James Mawson: It now gives me the great pleasure to introduce the final keynote from Jon Moulton – he has spent 30 years in the private equity and venture capital industry doing turnarounds, he has built what is now known as Apax Partners, where he was Head of Europe and he has built what is now known as Permira, where he was one of the founders. He also built Alchemy Partners and now he is building what is, I think, ranked number one and two in the current list of about 600 private equity firms, which is Better Capital. I will say no more, Jon, thank you.
Keynote Speech: Jon Moulton, Founder and Chairman, Better Capital – click here for his slides
Good afternoon. Thank you for staying on, though it is wet, cold and miserable outside. I stand here as a rather diverse character: I do angel investing, I own an early stage venture capital management firm that manages government money, I have a material stake in the management company, invest in an infrastructure fund, and I run a large quoted turnaround fund in the UK, so I do quite a lot of different things.
I’ve done a lot of corporate venturing, but it comes in so many different types: You have spin-outs, you have people coming and taking a stake as you go along, you have partial buy-outs, and in fact, in my turnaround world we have the ultimate in corporate partners, they are called banks, who also end up owning a great chunk of the equity and behave like nothing else you ever met. I’ll try not to dwell on that today.
Why would anybody fund any business? First objective, to make money – you might think that’s the only one, it isn’t. Quite often people do it for ego – it’s hard to imagine anybody buying Facebook shares at the moment on the basis of a rational valuation, they are hoping that other people will be as irrational as they are. You can find, particularly in the UK and Europe – and I’m mostly going to be talking about that, because I know next to nothing about the US venture business – people do invest simply because they are matching government targets – there is a huge amount of money basically poured down drains by government bodies supporting provinces on the outer edges of Europe, or they are today, they may not be there in a few weeks’ time. So there are a lot of those out there.
Regional initiatives – this is almost the definition of a write-off, in practical terms, any deal which is driven by a requirement to be done in a region has almost no hope.
Incompetence: now, that is actually a remarkably common reason for people to invest in deals, because when you look back you wonder why anybody could possibly have done it otherwise.
I think that’s a pretty comprehensive list of what actually people do. So what’s attractive to an investor? Well, quite often the first thing is it has to qualify for one of our assorted government schemes, or co-investment schemes, the right geography, the right industry, number of employees, size of revenues, and it can get all kinds of tax incentives, provided it passes a string of rather odd tests. But then of course you have the real world, commercial investors, they need to be able to make money, they need to make lots of money on the upside to pay for their failures – venture is an area of high failure, however clever you are. My personal record in angel investing is nice and clear: I have made a fortune, but I have lost a third of the capital I deployed, and that’s a better than average rate. So people have to remember, you need to make a lot on the other.
So what do you look for? Good businesses, good management, sensible plans – they are all rare, and very often they are actually disguised from you by excellent presentation, but you tend to know when you see the con trick.
Global private equity in this part of the world we’re playing in is down one hell of a lot. Buy-up business down to a fragment of where it was in Europe, not far off the levels of the late 1990s. There are huge amounts of money still in the private equity world, by no means is this all venture, as you can see. Venture isn’t one sixth of it, it’s probably about one seventh, globally, but there’s a hell of a lot of money out there, relative to the rate of investment, and those buy-out values nowadays, divide them by two to the get the equity component, and that gives you something to compare, so there’s seven or eight years of money swilling around.
Money was raised last year at a reasonable level, a lot up on 2010, but it was a year where we had a lot of confidence at the start of the year and not much by the end – I hate to think what people’s fundraising numbers are going to look like over the next few weeks, they’ll be terrible. Investments were up a touch in 2011, but realised investments actually came back up a lot, all in the first half of last year.
You can have a look at the global buy-outs, same sort of number, and up from 2009, but a fraction from the peak.
Now, venture capital in Europe is, I’m afraid, a small and weak business: UK investment in venture is comparable to one day’s government debt fundraising, that’s the reality of where we are at, so the industry is very small, small relative to GDP and small in effect. I sincerely wish it wasn’t – there are all kinds of reasons why it is, corporate venturing is material in that market. Depending quite how you cut the numbers, and it really depends how you cut the numbers, perhaps £200 million or so of corporate venturing took place in the UK last year, which gets you up to about lunchtime in terms of the government borrowing.
