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Venture, Growth and Buyout Investment Criteria
On the 13th of July 2021, MarktoMarket hosted a webinar for over 140 attendees. The panel discussed the investment criteria from the perspective of venture, growth and buyout investors, and we are pleased to provide the highlights from that conversation below.
MarktoMarket CEO Doug Lawson (DL) introduced the webinar by introducing the panellists:
- Mark Hogarth (MH), Partner at Techstart Ventures, a leading investor of seed capital across Scotland and Northern Ireland (speaking from a venture investor’s point of view);
- Dan Halliday (DH), Senior Investment Manager at Foresight, a private equity and infrastructure fund manager with over £7 billion of assets under management (talking from the perspective of a growth capital investor); and
- Steve Scott (SS), Founding Partner of Penta Capital, a mid-market private equity investor (giving the perspectives of a buyout funder).
The panel were asked about the specific criteria they are looking for when initially screening an investment opportunity
MH responded first. He explained that Techstart’s investments were in companies that were always pre-profit, often pre-revenue and sometimes pre-product. As such, there is little in the way of financial fundamentals to focus on. Instead, they spend a lot of time thinking about the founders and the market opportunity. Regarding the founders, the questions are whether they have experience in their chosen market – their preference is to back founders that have discovered a problem whilst operating in an industry rather than coming to an industry ‘cold’ with a hypothesis. Regarding the market opportunity, Techstart is looking for a market big enough for the creation of a very big business and MH commented that: “if the market size can be accurately defined, it is probably too small”.
DH confirmed that his criteria (when investing from Foresight’s pool of growth capital) pitches him at a stage further forward than MH and many of the initial questions about a business’ viability have been answered. Typically, prospective investee companies will have demonstrated product market fit and will be generating run-rate annualised recurring revenues of greater than £0.5 million.
SS also emphasised the importance of management experience when he is appraising buyout opportunities. SS has backed some entrepreneurs several times over in industries that they understand really well – for example, Peter Wood in the insurance industry and Charles Dunstone in telecoms. The buy and build opportunity is also important to Penta – in other words, is this an asset and a market that is fragmented and lends itself to consolidation. SS also wants to see business models that offer resilient and recurring revenues to support debt servicing.
DL asked the panel what quantum of investment return they target and how they appraise potential outcomes
DH replied that he will sensitise management assumptions and often work backwards from a theoretical exit value to determine what entry value would generate their required rate of return, which they may model around 5x cash-on-cash. Where an opportunity is attractive but founder valuation expectations are high, Foresight may be able to bridge the gap through structuring (investing in an instrument with a preferred return and downside protection) although their first choice is to avoid this.
MH said that Techstart’s fund return is expected to come from a small number of winners and every investment they consider should have the capacity to generate the fund’s entire return on its own. Their approach is classic venture capital in that they will tolerate a high degree of failure if a small number of investments can produce outsized returns.
Using the context of £250 million enterprise value buyouts, SS said that the target should be a 2.5-3x cash-on-cash return across the fund. He added that the bigger funds are willing to sacrifice returns and accept a 10% IRR for very predictable, cash generative investments. SS felt that prices were trending up in all sectors due to the quantum of private equity waiting to be invested – he estimates that $1 trillion in dry powder and a further $2 trillion in secondary firepower is available globally. Non-traditional lenders are now his main source of debt funding – they are more nimble and flexible than mainstream lenders and willing to accept lighter security for additional margin.
DL then asked the panel how advisers could play a role in helping businesses meet the expectations of investors
MH felt that, at the very early stage end of the market, dealflow should come directly from companies. In his opinion, it can be challenging for corporate finance advisers to earn (and investors to accept) a commercial fee and that traditional CF work may be less appropriate when a business is very early stage and raising seed funding. Regarding lawyers, MH feels they play a vital role at an early stage in educating founders of what they should expect from a funder in the legal agreements, for example, warranty obligations.
DH said that around half of their dealflow comes from Foresight’s network of corporate finance advisers. At the growth stage, DH thinks that CF advisers are vital for expectation setting around valuation and other terms. DH is always keen to see more dealflow from the advisory community.
SS said that corporate finance advisers are critical at his stage of investment. If a business comes direct, he often recommends that they appoint an adviser. Advisers help to run a process, test the numbers and manage expectations.
The panel were then asked about their expectations for the rest of 2021 and beyond – what kind of opportunities did they expect to see and what would they like to see more of
DH said that their ‘growth’ dealflow was concentrating around healthcare-focused tech companies and he expected to see more of this. He added that the weight of capital in VCTs was making the growth space very competitive for good quality assets and Foresight was no exception in looking for high-quality businesses rather than fishing for lower quality assets at depressed prices.
MH called out digital health and cyber security as two areas where Techstart is seeing lots of opportunities. His concern was around elevated valuation expectations, which are being driven by the London market but are making their way into the regions. The London market is being pushed ever higher by US sources of capital. MH expected ‘no code’ and ‘low code’ digital businesses to continue to be very popular with venture investors.
SS expects to see more ‘take privates’ following several very high profile buyouts of plcs, such as Morrisons, Senior and UDG. The impediment to take privates will always be the costs involved. However, he also felt that SPACs were leading to some businesses bypassing private equity as they see these vehicles as alternative sources of capital. He remains interested in health, technology and financial services businesses with recurring revenues.
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