While SE had hoped to start making serious returns over 2009 and 2010 from the first few investments made in the early days of its Co-Investment Fund (CIF) for high-growth companies, these expectations have been pushed back by a dearth of interest from standard exit partners such as venture capital (VC) investors, banks and the stock market.
This means that millions of pounds that could have been invested in new start-ups are not available when private investors are at their weakest.
Concerns are being compounded by the fact that major Scottish lenders have been telling the small investor business angel community that they have no intention of partnering their investments in the future.
SE’s director of investments Gerard Kelly declined to put a figure on the amount of investments where exits are being deferred, adding: “Exit plans have been stretched because there’s nobody buying or because the VCs or corporates are more risk averse than before.
“The dynamics of the market have changed quite a lot because of the recession and the consequences of that are that five to seven years has gone maybe to seven to nine years to get to the point of profitability.”
To ensure that the best investments have enough cash to reach break-even, Kelly said that SE was also having to divert funds into companies already on the CIF books. Having injected some £1.5 million of working capital last year, he expects spend to exceed £2m this year.
Although the CIF and SE’s other investment funds are usually cited as the jewels in its crown, the pressure is being increased by the fact that they are only three years away from requiring refunding.
The funds can already expect to have their budgets cut in their final couple of years as part of the wider deficit reductions, and they will need to have achieved decent returns to stand any chance of being financed again.
One source said: “Gerard is probably feeling the political heat because the fund is not yet showing the churn that you might have hoped for in more normal times. It’s been going six years now and normally six or seven years in, you might be seeing a bit more return than has happened so far. Saying that, there hasn’t been a disastrous run of failures; more just non-return.”
David Grahame, executive director of LINC Scotland, which represents angel investor groups, agreed that it was more difficult than usual to exit investments.
He said: “There are a lot of propositions out there not getting funded, despite the fact that our community is parting with more money than ever, because nobody else is doing anything. The banks are not playing their part. We have been told by some of the major lenders that although they are getting back into the SME [small and medium enterprise] space, they are not coming back into the early stages where we are. They now say that their participation in 2006-07 was unusual and will not come back.”
He said that the picture was more mixed on closer examination, however, with American IT giants willing to back start-ups at earlier stages than previously. On the other hand, the life sciences sector, which has consumed a large proportion of SE investments, has been very weak recently.
His organisation, which represents about one-third of Scottish angel investors, has been relying almost entirely on new investors to make money available to start-ups. Despite the difficulties for start-ups, the LINC figures from the first quarter still showed a year-on-year rise in new investments to a highest-ever £7m.
But Grahame said: “You need a couple of big multipliers to cheer up the community a bit, but I would have thought that if they happen in 2010 we will be doing quite well. Early next year is more likely and a lot of horses can fall at the fence before then.”
SE’s co-investment, venture and seed funds all consist of partnered investments with the private sector. Since 2003 a total of £310m has been invested, £108m of which came from SE. The agency invested £28.4m last year and expects to invest amounts in the “mid-twenties” for the remainder of the funds’ duration.