There are plenty of people moved out – I worked at Apax back in the 1990s when they were a big venture firm, they are no longer to be seen. Some have disappeared; others have found it impossible to be re-financed and some have seen part or all of their teams move on. It’s not been a great story. What’s wrong? All kinds of things, actually – this is one set of view that were given to one of my troops: you have to have £200 million to be credible – well, you might need £200 million to be credible, but there are only a very small number of people who could possibly raise £200 million. When you have a lot of money under management, of course, over-investing isn’t good if there isn’t the demand – I’ll come back to the demand in Europe later.
So let’s have a look at the scale: that’s the entirety of Europe. Remember 2000? I do: I felt really old then, now I merely feel mature. Blue button-down shirts, open necks, if you were wearing a tie you were some kind of weakling, bunch of nutcases wandering around with business plans which never got anywhere, it was quite hard to imagine. Of course, the buy-out firms did it seven years later, but it was amazing. But you can see that this is not the pattern of a successful industry – the returns are not attracting money to this business. Now try it as a percentage of the buy-out business: dire! It’s almost an irrelevancy, so we have the British Venture Capital Association changing its name to rapidly add private equity, because it needed to. We need to get this moving up if we are ever to get growth back into the European economies, particularly the UK, and corporate venturing is one way it can come, because as our government is pointing out, besides accusing business of being whingers, their larger companies are awash with cash, and this is one way they can deploy some of it – it’s an improvement, probably, on leaving it in government bonds at one half per cent or something, but the risk level is mind-boggling, we’ll see in time who does better but it’s hard to see venture doing it.
Venture business has all kinds of characters in it: angels, people like me – they’re difficult to organise. Angels have different objectives, different times, different amounts of money, different prejudice on legals, they may or may not be undergoing a divorce at the start or later, they are often much influenced by other investors playing in the area, so a name can bring people to a deal. I’ve been around long enough for people to see me as a name! So people are forever offering me hopeless deals, cheap, in the hope they’ll attract some other mugs to follow me. Be aware of that one! Highly variable – that’s the minimum description of the angel population, they have almost nothing in common; some of them don’t even have any money, which makes it even more confusing. [Laughter]
They can, however, be very quick – my normal analysis period for a venture investment is somewhere between ten minutes and two days, that is the reality, it’s one of the reasons I lose a third of the capital, but it’s also genuinely a much more efficient technique than many follow. When you are doing an early stage deal your ability to gain much from doing months of due diligence is illusory – you might improve your odds from 1 in 5 to 1 in 5.1 or something, but you know, it’s madness.
Angels can add serious value: an angel who has industry experience, financial skills and good contacts, can add a lot of value to a company, as can a venture capitalist, but angels are typically better able to do it, they have more time and they are more determined – but not always. But this is a problem, they have limited pockets, and who knows how much money they will have in five years when the company still needs money. Remember, the average life of a venture deal in Europe is something like ten years, average exit period is out there as well now. And of course, angels mostly lose money. If I’m speaking to an audience of angels, I always start off the same way: how many of you have had more money back from your deals than you have put into them? Sometimes you actually get a hand that goes up, but it’s a real rarity – you have to get the reality, they do mostly lose money, so you have to have some sympathy with them when they are chasing valuations.
Institutional private equity funds: they have processes, and some of them are very onerous and tedious, some have incredibly fixed minds on legals, they are mostly quite professional – there are very few really bad venture capital firms left in Europe. That paucity of capital has meant that actually the very bad ones were thrown out of business totally quite some time ago, so they are mostly pretty professional. But they are also mostly not very successful, and generally in decline, which is, yes it’s amusing, but actually, it’s a bloody shame, because we really want these firms to do well and the economy to be doing well with them. These are where new businesses, new ideas, are, at least in part, going to come from. They may have some long term money, they may not – at the end of an investment term a venture capital firm is not a very good investor. They are mostly quite ethical, they won’t nick your ideas, and people don’t worry about it – there has been the odd exception, but it is very much the odd exception. And they have deeper pockets than angels, as a rule. But they are actually, in Europe at least, far fonder of funding acquisition rather than funding growth risk and technology development risk – I wish they weren’t.
Then we have all the tax advantage stuff we have the UK Venture Capital Trust, they are institutional funds with additional tedious rules; EIS funds same again. The government decided, by the way, to simplify and help the EIS, so the new finance bill contains only 39 pages of new provisions on EIS and SEIS, parts of which will defy the brightest people in this audience to read or understand. There is one clause which – bear in mind that the whole idea is that these things give a tax advantage – says that if one of the main purposes of investing is to gain a tax advantage, you don’t get it. That’s absolutely the drafting as it’s laid out – incredible.
