Report from the VC front line

Committed Capital is a Venture Capital business based in Belgravia, London, and was established in 2001.

Focusing on the technology sector, Committed Capital has a portfolio of promising growth stage and post revenue UK-based companies. Glen Stewart, their Head of Intermediated Capital Raising, talked us through some of the key areas including investee selection, risk mitigation, success rates, portfolio diversification and fees.

How do you go about selecting investee companies?

We have a wide network of entrepreneurial angel investors in addition to the networks within our team and a number of intermediaries who are well versed in what we do and how we do it. As a consequence, the investment opportunities presented to us have already been through a filtering process, to a degree, which makes the process a little more streamlined. Companies then go through an more detailed filtering process to establish which ones we may wish to consider for full due diligence. Whilst not exhaustive, the filtering process includes areas such as:

• Is the underlying market growing rapidly or otherwise dynamic?
• Does the product/service compete with or complement key market incumbents?
• Does the company have the products or services to take advantage of the market opportunity?
• Is the company’s strategy overall, and product market strategy in particular, sufficiently well considered to optimise success/sales growth?
• Does the management team have a track record of delivering value to shareholders in the relevant sector?
• Is the company post revenue £1m+?
• Can Committed Capital lead the round?
• Can a Committed Capital representative sit on the board?
• Has HMRC EIS Advance Assurance been provided?

If any of these criteria are not met then that is a red flag for us. Other negative indicators can be if, for example, returns are contingent on third party intervention we have no control over (such as FDA approvals, Government approvals).

The patient capital review brought about the end of capital preservation investment opportunities thereby increasing the risk profile of EIS investing. Is there any way of mitigating this increased risk?

Yes, there are many ways to mitigate risk. Before the Patient Capital came in to effect it was commonplace for an investor to place their EIS portfolio allocation with just one fund manager, with a reasonable prediction as to the investment outcome, providing that the underlying companies remained EIS-qualifying throughout the investment term.

That has now changed and there is now more specific risk which can be mitigated. Most fund managers specialise in a particular sector such as life sciences, renewable energy, media and, as we do, technology. It is important, therefore, for investors to spread investments across both fund managers and sectors to achieve a balanced portfolio and reduce the specific risk.

When considering which fund managers to invest with, advisers should consider whether the manager has sector-specific experience and track record, is that in line with the target returns of the fund, number of exits and how many of these have been profitable and the typical exit time frame. Whilst previous performance of course does not guarantee future performance, it is a very good indicator as to how a fund manager selects investee companies, how hands-on they are with those companies, the valuation analysis and the depth and breadth of their initial and ongoing due diligence.

Other considerations are HMRC Advance Assurance and deployment time. There is always a risk that HMRC do not deem that a business meets the exacting legislative criteria to obtain EIS qualification, and so investors and advisers should satisfy themselves that fund managers have HMRC Advance Assurance in place for each underlying company before investing. Some Fund Managers can take as long as 18 months to deploy funds, so it is worth checking the anticipated deployment timeframe with Fund Managers because investors do not receive income tax relief until the manager has deployed the capital and has issued EIS3 forms. At Committed Capital, we insist on HMRC Advance Assurance being in place prior to investment as part of our heads of terms with potential investee, companies, and we typically fully deploy investors subscriptions within 6-9 months, although we can accelerate this on request.

As a fund manager, how many successful exits and how many failures have you had?

Since 2001 the team have achieved an average 2.4 x ROI (excluding any tax reliefs) with an average holding period of 4.5 years.

We have invested in 33 EIS qualifying investee companies and made 19 exits and 2 partial exits of

which 20 have been profitable and just 1 has made a partial loss. Our most recent exit was on 31st July 2019 which saw us sell our shares in FSB Technology Ltd to a strategic buyer, generating a return to investors of 2.71x ROI (excluding tax relief).

We put this track record down to a well-grooved due diligence process, and being very hands on with our companies. In addition to finance, we provide support during the holding period in areas such as governance, remuneration, personnel, audit and sales and marketing strategies, and work with companies in identifying exit strategies from an early stage.

How can investors achieve diversification within a technology focused fund?

As you know, technology encompasses almost every part of our lives, and the sector is deeper and broader than ever before and so, represents an exciting and opportune time to invest in this sector. In fact, total VC investment in UK tech in 2018 topped £6bn which was more than any other European country.

Investors can achieve diversification by ensuring they are invested across a range of sub-sectors. Sub-sectors that the Committed Capital Growth EIS Fund invests in have included FinTech, InsureTech, EdTech, Gaming, Security, Internet of Things, Software as a Service, Digital Marketing, Cloud applications and Electric Motors.

Fund managers charge fees either to the investor, the investee company or a hybrid model. What is your view on how fees should be charged and can the industry offer greater transparency in this area?

This is a somewhat emotive topic between fund managers, wealth managers and investors alike. How a fund manager chooses to charge fees can in part depend upon the stage of investee companies that the
fund manager is focusing on. There are certainly pros and cons on both sides of the fence.

Ideally of course, placing all charges on investee companies works in the investor’s favour as income tax relief is calculated on the full investment amount; however, this may not always achieve the best commercial outcome for the investee company which ultimately investors are relying upon to generate a profit on their investment; therefore, fees can alternatively be levied on investors. Lastly, of course, there is a blend between the two using a hybrid model.

For Seed stage companies, charging all fees on to the investee company is quite often the norm. A Seed stage company must access capital from somewhere to turn their business idea into a commercial reality and is less sensitive as to the cost. It will naturally struggle to obtain finance from traditional banking routes, relying instead on a variety of alternative funding sources including friends and family, R&D tax credits, crowdfunding, peer-to-peer lending and finance secured through SEIS, VCT and EIS.

By contrast, Growth Stage companies have more options available to them; they recognise the cost of capital and are much more sensitive as to the cost of finance. Placing all fees on to the investee company can run the risk that they seek more competitive finance elsewhere initially, or a fund manager not being able to follow their money as the investee company seeks out more competitively priced finance in a subsequent funding round. It is of course important, however, for the company to fully understand what they are getting as a part of a financing round. If it is just finance that is fine; however, assuming the fund manager is very hands on then cheaper finance is not necessarily and often not the answer.

At Committed Capital, we invest into Growth Stage companies and operate a hybrid charging model whereby we charge some fees to the investee company and some to the investor. The importance of human capital cannot be underestimated, and we believe this is instrumental in optimising growth. We always take a non-exec board seat with our companies, spend time working with companies on their go to market strategy, set up a remuneration committee, work with them on their corporate governance and introduce them to strategic partners, whilst being mindful of potential exit routes from the point of engagement.

Greater transparency with regard to fees is absolutely required. Having reviewed all the charging structures in the EIS arena, the way fees are charged varies widely, including different levels of fees, who fees are charged to, for how long they are charged, what they are charged for and whether VAT is or is not included. Transparency around fees disappointingly continues to fall below the level that they should have, making it difficult for advisers to make meaningful comparisons between fund managers. It would be great to see a third-party review service or platform provide a useful solution. There are of course fund managers who are crystal clear in how charges are presented, but also others who are rather opaque.

What I would say, is that it is important to model all fees out over a 5 year term from both sides of the fence to calculate the total costs, and also to pay particular attention to how success fees are charged and whether these are on a company by company basis or on a portfolio basis.

Click here to learn more about Committed Capital

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