The Report on 1997 Investment Activity published by the British Venture Capital Association (BVCA) contains a number of surprises as well as a predictable quota of broken records. It became clear as 1997 progressed that fund-raising records would not just be shattered, but pulverised. This indeed was the case: UK funds attracted GBP6.496 billion (ecu 9.681 billion) of commitments, two-and-a-half times the previous annual record set in 1995 (Table 1).
That investment levels would also hit an all-time high was not in doubt. The UK venture capital companies surveyed (100 out of the BVCA’s 105 full members) invested GBP4.184 billion (ecu 6.235 billion) worldwide in 1997, 29% more than in the year before. Of this total, GBP3.066 billion went to UK companies, 9% more than in the previous year.
The more surprising findings of the survey, however, included a sharp decline in private equity commitments from domestic pension funds, record levels of investment in technology companies accompanied by significant increases in start-up and early-stage investment, and stabilisation in the amount invested in buyouts and buy-ins.
The stabilisation in levels of buyout investment seems perverse at first, given the number of massive buyouts that hit the headlines last year. However, it largely reflects the UK private equity industry’s drive for internationalisation in response to increasing competition on the domestic front.
More than GBP1 billion went overseas, a figure that excludes investment through overseas offices of UK venture firms. At 27% of total investment, this represents the highest percentage ever invested outside the UK. Continental Europe absorbed GBP965 million, or 86%, of the GBP1.118 billion invested outside the UK by the domestic private equity industry.
Although UK venture investment worldwide rose by 29% last year, larger average deal sizes resulted in an increase of only 6% in deal numbers, to 1,272.
Whereas in 1996 the UK invested nearly 33% more than it raised during the year, the pattern was reversed in 1997, with the record GBP6.496 billion of new funds raised exceeding by 35% the total invested worldwide by UK firms. Levels of domestic investment have more than tripled since 1990.
In 1997, GBP12.2 million of venture capital was channelled into UK companies each working day – an 11% increase from 1996’s investment rate. Averaged over the year, 22 UK companies a week received equity backing from domestic venture capitalists last year.
Meanwhile, each working day the private equity industry’s coffers were being topped up by an inflow of almost GBP26 million.
The “they only back buyouts” lobby that rejoices in censuring the UK venture industry for a reluctance to provide “proper” venture funding will have to abandon one of its most cherished tenets; in relation to GDP, the UK invests as much as the US in start-up and expanding businesses and, in 1997, UK venture capitalists invested in nearly half as many such companies as did US venture capitalists even though the US economy is six times larger (Table 2).
Investments in high technology companies last year totalled a record GBP690 million and accounted for a larger share of the market than any other single sector.
More than 60% of companies backed by the UK venture industry during 1997 received sums of less than GBP1 million, although average deal size increased to GBP2.74 million from GBP2.64 million. Excluding MBOs/MBIs, the average 1997 deal size was GBP1.4 million, compared with slightly more than GBP1 million for 1996’s non-buyout deals.
The BVCA emphasised the fact that MBOs and MBIs made up less than a third of companies backed in 1997, attributing this to the stable amount invested in MBOs and MBIs and growth in expansion and early-stage investments. The continued increase in average investment size recorded last year is attributable principally to the growth in average funding sizes in the expansion capital sector. Rather than representing a general trend, however, this might simply reflect the existence of a very small number of atypically large development fundings.
Stage Distribution of Investments
Investment in early-stage companies in 1997 rose by 21% to GBP159 million, the highest amount for seven years. The amount invested in start-ups alone rose by 41%.
The number of early-stage deals recorded was 219, a marginal decrease from 225 in 1996. However, as in 1996, start-up and early-stage investments combined accounted for only 5% of total investment (Table 3). Reversing the trend seen in the past two years, more investments were made in start-ups, 113, than in other early-stage companies. The average funding size of start-up investments rose by GBP25,000 to GBP515,000 from GBP490,000 between 1996 and 1997. Investments in other early-stage companies had an average size of GBP950,000, compared with GBP900,000 in the previous year.
Expansion fundings remained the most popular investment category, accounting for 49% of deals in 1997, the same proportion as in the previous year. Within this category, which encompasses secondary purchases and bank debt refinancings as well as “ordinary” development capital, ratios have remained constant over the past three years, with development capital fundings outnumbering secondary share purchases by around five to one; bank debt refinancings have accounted for only 1% of deals by number for each of the last three years.
Although they constituted 49% of transactions, however, expansion capital deals absorbed just 30% of total UK investment last year, an increase from 21% in 1996. In absolute terms, however, the GBP907 million channelled into expansion fundings was 53% greater than the 1996 total, and average funding size in this category rose by more than GBP500,000 to GBP1.65 million in 1997.
Although MBOs and MBIs represented less than a third of deals completed during 1997, they absorbed GBP2 billion, or 65% of total equity funding. This disparity, accounted for by the larger average size of such deals compared with other funding categories, was less pronounced in 1997 than in the two previous years.
The average funding size for buyouts and buy-ins combined fell slightly to GBP5,731 million last year from GBP5,852 million in 1996.
The size distribution of buyout and buy-in fundings last year reveals that deals involving equity funding of less than GBP2 million still predominate in the sector, accounting for 47% of buyouts and 59% of buy-ins, though their respective shares of total investment in buyouts and buy-ins were only 6% and 9%. This pattern is reversed for large buyouts and buy-ins: buyouts with GBP10 million or more of equity funding represented 19% of the 1997 buyout population, absorbing 69% of MBO investment. Large buy-ins were relatively scarcer, comprising only 9% of the MBI population, but still received 62% of the GBP487 million backing for buy-ins last year. The BVCA suggests that the greater average deal size in the large MBI category – GBP33 million, compared to GBP22 million for large MBOs – is “due to the inclusion of one or more very large deals”.