Regional Development Agencies have gone in the UK, but there are enough similar-looking things around for me to still call them: these are people who are desperately trying to shovel money into South Wales or Merseyside, simply because of the business in those areas. If you are raising money and you’re in these areas, you are almost mad not to try these folk first. Assorted government schemes – there are a lot of them. Over the last decade or so I think it’s fair to say the UK and Europe have had somewhere in excess of 100 private equity and venture capital investment schemes, many of them utterly trivial.
Corporations – this is where we’re talking about corporate venture capital again. They are nowadays awash with cash, particularly the big ones, and many of the companies you see here – I’ve done deals with Siemens, Inventages in the last year, I’ve done it with a Dutch corporate – all those had tons and tons of money behind them. So these guys actually have a problem getting return on their piles of cash. In the UK we even used to have a tax-assisted scheme for corporate venturing which went in 2010, but it was another of these absolute air rifles, with typically £15 million a year being deployed under the corporate equivalent of EIS – that is the right sort of number. James, if you’re writing it down, table 2.10 of the statistics!
Then we have the government’s endless churn of initiatives. You can really get bored going through this lot. They are all too small, they need to be larger, they need to be better focused, they need to better run. Easy to say, but a lot of it is a waste of money.
There is feeble evidence of success. If you look at Wales, picking up part of the UK, how many successful medium-to-large companies have come out of Wales from all the money poured into the venture business. Can anybody in the audience think of any? New British Networks was based in Canata – I was one of the first round investors in it, so I remember it fondly. It is also the biggest mistake of my career! I got out at 6.5 times my money and a year later it was trading at 72 times! Some nights I wake up, but not every!
It is hard. There is nothing. If you try it another way, just to see how decayed our regions have got in the UK. Name three medium-to-large enterprises’ headquarters in Wales. [Pause] It has at least 11 people in it! Admiral Insurance is really the only large one left; Peacocks was the second largest and it went bust. By the time you get to No. 10, you have tonnes of companies of 500 people.
There is nothing convincing about the success. Early stage investment has not been very successful in the UK. There is lots of PR wrapped up as research, mostly by organisations with a vested interest in trying to get more money into the area. We end up in the UK with probably 50% of early stage coming from public money, with generally lousy returns, and that is being polite. The returns are actually dreadful.
Well, we have this in the UK, the equity gap. If there was a shortage of money in an area of a market, those who had money would get superior returns. That would seem a reasonable view? They don’t, do they? That’s because of course there is no equity gap. There is a shortage of demand for money. Not enough good companies in the UK. That is a really important thing to get your head around. Pouring money into an equity gap when there isn’t one will not generate growth or a return on investment. It’s a hole. If you pour money into it, the money goes straight through it. Sorry, but this is really not a comfortable position. The UK is short of demand from good companies.
There would be a gap if there was some return. If people were making 45%, then you would worry about it. What happens now? It is more public money being poured into address a non-existent gap which destroys the market, crowds out the private sector, crowds out the effective investment. So you have the perverse thing. Putting money into small companies is good – not if there is too much of it, and there is too much.
That’s what the government should be doing, focusing on increasing the deals supply, back in the educational area, back in the taxation area, back in the regulation area, back in really helping companies to grow, not providing a supply of cash for gap-fillers. It is not a bad thing being a gap-filler. It gets well-paid, but it achieves nothing of any utility.
Just to remind you – returns. These are British Venture Capital Association venture returns. This is 2009’s, but they are equally miserable over pretty well any period I could quote you. I wish they weren’t, but that just drives it home. The data on angel investing in the UK is just awful. There is one weakish study which showed 56% of exit at a loss, but that same study showed 2.2 overall. Basically one or two deals motored. My own history of doing something like 100 angel deals over a long period is that if I take out the top five deals, I break even. The top five were a bit better than average, so I made a lot of money on them, but it was a terrible distribution. It is not a good place to play easily.
What’s happening to the portfolio companies? Low interest rates, cost-cutting to help portfolios to survive. We have had a very low failure rate of companies in the UK over the last few years. A lot of entry hit-back companies have clearly throttled back in anticipation of shortage of capital, and they are certainly not failing in very large quantities. But at some stage, we are going to see interest rates jerk upwards. I have no idea when that is going to be, but the markets are at the moment incredibly volatile and some of the scenarios for the break-up of the Eurozone would lead to an interest rate rise at very high pace. Don’t forget, the average base interest rate in the UK for the last 20 years is still over 7%, so the 0.5% we currently have is just an aberration in historical terms. If rates went back to 5%, we’d have companies failing in very large quantities.
