Worth the venture?

Posted on 20 Feb 2008 by The Manufacturer

Venture or vulture? Colin Chinery looks at what is hailed as a British success story on the one hand, and denounced as a predator on the other: the £22 billion a year real dragon’s den

T he dogs bark but the caravan moves on – a Bedouin adage that venture capitalists (VCs) might recount when fielding another assault out of the book of fat cat epithets. Trade unions and others slate asset–stripping, pension raiding vulture capitalists. But when Science and Innovation minister Ian Pearson says: “The Labour Government has always supported the venture capital industry and we must continue to stand up for it as a positive change agent” then VCs are confident they command all the big battalions.
“Private equity,” (PE), enthuses Pearson, “is a driver of competitiveness, innovation and productivity.” The statistics support him: total investment in 2006 doubled to £21.9 billion, spread across more than 1,600 companies.

According to the British Venture Capital Association (BVCA), 90 per cent of companies enjoying private equity investment say that without it their business would not exist, or would have grown less rapidly. Investment growth in PE–backed companies far outpaces the national average 18 per cent compared with one per cent over five years – and sales across the same period grew faster than FTSE 100/FTSE 250 companies, with exports moving in the same pattern. And it is not all in the figures and charts. Two in three businesses, says the BVCA, identify strategic direction, financial advice and help with contacts as key supports from their PE backers.

This is the post-VC experience of Edward Naylor, chief executive of Barnsley–based Naylor Group core product, drainage pipes and now succeeding in niche garden ware.“We are more corporate now, which I think is generally a good thing. For example, board meetings are very much structured, and this helped us have the good things of a plc culture. I think there’s an independent scrutiny of what we do, which is not a bad discipline. It means you have to have thought through what you are doing rather than taking off the cuff decisions.”

Over ten years, Naylor primed £18 million into capital investment, a sizeable achievement for a privately–owned business, but funding up until 2000 was self-generated. It was, he says, “a fairly slow process. It meant every year we bought one piece of kit and the rate of progress was commensurately slow. It was pretty frustrating. “So in 2000 we raised venture capital finance with Aberdeen as VP minority shareholders, and also a slug of bank debt on board. This accelerated the rate of investment and the bulk of that £18 million investment has been since 2000.“Effectively we dovetailed what might have been ten years of development work into one year.”

Leading designer, developer and manufacturer of specialised components and subsystems, e2v of Chelmsford and Lincoln, is an impressive example of another core area of VC funding – MBO and MBI, with the management team investing and demonstrating commitment to success. While ‘uneasy’ about the cynical agenda of some VCs, chief technology officer Trevor Cross argues that the virtues far outweigh the sins. “3i enabled us to separate from the Marconi Group, exist as a separate entity, and preserve all the jobs in Chelmsford, and that shouldn’t be under-estimated. If you look at the whole Marconi story most people think ‘what an utter and terrible disaster, and whatever happened
to GEC?’

“But the vast majority of jobs and value creation in the UK has been retained, half of it is part of BAE Systems and a good half of what was left is now owned by other people, including e2v. Hotpoint washing machines are still made in England, Avery Vertical, Woods of Colchester – these companies still exist under different ownerships and still manufacture in Britain. And venture capitalists helped a lot of that to happen.” “The facts show that, in the long run, private equity creates more jobs than listed companies,” says BVCA chief executive Simon Walker. But given all this, the potential gains must be met with specific company criteria, among them high growth prospects and ambition, a product with USP or competitive edge, quality, sector-experienced management, and a willingness to accept a PE investor. None of this spares PE from the sort of dread warning written on ancient maps at the shorelines of the known world – ‘Dragons Begin Here’.

Unsurprisingly, Walker is scornful. Talk of fat cats and asset strippers, he says, “mix personal attacks with a slug of political invective. And what do you have? A debate in which facts and rational debate give way to fiction and emotion. Some unions blame PE for the collapse of Northern Rock – a calamity entirely unconnected with the industry. Next they’ll be blaming us for England’s defeat against Croatia.”
But if, as he claims, some criticism arises from ignorance, Walker concedes that the private equity sector is largely to blame. “A lack of transparency and hard data has given undeserved credibility to the critics.”
Much of this is set to change following the recommendations of veteran banker Sir David Walker. Dozens of large companies owned by private equity and employing tens of thousands will in future publish voluntarily detailed information about their business, effectively renouncing the privacy afforded by the
Companies Act.

But, there are times when PE’s dealings are all too naked, as in the case four years ago of Rover holding group Phoenix Venture, denounced by BMW’s UK CEO Jim O’Donnell as the ‘unacceptable face of capitalism’. “Clearly some of these venture capitalists do come in and sweat the assets, shut, and perhaps want to get out in a few years,” says leading auto industry authority Professor Garel Rhys, emeritus professor Cardiff University Business School “But when you get mergers, often you will find that the company buying shuts a great deal of the company it has bought. So these things are not unique to venture capitalists but perhaps they are a little bit more bare-faced. Manufacturing under the guise of rationalisation can do a lot to effectively sweat the assets they’ve bought.”

At one end of the spectrum, says Professor David Bailey of the Birmingham Business School, “vulture capitalists aim to slash costs, sweat assets and sell off the firm sooner rather than later, in whole or in chunks, to generate cash to move onto the next target. Pension funds can indeed be vulnerable here and tougher laws are needed to protect workers’ interests. “At the other end of the scale, venture capitalists provide patient long-term equity finance, even over decades, to build successful businesses which ultimately pay them back.” A good example, he says, is 3i which worked with LDV, the Birmingham based van manufacturer for over a decade after the management buy-out in 1993. “Many manufacturers would actually die for such support – indeed this is often much better than the main-bank overdraft-financing on offer to many manufacturers, which can be pulled at any moment.”

A key issue in the car industry, says Bailey, is that investment needs for new model development are “very high indeed – £400 million to a billion to get a genuinely new model to market – and a long-term perspective is required. “And on that I am concerned that a private equity purchase of Jaguar/Land Rover could lead to the closure of one plant in Britain and significant job losses, as the owner will look to
cut costs drastically and split the companies up.”A longer-term perspective from the right owner could, in contrast, allow an x-type model replacement to be developed which could offer the prospect of keeping open the three UK plants, says Bailey. “Overall private equity can bring benefits in terms of long–term investment but also carries a risk of short–term asset stripping. Each investment has to be assessed on a case-by-case basis.”

Garel Rhys believes Jaguar and Land Rover are probably on the verge of some very impressive bottom lines. “But because of the problems in America, Ford wanted to clear the decks. So you are selling companies that are not hopeless, far far from it, and for a few years those companies are viable and sustainable. “But when you are that small in relation to the rest of the motor industry and the companies in it, the issue is how are you going to generate the funds to renew what you are making today? And that is the problem.

“You might do well in making profits but those profits might not be good enough for sustainability. And that, I think, is the problem with the private capitalists because they don’t bring true synergies, all they bring is money. Venture capitalism has certainly got its place, says Rhys, but you have to look at whether they are capable of being in for the longer term. “If they are buying companies that are in industries where economies of scale are very, very important, and the company you are buying is of a non-optimum size that’s where you have to look at venture capitalism almost on a case by case basis.

“You can’t write it off and say they are all the nasty side of capitalism. Venture capitalism can do a very good thing in industry but as always you have to look at it case by case. It’s the way the firms operate rather than the principles of venture capitalism that is the issue.”