in 2000/01. However, Quester VCT5, raised in 2001/2, actually put in a very strong performance given the number of VCT launches (some by blue chip investment houses) that fell flat on their faces during this period, ultimately being withdrawn, often without even reaching their nominal, minimum subscription level. Investor sentiment, thanks to turbulent equity markets and redundancy programmes getting into swing, being among the reasons for the fall off.

Still, GBP18 million is a decent amount of money to be looking to invest and with its relationships and brand name – not to mention a new institutional fund seeking investment homes – Quester is well placed to syndicate deals where and if it needs to. Syndication is something, John Spooner, co-founder and director of Quester, notes is easier for established players with limited funds for investment to gain access to the syndication market.

Despite the drop off in demand, VCTs have not become any less attractive; they continue to offer significant tax breaks for individual investors, (see box titled: “And a VCT is?”) Although, like other listed equities and equity vehicles, they have suffered the crushes in share price during the past year brought on by turbulent stock markets. The only significant change anticipated by VCT managers is the 2002 UK Budget announcement that is expected to eventually see (the legislative cogs are still turning) VCTs retain their tax-exempted approved status if they merge or are wound up. Previously this was lost and consequently M&A activity in the sector was not on the agenda.

Spooner says: “I suspect there will be some merger activity but it will not be across management companies but inter-management company.” This would mean a management company like Quester could merge all of its VCTs to reduce its fixed cost base (e.g. audit costs) and improve liquidity. Clearly, the liquidity in a GBP200 million fund will be greater than for five funds of GBP40 million apiece.

Spooner does not dwell on this, however. “The main thing is that it is important, down the line, to get other sorts of shareholders into VCTs, such as the smaller institutional shareholders,” he says. The argument being that many of the VCTs currently on the market are hardly differentiable from venture capital and development capital funds.

Starting out

Quester’s entry into the VCT business involved a fortuitous act of timing. Spooner explains that when the Finance Act of 1995, which created VCTs, came along Quester had the embryo of an angel investing business that planned to have some active and some passive members. With the arrival of the VCT legislation and its attractive tax breaks those wealthy individuals were placed into the first Quester VCT, which was raised in tax years 1995/6.

Spooner notes that the VCT investors have themselves been a good source of deal flow since many work in banks and broking houses and if they see a potentially good deal they are likely to refer it to their own money manager. Other good sources of deal flow include past investee company management teams and referrals from those same individuals.

A third good source of deal flow has been provided by Quester’s involvement in the University Challenge Funds. These were set up as part of a UK government initiative in March 1998 when GBP25 million of State funds were committed alongside GBP18 million from the medical research charity, Wellcome Trust and a further GBP2 million from the Gatsby Charitable Foundation. Following massive oversubscription, two years later a further GBP15 million was committed by the State. All of the funds have been awarded to universities or university consortia, which typically employed the use of seasoned venture capital investors to manage their awarded funds. Quester manages two such funds – firstly the Sulis Seedcorn Fund formed by the universities of Bath and Bristol and secondly, the Lachesis fund on behalf of an East Midlands university consortium.

Separately and prior Quester’s university links extended to managing the ISIS College Fund VCT, which invests in Oxford University spinouts. As well as deal flow all of these university relationships assist Quester in its due diligence process.

Quester’s choice to go back to the institutional investor market to raise a fund – the Quester Venture Partnership, which raised some GBP75 million, – stemmed from its 1989/90 fund Parquest Venture Partnerships having been almost wound up. Quester Venture Partnership originally hoped to raise more but was launched at a time universally acknowledged as difficult for fund raising. This situation was probably compounded by the fact that all of Quester’s funds invest in ICT and healthcare and life sciences, although the latter two have experienced something of a renaissance, at least as far as optimism in the venture capital investment market goes, in the last 18 months.

Going overseas

Two years ago (July 2000) Quester linked with NIF Ventures, a Japanese venture capital firm founded in 1982 and associated with Daiwa Securities. Nothing more formal than co-investment rights resulted but, says Spooner, both sides have already invested in one another’s deals. “We really developed this relationship because we see Asia as being an important area for our business. The partnership has always been a practical and straightforward one; to develop [investee] companies’ business in Asia, alongside people with very good contacts,” says Spooner.

A similar arrangement does not exist Stateside but that is more down to the need for the proper introduction in Asia in order to make things happen.

John Spooner and Andrew Holmes founded Quester Capital Management in 1984. They had both started their careers at ICFC, the forerunner to 3i, when the management buyout and syndication in the venture capital market were non-existent and fledgling, respectively. Today the firm they founded employs ten investment professionals who spend their time investing and, in part, getting involved in the institutional fund raising process. Marketing of the VCTs is a complex database driven affair, which Spooner oversees.

And a VCT is?

Venture Capital Trusts (VCTs) are companies listed on the London Stock Exchange, which specialise in investing in small higher-risk unquoted trading companies of the same kind as those which qualify under the Enterprise Investment Scheme. By investing in a VCT, individuals are able to spread the risk over a number of such qualifying companies. The investor is entitled to various income tax and capital gains tax reliefs, including:

* income tax relief (at 20 per cent) up to an annual limit of GBP100,000 on the amount invested in new ordinary shares provided that they are retained for at least three years;

* deferral of capital gains tax on a chargeable gain from the disposal of any asset where the gain is invested in shares for which income tax relief is obtained;

* exemption from capital gains tax on the disposal of any ordinary shares and from income tax on dividends on ordinary shares on acquisitions of VCT shares up to GBP100,000 per year.

Source: HM Treasury

Quester’s VCT quick view

Quester VCT

Launched in 1995/6, raised GBP32 million and is now fully invested. Dividends paid to shareholders as at July 31, 2001 totalled 41.5 pence meaning original shareholders taking advantage of both income tax relief and capital gains tax deferral have recouped over 100 per cent of the investment.

Quester VCT2

Launched in 1997/8, raised GBP45 million and taking into account commitments and reserves for further investment was fully invested at July 31, 2001. Dividends paid to shareholders as at July 31, 2001 totalled 26.6 pence meaning original shareholders taking advantage of both income tax relief and capital gains tax deferral have recouped 66.5 per cent of the investment.

Quester VCT3

Launched in 1999/2000, raised GBP48 million and taking into account commitments and reserves for further investment was fully invested at August 31, 2001. Dividends paid to shareholders as at August 31, 2001 totalled 1.75 pence.

Quester VCT4

Launched in 2000/01, raised GBP53 million.

Quester VCT5

Launched in 2001/2, raised GBP18 million.

Source: Quester