In the era of internet euphoria, technology investing was flavour of the moment. Deals were being put together in a few days, due diligence was skimped on and some venture capitalists expected the companies in which they invested to go from start-up to initial public offering in less than nine months.
But many of the venture capitalists who gorged themselves on such activity are now licking their wounds. 3i, for example, has suffered some notable disappointments through its investments in early-stage tech companies, including Orbital Software. Meanwhile Silicon Valley investor Bowman Capital has pulled out of venture capital, closing its European operation and leaving ex-3i executive Hazel Cameron jobless.
So isn’t jumping on the technology bandwagon now a bit like trying to board a train hours after it has left the station and been derailed up country with scores of casualties?
Not so, says Bill Troup, head of Royal Bank Ventures. Where others only see only negativity, Troup believes there are plenty of good deals to be done. He says the Connect Scotland investment conference, held last week in Edinburgh, provided a good barometer of the state of the tech sector in Scotland. Troup is encouraged that last week’s event, designed to enable technology hopefuls to showcase themselves in front of ventural capitalists, was attended by 250 people — only 30 fewer than last year.
“Scotland is still punching above its weight in the technology sector,” said Troup, a chartered accountant who worked for KPMG, Merrill Lynch and Morgan Crucible before joining Royal Bank of Scotland’s acquisition finance department in 1994.
The Royal Bank of Scotland was perhaps fortunate in that, for much of 1999 and 2000, it was side-tracked by the protracted takeover battle for NatWest. This came hot on the heels of the exodus of five of its most promising venture capitalists in July 1999. They departed to set up Penta Capital in Glasgow.
But since March 2000 Royal Bank has been regrouping, piecing together the Royal Bank of Scotland Private Equity Group under the leadership of former SG Warburg corporate financier Mark Nicholls. Today this incorporates NatWest Development Capital, employs some 60 people and has offices in Edinburgh, Glasgow, Manchester, Birmingham, Leeds, Nottingham, London and Paris.
The latest piece in the Royal’s private equity jigsaw is Royal Bank Ventures. Launched in January 2001, the fledgling unit, led by Troup, will focus entirely on investing in high-growth tech firms and anticipates putting in investments of between £1 million and £10m.
Despite having already pulled off a number of deals — including investing £4.6m in Edinburgh document specialist Stortext in exchange for an estimated 30% stake and £2m in Bellshill optoeletronics firm Photonic Materials — Royal Bank Ventures is only now emerging into the limelight. It has also invested in other information technology companies including KAL, Scapa, Omnicom and Elata.
But with a war chest of some £150m to invest and six investment professionals at offices in Edinburgh and London on its staff, the new unit is 50% larger than Calum Paterson’s SEP-2 — and clearly means business. It is scouting around for suitable companies to invest in throughout the UK and in mainland Europe and has retained headhunters Whitehead Mann with a view to appointing three more investment professionals.
Troup does not believe that launching Royal Bank Ventures after the dot.com bubble had burst was bad timing. Indeed, he is convinced it will bring positive benefits.
“You have to look back at the last two years as being exceptional — some would say irrational. A huge amount of money was invested in technology businesses and people lost sight of the fundamentals. By the time we launched in January the froth had been blown away. There’s always going to be a stream of good technology companies that are worth investing in.
“You have to remember there was technology venture capital before the dot.com bubble. Things just got out of kilter, with a wall of money chasing a wall of deals. People were doing deals in 10 days and due diligence was skimped on. Big valuations were paid on the basis of ‘we’ll get out at a bigger price.’ Now its gone too far the other way with people saying they don’t want to touch it because its got technology written on it.”
Troup suggests this actually makes life easier — less competition means it is easier to acquire a decent chunk of equity in an early-stage tech firm for a reasonable sum. The valuations of such businesses are lower than at any time since 1998. He concedes however that the transition between then and now has made it tough for tech firms that completed their first round of funding before the bubble burst.
“We still sometimes come up against the mentality of ‘we were worth X last year’. And we say ‘well that was last year’. It’s all very different now and its far more realistic as far as I’m concerned.”
Another repercussion of last year’s technology correction is that investors are now erring on the side of caution, which means deals have become more complex and are taking much longer to complete. “We are spending more time on due diligence. We are building more protection into the investment agreement. So it all takes time.”
Royal Bank Ventures uses a network of “due diligence providers” — including Interregnum, Scientific Generics and Parthenon — to size up companies in which it intends to invest. Where appropriate it also seeks advice from people in Royal Bank’s own massive IT team.
Troup says another of Royal Bank Ventures precautions is that it only intends to invest in companies that have proven and strong intellectual property that will provide them with “barriers to entry”, in addition to having strong management teams.
He is full of praise for the management at Stortext, which secured £3.8m from a syndicate of investors led by RBV in a second funding round earlier this month.
“They are a fantastic management team who have exited two businesses before. We don’t back technology risk. The technology has to be working before we get involved. The best way of testing that is speaking to customers. It’s rare for us to invest in a company which is pre- revenues. We tend to ask them does the product work? Why do you think it’s better than the competition? How much would you pay for it?
“Everybody in the tech market is now much more focused on cash burn: when will you be cash positive? When will you be profitable? Who are your customers going to be? How are you going to get to them? All the questions you should probably have been asking anyway.”
So for Troup it’s back to normality after an aberrant period. He sees no reason why a two-year lapse of reason should prevent Scotland from continuing to breed innovative and promising technology companies. His one complaint is that too few Scottish technology start-ups have global ambitions. “Sometimes I wonder if they shouldn’t be setting their sights a little higher.”
This article was published in the Sunday Herald on 28 October 2001