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Comment 6 January 2011 BVCA Briefing Venturing on the fundraising trail Ahead of the much-anticipated wave of funds set to hit the market this year, Patrick McCurry reports on the hopes and fears of Britain’s venture capital community. The venture capital industry in the UK and Europe is facing tough fundraising conditions. This is partly due to the general squeeze on available investment capital from LPs as well as the asset class’s poor returns in recent years. “We see the fundraising environment as challenging in the short term, as returns for the venture sector as a whole have been poor since the dot-com bubble, both in terms of IRR and liquidity,” says Richard Anton, a partner at Amadeus Capital Partners. But he believes that this situation will change in the longer term, as improved venture performance starts to show through in the industry figures. He adds that it is ironic that the current fundraising challenges come against a backdrop in which venture investing and realisations are looking very positive: “Deal flow is good at the moment and portfolio companies are of high quality. Also, pricing on entry is reasonable and portfolio companies are performing well because the market segments venture is invested in are doing well. Our businesses have done well through the recession and afterwards.” Calum Paterson, managing partner of Scottish Equity Partners (SEP), argues that successful fundraising in this asset class will come down more to the long-term performance of individual firms rather than the venture industry as a whole. “Clearly, these have been tough market conditions but what’s important is how firms have responded to the challenges and the extent to which they’ve been able to navigate their way through choppy waters,” he says. Paterson believes that general fundraising conditions for venture are unlikely to become more benign for a long time: “But our investors are more interested in track record over the long haul than the pace of exits over the last couple of years. They want to see a credible investment model, experienced team and strong leadership. “Maintaining good investor relations is also important, not just when you’re embarking on a fundraising drive but throughout the life cycle of a fund so that investors are aware of the strategic milestones that have been achieved and the value created.” Amadeus’s Richard Anton says that the exit environment is becoming rosier for venture, which should have a knock-on effect on fundraising in the longer term: “Trade buyers came back to the market in 2010, as many corporates in technology are cash rich and need to buy in technology innovation. The IPO market has not really re-opened, however.” He believes there will be only modest fundraising in 2011, with only a relatively small number of venture firms tapping the market. But those who do embark on raising capital may reach their goals, he believes, because of limited competition. “Most people in the venture capital industry are positive about the longer-term trends for the sector,” he says: “Trade buyers are making more acquisitions, which means more competition for assets and that pushes up prices. “It is also the case that the cohort of companies in the portfolio of many VC firms is more mature, because until recently the exit market has been subdued. That means that those more mature portfolio companies are generating higher earnings than might normally be expected and their underlying operational growth is good. A much higher proportion of our portfolio companies are now profitable than ever before and that means they are more attractive to more classes of acquirer and so will fetch higher values at exit.”
Comment New fund, new challenges The heavier regulatory burden on financial services means new managers of start up and spin out funds are facing an increasingly complex regulatory landscape, writes Bryony Livingstone, a member at Kinetic Partners. In the early stages of establishing a new group, the key concerns centre around structuring the fund, building the investment team and determining whether or not the fund is likely to attract enough investors to get off the ground. There are now a number of challenges facing new managers which mean that regulatory issues need to be considered even earlier on in the process than was previously the case. One of the practical challenges facing new managers is that the lead time to become authorised by the Financial Services Authority (FSA) has increased considerably in the last two years. The statutory timescales for processing applications have not changed and remain up to a year (for incomplete applications). Previously the FSA worked to and often exceeded its voluntary service standards of processing 75% of new managers’ complete applications within three months of receipt. However, this is no longer the case and to reduce the possibility of delays to first close (by when managers would need to be regulated), applications for regulation need to be submitted much earlier in the process. Together with the longer approval process, the regulator is adopting a more forensic approach to its scrutiny of new applications. Case officers dealing with applications request detailed information and will require drafts of legal documentation so that some of the decisions and drafting that a new manager could often in the past delay to nearer to close now have to be carried out much earlier in the fundraising process. Consequently lawyers’ and other advisors’ fees are likewise incurred earlier on when there is less certainty that the business will succeed. The FSA’s prudential requirements require firms to provide at least 12 months’ month-by-month P&L, cash flow and proof of adequate capital, amongst other things. The amount of capital required will be dependent upon cash burn and start up costs as well as the FSA’s ‘headline’ financial resources requirement which tends to be low for most venture capital managers. The FSA stress tests financial projections, for example to determine whether a fund can cope with several months’ delay to closing. There is a range of non-prudential regulatory requirements that new managers need to consider, including requirements for adequate systems and controls to be in place on authorisation, establishment of effective governance, conflicts policies, and compliance with five key threshold conditions. From the financial crime perspective, rigorous anti-money laundering controls are required including detailed processes for KYC/source of funds identification for investors and KYC/due diligence processes for potential investments of the fund. The new bribery provisions are an additional area of compliance that will attract greater regulatory focus in 2011. The unprecedented regulatory burden does not stop with the UK’s regime. In the US the Dodd-Frank Reform Act raises more regulatory considerations which will require some managers to also become registered with the SEC from 21 July, 2011 and for others to provide information to the SEC as “Exempt Reporting Advisers”. Those requiring dual regulation will need to submit applications to the SEC as well as to the FSA and to comply with both sets of regulations. Although the regime has not yet been finalised, the SEC has proposed that Exempt Reporting Advisers will include “Venture Capital” managers (narrowly defined), and a further category entitled “Private Fund Advisers”. The proposal is that these Exempt Reporting Advisers will be required to submit reports including detailed information about both the manager and the funds to the SEC, and that this information will be publicly disclosed. The SEC would have access to the books and records of Exempt Reporting Advisers as the proposals are currently drafted. The only managers who would not be subject to either SEC reporting or registration would be those who: have no place of business in the US; manage less than US$25m of investments from US investors; have fewer than 15 US investors; and do not hold themselves out generally to the public in the US as an asset manager. At the European level the AIFM Directive is due to be implemented by member states within two years and will affect the way managers and their funds are structured. The wide ranging provisions of the Directive add yet another layer of requirements and disclosures to be considered by start-ups and spin out managers. New managers need to plan ahead and structure funds to take account of the provisions of the Directive on their business. New managers are increasingly required to satisfy many and complex regulatory conditions early on in their formation process. Long lead times for FSA authorisation in the UK mean that forward planning and early decisions are required, whilst European and US driven regulations add to the burden. It is important, especially for first time managers, to tackle these regulatory challenges early on in the process, and if necessary, to seek specialist advice to ensure compliance at each stage of the authorization process, across all relevant jurisdictions. January 2011 BVCA Briefing 7
Page 1 and 2: 2011: the Year of Venture fundraisi
Page 3 and 4: January 2011 Contributors Special t
Page 5 and 6: CeO Simon Walker Happy New Year and
Page 7: Q) Is liquidity important to you? Q
Page 11 and 12: Comment To do or not to do, that is
Page 13 and 14: Comment Mega funds or mega flops? A
Page 15 and 16: these was the Inaugural Venture Cap
Page 17 and 18: We are size agnostic when we look a
Page 19 and 20: iHealthcare Just as Apple revolutio
Page 21 and 22: BVCA Portfolio Company Management A
Page 23 and 24: which will collect comprehensive an
Page 25 and 26: AifM Directive The BVCA Regulatory
Page 27 and 28: industry index The real reasons to
Page 29 and 30: 2010 UK Pe fundraising by Stage foc
Page 31 and 32: The BVCA Transaction Tracker is (a)
Page 33 and 34: Transaction tracker: UK private equ
Page 35 and 36: Case study The Right Fit Kurt Geige

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