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Foresight Group’s Andy Bloxam debates if deep pockets are required for deep tech

by | Apr 3, 2024

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“It’s a unicorn! It’s a decacorn! It’s a dragon!” No, I’m not pointing to a fantasy novel or the latest World of Warcraft video game. I’m referring to technology companies, where each creature represents a different valuation or investment return potential. These creatures, often believed to originate from California’s Silicon Valley, have received more than their fair share of headlines. But the global tech landscape is much bigger than this. Decent investor returns don’t only come from the US companies that have raised the most venture capital.

Yes, the tech companies in the UK are smaller than the behemoths of the Magnificent Seven, but they also represent a tantalising investment opportunity. As the tax year in the UK draws to a close, individual investors are faced with questions on where to allocate their capital, especially if their ISA allowances are all used up. Enter Venture Capital Trusts (VCTs), with their generous tax breaks and larger annual investment allowances. 

VCTs were launched in 1995 to help grow small, innovative businesses across the country. In the hunt for better returns and a differentiated strategy, some VCTs turned their attention to chasing unicorns and growing digital technology companies. We’re all familiar with the boom of big tech and the sizeable rewards this has reaped for early investors in the winners (those who cashed in on Facebook back in the day certainly made a tidy profit). In venture capital, there is a phrase called the ‘power law’ where, if you’re lucky enough to find one company that takes off in a portfolio of early-stage investments, the returns made can far outweigh the losses from the other less successful companies. Following the massive fiscal stimulus in the wake of the Covid pandemic, which resulted in swelling of asset prices, this type of tech investing has appeared to be a seemingly easy endeavour.

 
 

Warren Buffet once said, “only when the tide goes out do you learn who has been swimming naked”. For the last 18 months, the tide has very much ebbed in digital tech investing, resulting in the implosion of some high-profile unicorns including WeWork, Hopin and Cazoo. These businesses, as well as many other digital platforms, saw a meteoric rise, but, in these cases, the larger they grew, the harder they fell. For retail investors looking at tech focused VCTs, this might raise some questions. Is this a good approach for a VCT portfolio? What happens if we don’t manage to back thewinner? What about all those great businesses which might deliver a good return but won’t single-handedly return our portfolio? Can we not have some of the exceptional returns potential without letting the rest of the portfolio fail?

We believe that there could be a more attractive returns profile from investing in scalable ‘deep tech’. These are companies that are commercialising meaningful scientific or engineering breakthroughs which are addressing large and important societal challenges. In our view, by solving large and valuable problems – often by developing a technology which is 10, 100, or 1,000 times faster, better or cheaper – these companies stand a better chance of growing into successful enterprises with enduring value. Similarly, with technology built on years of research and protected by patents – making them very hard to copy or replicate – these deep tech businesses can present desirable acquisition targets for bigger companies even before they have become profitable. For this reason, a carefully selected portfolio of deep tech companies might still offer the chance of some exceptional returns with potentially fewer failures.

The UK is a supportive ecosystem for growing these businesses. Sometimes they can be harder to get off the ground than a new digital app and take longer to enter the market, however, an increasing amount of grant funding is available for these companies from the Government as it seeks to return Britain into a Science and Technology Superpower. For this reason, the UK has seen a rapid increase in these deep tech businesses, with the number totaling a colossal 3,500. This ‘non-dilutive’ funding can also benefit investors as it increases the amount of progress these companies can make without needing to raise further funding, in effect increasing the return potential of an investor’s equity investment.

 
 

Rather than focusing on investing into companies that aim to grow as fast and as big as possible, our VCT strategy focuses on investing into companies such as Refeyn, Codeplay, Cambridge GaN Devices, Rovco, Forefront RF and Audioscenic, which have developed breakthrough, defensible technologies with long term market applications and value creation potential. What’s more, we’re starting to see the early signs of this investment strategy paying off, with our portfolio company Codeplay being acquired by Intel in 2022, generating a 16x return. Indeed, we might even argue that our approach more closely resembles Warren Buffet’s “value investing” philosophy rather than the conventional Venture Capital “all-or-nothing” power law approach.

We therefore believe that a disciplined and considered approach to investing in deep tech could deliver attractive returns for VCT investors while also helping to build the next generation of UK-based, world class technology businesses.

Written by Andy Bloxam, Foresight Group

 
 

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