In the larger private equity end, we are seeing that people are paying too much, bargains are hard to find, and returns are bound to be modest in private equity due to very weak economic situations, lack of credit, high purchase prices for buy-outs with low leverage. Private equity is not going to have a boom period, that’s clear. It might be respectable, but it certainly won’t be good. The only way you can make money out of a market like this, low debt/low growth, is to make the companies motor or to develop some new technologies. We are going to be forced to do what the industry is supposed to do, otherwise we simply won’t make any returns and we won’t get any money, and we’re probably going to end up with a smaller industry across the lot.
Corporate venturing: it can be a justified financial investment. You’ve heard that many times. You can do spin-outs. This is a way of corporate venturing which I don’t think has been talked about much today, but it can be just as effective a tool as a corporate arriving and taking a minority, but deciding to retain a minority whilst spinning out a research project to expose it to the more traditional capitalist pressures. Bringing in some outside capital, take the loss out of the P&L – that can be a very creative thing to do. It isn’t caught in all the statistics as a kind of corporate venturing, but it is a perfectly valid strategy, so it’s a partial buy-out if you like, leaving them with something to play for. [Interruption] Yes, not many around.
You can do it indirectly through funds, and you have seen over the years quite a few corporations pile into funds, but that doesn’t achieve very much, it tends to be unfocused. A corporation doesn’t seem to me to want to just be a general purpose private equity or venture capital investor. It wants to invest in its own areas of competence and interest, which probably means that they are into the first couple, taking targets directly.
Now, the non-purely financial side of doing deals with corporates is where it gets interesting. First of all, there are the fiddles. How do you put a high priced round into a company? The answer is you get somebody who has just been given a whacking great contract by the company to put up 5% of the equity at a high price, a practice that has been seen from time to time. How as a pharmaceutical do you avoid taking a loss in your R&D? You get the R&D done in a life sciences company where it is an investment, it doesn’t touch your P&L, and then eventually you buy what is either research or potentially your own bad debt. People can do that, so you can at least amuse yourself by abusing the structures.
An ideal thing is that you get a company which is a better business because it has a corporate player and a private player. It is not that easy to do that. Most of you are here because you know it isn’t easy, but the small company can take advantage of labs, logistics, purchasing power, expertise, marketing, distribution, from a large corporate. It can pick up the experience of that large corporate, it can pick up the intellectual property knowledge of that corporate. Sometimes, just the reputation. If you are a small company trying to break into a public services market, being able to drop the name of a large corporate may be the way that you actually get the order.
There are larger companies deliberately going into a company to make sure that the small company doesn’t thrive. I have seen it, but it is extraordinarily rare, so don’t get too excited about it. Small companies are really worried about investing by corporates because they are always afraid of losing their technology, and they are afraid, legitimately, that tying up with one corporate can block them out from others. That is not going to happen, and that is something which is inevitably present, and should be present.
Basically, all you can do is be honest and straightforward with each other and build relationships. At the end of the day, financial necessity may drive a deal more than any concerns about conflicts of interest and objectives. You can do some legal steps to lots of things there.
I don’t know if you have seen this one, but they show the UK’s actual success in the area. Morse – a company that hasn’t done as far as I know much other corporate venturing – provided money, a partner, minority interest. Monitise was doing money transfer in the banking sector and needed a name to make it look real. Having started quite literally in a shed, virtually any corporation was going to be progress and Morse was more than sufficient for them. They also gave them a back office, so they could get going. Even the secretary of the CFO was somebody who could type, which apparently was otherwise absent. Result, a quoted company, value £250 million, and the company worked. It could have gone in to licensing, but they would probably have missed the opportunity.
Now then, just finishing off, managing corporate venturing. Remember Accenture. You used to go through the airports and you knew what Accenture did, at the bottom it said ‘venture capital’. Then one day you went through and somebody put white paint all over it, because they had lost virtually all the deals they have done – absolutely catastrophic in early 2000s game. They are not the only people who have made a mess of corporate venturing. The consultants seem to have been uniquely good at it! It brought two other consulting firms into bankruptcy.
You need clear objectives on both sides, the company and the corporate. They are not always present. If they are, it’s good. Control – who’s in control? Corporates are very often poor at not being in control. They need to feel in control. They need to be able to stop the company. Sometimes they have good reasons to because if you have 10% of a company and it does something which damages your corporation, relationships are going to get very bad, very quickly, and it could easily happen.
