Venture Capital – UK high-tech delivers stunning returns

Figures published by the British Venture Capital Association (BVCA) should challenge institutional preconceptions regarding the performance of high-technology venture investments. The survey, the first of its kind, was carried out in conjunction with The WM Company. The UK High Technology Venture Capital Performance Measurement Survey reveals that, overall, high technology investments have produced an average return of 23 per cent per annum and a return multiple of 2.9 times cost during their lifetime.

The performance research, covering the period from inception to end December 1998, was undertaken on a by investment’ basis in order to give a more precise picture of the returns derived from high-technology investment In previous BVCA/WM performance surveys, returns from such investments have been aggregated within the early-stage and generalist fund categories and have therefore, to a great extent, been masked.

As ever with performance surveys, considerable variations underlie the pooled figures. Early-stage investments in the communications sector emerge as the real winners, delivering a staggering 58 per cent IRR, equivalent to a cost multiple of 7.7. Buyouts and buy-ins of communications companies were also strong performers, returning 4.7 times cost to investors, corresponding to an IRR of 31 per cent.

The survey shows that, in sharp contrast to the UK fund population as a whole, in the high-technology sectors early-stage investments have outperformed buyouts, generating an annual IRR of 28.3 percent compared with the 19.5 per cent delivered by buyouts of technology-based companies. Expansion stage investment in the high-tech sectors produced a 15 per cent IRR, returning 2.2 times cost; within this stage category, IT companies performed better than biotech/healthcare, commun-ications or electronics and engineering deals. Communications sector deals outperformed IT investments at all stages except expansion, where IT companies delivered an 18.8 per cent IRR to investors and a cash multiple of 3.7, whereas similar investments in the communications sector generated an annual return of 17.5 per cent and a 1.9 multiple of investment cost.

Electronics and engineering investments showed the lowest overall returns and – somewhat surprisingly – were outperformed by biotechnology/healthcare sector deals at every investment stage.

It is difficult accurately to compare the figures for UK high-tech performance with US venture fund returns because of the by investment’ methodology used in the UK fund survey as opposed to the fund analysis used for the Venture Economics’ US benchmarks. As a yardstick, however, according to Venture Economics’ Investment Benchmarks survey, the cumulative capital-weighted IRR at end December 1998 for US early-stage funds was 21.5 per cent, for seed funds 7.6 per cent, for balanced vehicles 14.3 per cent and for later-stage venture funds only 1.5 per cent. It should be noted that these figures apply to the entire spectrum of venture funds rather than purely to high-technology vehicles.

The UK survey also explodes the myth that early-stage investments necessarily have extended exit horizons. Overall, high-technology investments are held for an average of 4.6 years from initial investment to exit. The average life span for exited early-stage investments, however, was just 3.6 years, compared with 4.5 years for buyouts and buy-ins and a full five years for expansion-stage deals. Biotechnology and healthcare deals had the shortest exit horizon overall, thanks primarily to the brief duration of buyouts and buy-ins in this sector. Although the average time to exit for biotechnology buyouts is 2.6 years, expansion-stage deals in the sector were held for an average of 8.4 years, with a number of such investments having lifetimes of more than ten years.

Dr Paul Castle, the chief executive of MTI Ventures, one of the UK’s longest established early-stage high-tech specialists, was instrumental in the development and design of the performance survey. A longstanding advocate for early-stage technology investments, Castle is clearly delighted with the findings of the survey, which tend to confirm the arguments MTI has consistently propounded. “Although it is too early to have had much market feedback on the survey’s findings, the initial response from opinion formers has been good, and the survey appears to have put technology investment centre stage,” says Castle. “It demonstrates that the results from technology investments, which previously have been subsumed in the aggregated fund performance figures, are very good – and shows that the returns from early-stage deals are the best of all.”

Although the performance data may come as a revelation to some institutions, they held no surprises for MTI, Castle says, pointing out that the figures confirm what MTI has been saying for the last 16 years’.

Any impact the survey may have on UK institutional attitudes to venture investing will take some time to make itself felt. While its findings are encouraging, institutions are likely to wait until a body of data has been built up over several years before making any radical revision of their investment criteria. Nevertheless, as Duke Street’s Edmund Truell, chairman of the BVCA Investor Relations Committee, observes: “These are outstanding returns. If UK pension funds take account of these figures along with the figures in our annual performance measurement survey, it clearly must be time for them to re-evaluate their out-of-date view of venture capital investment and acknowledge its merits.”