Oxford Capital explains why personalised due diligence is fundamental to its investment process
Not everything in the world of EIS has changed since the Autumn Budget 2017. Venture capitalists targeting high growth have been offering their propositions within the EIS wrapper for many years.
Consequently, there are some EIS providers that fully understand the high-growth market and the exciting opportunities that continue to be created there. They also understand that it takes more than just a good idea to take an early stage business to fulfilling its operational potential. Understanding the possibilities and roadblocks to arrive at a sufficiently informed decision about where the best chances of success lie is a highly specialised task.
Xihelm: A Live Example
Take, for example, Xihelm. In May 2018, Oxford Capital closed its £1.3 million investment in Xihelm.
The company is developing technology in the field of computer vision applied to agriculture, initially within glasshouses. Its software turns off-the-shelf robotic arms into automatic fruit and vegetable harvesting machines. This brings automation to the part of the process which accounts for the highest operating expense within this multi-billion-dollar industry. Xihelm’s first product is a tomato-picking robot that is currently undergoing field trials with a large UK commercial producer.
Within the UK context, the premise is compelling, with 60% of agri-food products consumed in the UK sourced locally and almost all tomatoes grown in glasshouses. But the labour-intensive process of croppicking is likely to take a hit soon with some forecasting that about 20% of picking jobs will go unfilled post-Brexit. If home-grown produce is simply left in the ground, it’s bad news for UK Plc which has an annual income of £110 billion from its agri-food sector.
The technology is also generalised enough to be portable to other fields in the future where an understanding of organic objects in 3D space is crucial, both within and beyond the glasshouse. So, beyond fruit and vegetables, there are massive implications for worldwide food production.
The statistics around future global food requirements are stunning, climate change is reducing the size of arable areas and the UN’s Food and Agriculture Organisation estimates that to feed 9 billion people by 2050 the world will need to raise food production by 70%. This is one of the factors contributing to a surge in higher-yield greenhouse and glasshouse growing. The estimated total global greenhouse area now stands at 488,303 hectares and the global addressable labour spend in greenhouse agriculture is $68 billion. And with the total global indoor farming market growing at 14% year-on-year, this already significant opportunity is continuing to grow.
The market drivers are undeniably very strong, and a fully automated robot arm running 24/7 could replace six human harvesters. But, success or failure rests on delivering the technology. So, Oxford Capital’s due diligence extended well beyond in-depth research into the possible size and scope of the opportunity.
How we approached this investment
Bespoke due diligence is a crucial part of the activities undertaken by venture capital investment managers to minimise the risks. For Xihelm, this meant seeking expert opinion and external validation on the quality of Xihelm’s IP, technical know-how, and the viability of its approach. Through our network, we identified a leading Professor of Information Engineering at Oxford University and engaged him to assist us with our specialised due diligence in this case. This person performed an in-depth technical review, entered into discussions with the Xihelm technical team to evaluate the potential for future development, and did a further review of team competencies and processes.
We also took references on the founder from his nominees to pinpoint his previous experience and to determine his strengths and drivers. His entrepreneurial nature, practical ability, and talent for identifying the real problem, and giving clarity to different audiences shone through so we crosschecked these findings with other individuals in our network to whom he was known.
The competitors in this market were also identified, along with the stage of their development, the type and complexity of solution being developed and any potential positives or negatives. Some were focused more on outdoor harvesting, others were looking to build complex, specialist hardware with higher costs and more restricted application.
The potential client-base for Xihelm’s product was also addressed. The industry’s view on the technology was sought from experts in the farming, horticultural and greenhouse markets. Their feedback emphasised just how critical the labour issue is and the importance of robots in resolving this problem and even staying in business; the consensus was that growers are focused on operational improvement to preserve their margins and that they understand the value of spending on technology to do so.
As we go through our due diligence process, we want to ensure that our work is not only increasing our understanding of the business and the opportunity but also that it is increasing the business’s understanding of itself. If we are able to bring our own expertise and specialisms, to ask the right questions, introduce the right people and analyse the correct factors we will be well on our way to doing this.
A standard process, continually adapted
Bespoke due diligence doesn’t mean random checks for each potential investment. For Oxford Capital, it means relevant and additional research within a strict framework of required information, before any consideration of financial backing. Each opportunity is judged by standard criteria so that benchmarking can be carried out.
The standard Oxford Capital due diligence process involves nine separate stages, from several initial meetings with the founders, through initial document preparation on the opportunity as the basis for investment team discussions, with formal approval processes for team and investment committee approval. After a term sheet is agreed with the potential investee company, the proposal goes through a second formal investment committee approval process, followed by the completion stage during which there is a raft of compliance checks, including verification of EIS advance assurance.
We understand the importance of innovators and entrepreneurs and our review process is designed to be as smooth and collaborative as possible for them. Oxford Capital is also acutely aware that there must be a focus on backing success and those with the potential for it. As a result, if, after full and frank discussions, there is a barrier to proceeding at any stage, we will withdraw. In fact, recent internal reviews showed that around a third of companies do not make it from issuing a term sheet, an advanced stage in the due diligence process, to actual investment.
Since typically, Oxford Capital reviews over 2,000 potential investment deals per year and sees more than 70% of industry deals in its target sectors, this process is critical. It is the frontline of the methods employed to mitigate the risks of investing in small, young companies.
The investment in Xihelm is characteristic of the approach Oxford Capital takes in investing in early stage companies. We seek to fund 18-month windows to allow the company to garner further evidence of product acceptance. Our conviction increases as evidence emerges and we invest further only when and if the evidence emerges. This allows us to minimise concentration risk and build a portfolio of EIS-qualifying companies to spread risk and improve the chances of good overall returns. In addition, we only invest alongside like-minded venture capital investment firms as a means to manage finance risk. In Xihelm, Oxford Capital invested alongside Passion Capital and Entrepreneur First.
Due diligence continues after investment
Our strategy is to increase investment as we see progress and we have found the best way to do that is from within our portfolio. We work closely with management teams to define and, wherever we can, help to execute a clear strategic plan encompassing the key drivers of value creation, detailing milestones, measurements and accountability.
We also provide specialist business support to help nurture an investee company and this can be invaluable. For instance, Oxford Capital runs a quarterly series of events for our portfolio companies to encourage knowledge sharing between companies. They cover common challenges faced by the different companies (e.g. GDPR implementation, scaling technical teams).
Through our network of contacts, we are also able to introduce third party industry experts who in turn help portfolio companies to develop and refine their propositions and relationships. These experts provide the management teams we back with additional insights to our own and can often become customers, advisers, investors or employees of our investee companies.
Our portfolio management team leads a monthly portfolio review, focused on key metrics and progress against strategic milestones. Our system of bespoke KPI reporting highlights deviation from plan, against which all portfolio companies are measured. If these strategic milestones are met, we may then invest again after a period of time. As a result, we have close working relationships with companies ready to scale and our long-term mindset means that we continue to invest in growing businesses.
At Oxford Capital, we know this is an exciting market, but its size and complexity demand a disciplined and knowledgeable approach.
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