Patience: … and corporations. Most corporations have quarterly or thereabouts reporting, and they don’t have the five and ten-year timeframes that may very often be necessary to make a success of corporate venture. Of course, this is where you go back to the bitch-whipping. In the year three, when the company suffers the almost inevitable dip, the guy in charge of this investment is going to come under a lot of pressure in the corporation which isn’t used to dealing with that kind of problem, whereas private equity firms are more philosophical.
Flexibility is something which comes easily to some corporations, and notoriously it doesn’t come to others. I could give you a good story about that, but I won’t!
Corporate ability to stay in the programme? Patience again. And availability of resources and consistency of objective. How many corporations actually have a ten-year consistent set of objectives? Very few, and probably appropriately. When you go into a venture, you are taking a risk that you will actually end up with objectives changing under your feet.
If you corporate-venture capital in haste, you can always repent at leisure! Thank you! [Applause]
James Mawson: We have time for a few questions.
Question: Jon, thanks for the presentation. Could you talk a bit more about the demand side of this, because that is a very interesting thing, about how are you going to create enough interesting deals that will then build an industry?
Jon Moulton: Just generally at the moment, the UK economy is weak on demand all the way across the bar. The banks are not at the moment stopping lending; they are finding it genuinely hard to find reasonable propositions to lend to, because the economy is weak.
In terms of getting demand up for venture and growth type stuff, I think you have to go all the way back into education as your first placement. It’s a long, slow job, it’s not popular with politicians because it takes too long. We need to have more people in science, probably fewer people through ordinary universities, more people doing technical-type subjects, not very politically popular, but probably needs to be done.
At the moment, quite a lot of people in universities in the UK are basically disguised unemployed. We need to reward entrepreneurs more obviously than we have historically done. We have honoured bankers, Sir Fred, in a way that we just have not done for any significant quantity of entrepreneurs and technological types. We need to release as much regulation as we possibly can to make it easier for small companies to get going. We need to make sure that the Government provides support and oversees markets. We need all these things. We need low taxes. We need to make it entrepreneurial, otherwise this economy, I’m afraid, is not going to go very far.
If you have any better ideas, please let me know, and even more, let the Government know, because they need them badly.
Question: I totally understand what’s in it for the small company, but when you talk about the larger company, you said ‘what’s in it for them is the fresh ideas’, but can you expand on a few more benefits to the larger company?
Jon Moulton: If somebody spent four years knocking out the basics of a technology, taking a minority stake and having a good look at that technology is a great deal cheaper than replicating it. That kind of very obvious thing is there to be got. A small company may have a piece of intellectual property which is impossible to replicate, so that’s an easy grab. A small company may contain within it managerial talent that the large company can’t readily access, because of constraints on the way it operates. It may offer geographic opportunities. There are lots of ways that it can be an advantage. It is a costly way of getting to advantages, so you have to make sure they are real.
Question: The point you were raising here about how do you get the whole economy and new ideas coming in, a penny dropped as you were speaking there about spin-outs from corporates. They have technologies, they have some business acumen, they have some things that would spin out, but certainly from what I have seen from corporates, it’s a bit of a distraction. When they are looking at building the big corporate – I have worked with a number of spin-outs from Unilever for example. They are trying to grow the business from a €40 billion to an €80 billion turnover business and spinning out a €5/€10 million type thing. I still believe that’s important to drive the innovation within the big corporates to get these things out. Do you see a better way of how we can help that in the corporate venturing space, to get some of these things out and then drive some of those new growth opportunities to the advantages of the corporate end of start-up?
Jon Moulton: Clearly a spin-out is in many ways a really advantagous technological start-up. It is going to pick up on something which already largely exists.
I don’t know of any brilliant ways of forcing it down the throat, other than simply harassing large corporates to do it, pointing out the benefits to them of doing it, and making sure they are rewarded for doing it, dangling something in the direction of the company if you are helping the old society out can work.
Question: There are those things where you have to try and make the incentives and how they are going to do it, because you get so many that get to that point, and then somebody like you comes along and says ‘this is interesting’, and they then decide to keep it then! That’s a huge challenge in lots of the corporates.
Jon Moulton: I fear it is, but it is something where if we could find ways of getting more, it would be advantageous. It is quick and a relatively easy way to get things going, and they are not starting at Ground Zero.
Thank you very much. [Applause]
James Mawson: It just gives me the pleasure of saying thank you to you all for being such wonderful delegates here. Thank you very much. [Applause]