However, when it comes to MBOs and MBIs, the methodology used to compile the BVCA statistics tends to give a misleading picture of actual investment activity by UK private equity firms, because the international nature of many of the large buyouts and buy-ins they back means they are excluded from these figures.
Upward Trend in Tech Investment
Investment into high-technology sectors – defined by the BVCA as computer, electronics, medical, health, biotechnology and communications – reached an all-time high of GBP690 million last year, an increase of more than 50% on 1996, compared with the 9% overall growth in UK investment levels. The number of companies backed also increased – by 39% to 295 from 212 in a market where the total number of fundings grew by only 6%. Rather than merely reflecting overall growth in the UK venture capital market during 1997, these increases show a genuine shift in favour of technology investment.
Within the broad high-technology category, medical and healthcare investments received more capital, GBP206 million, than any other category of investment (Table 4). The average deal size in this sector just topped GBP3 million. However, higher activity levels in terms of deal numbers were seen in the computer-related sector, where 108 companies received venture backing totalling GBP179 million, representing an average investment of GBP1.6 million.
Communications-related investments were, on average, the largest deals seen in the high-technology sectors at just over GBP5 million; 34 investments in this sector were recorded with a total value of GBP171 million. More investments, 53, were made in electronics-related firms, but their average funding size was smaller, at just less than GBP2 million; thus, their share of 1997 total market value, at 3%, was half that of the communications sector.
While technology investment blossomed overall, biotechnology fared relatively badly last year. It was the only one of the five high-technology sectors to see its share of total market value decline in proportional terms, to 1% from 2% in 1996; this equates to a fall of nearly 23% in absolute levels of investment, to GBP31 million from GBP38 million. Deal sizes in the biotechnology sector were also substantially smaller than in 1996: the average biotechnology investment in 1997 was around GBP970,000, compared with GBP1.9 million the year before. It is, however, encouraging that the number of biotechnology companies attracting venture backing has tripled since 1995.
In 1996, 16% of total investment was dedicated to high-technology sectors, while last year their share of market value rose to 23%, and technology-related investments made up more than a quarter of all deals in 1997, from one fifth in the previous year.
These figures provide concrete corroboration for reports of renewed enthusiasm for technology investment. The BVCA identifies a number of factors it believes are encouraging this trend, including: growing commercial awareness among entrepreneurs; the increasing internationalisation of companies; changes to Stock Exchange listing rules that have facilitated flotations of biotechnology companies; greater access to NASDAQ in the US; and the launches of AIM and EASDAQ. Since these factors, together with anecdotal evidence of a recent improvement in returns from investment in technology sectors have enabled a number of new technology funds to be raised, the BVCA predicts that levels of high-technology investment in the UK should be maintained or increased in future years.
Industry Distribution
High technology aside, engineering received more capital than any other sector, absorbing GBP360 million, or 12% of total investment. Leisure and hotel investments ranked a close second in value terms, absorbing 11% of capital invested in 1997 although accounting for only 4% of deals. Average leisure sector deal sizes were much larger than those seen in the engineering sector, at just over GBP8 million versus GBP2.4 million.
Heading the rankings in terms of activity was the support services sector, where 16% of 1997’s investments were made; these accounted for GBP299 million, or 10% of total disbursements.
Other active sectors included: distribution, food and general retailers, building materials, and transport. Broadly speaking, excluding high-technology investment, there were few strong variations in the relative importance of the different industrial sectors.
Independents Dominate the Market
Both the volume invested by independent venture firms and their share of market value continued to rise in 1997 (Table 5). The GBP2.099 billion they invested was 19% up on the 1996 total, while their share of the market increased to 68% from 63%; since 1995, independents have increased their market share by more than 20%. Semi-captives, however, saw their share of the market fall to 25% from 29%, along with a small decrease in total disbursements in 1997 to GBP767 million from GBP804 million. Captives’ market share continued to decline, to 7% in 1997, representing a record low of GBP200 million of investment, ; these figures compare with total captive investment of GBP642 million, a 30% market share, in 1995.
While the larger transactions now targeted by many of the UK’s independent venture firms go some way to explaining the increase in investment by independents, these figures also reflect the trend in recent years for formerly captive groups to bring third-party funds under management; in addition, a few captives or semi-captives have made the transition to fully independent status.
Shift in Fund-Raising Patterns
The GBP6.496 billion raised by UK-based venture firms in 1997 is two-and-a-half times the previous annual record set in 1994 and represents an astonishing 38.5% of the GBP16.8 billion total UK private equity funds raised since 1988.
It was not only the volume of funds raised that made 1997 an atypical year for fund raising. It is rare for overseas commitments to exceed capital raised from UK investors. Last year, however, the ratio of domestic to overseas funds was 43:57, an exact reversal of the 1996 model (Table 6), reflecting the fact that, while UK commitments to domestic private equity funds doubled, overseas commitments increased by a multiple of nearly 3.5.
There was a surprising – and disappointing – drop in commitments from UK pension funds, to GBP622 million from GBP734 million (Table 7); whereas in 1996, funds from such sources represented 30% of total funds raised, last year they accounted for only 10%. This was partially counterbalanced by a rise of more than 60% in investment from overseas pension funds, but, overall, pension funds accounted for just under a third of 1997 funds raised, compared with 51% of 1996’s total.
For the first time, commitments from UK insurance companies, which increased fivefold from 1996 to 1997, exceeded investment by pension funds; the BVCA suggests that changes in insurance company regulations governing the valuation of unquoted investments underlies this increase. The volume of funds raised from non-UK insurance companies also increased fivefold. Investment by UK banks trebled, in parallel with the total contributed by their foreign counterparts.
Corporate investors, however, demonstrated the most dramatic increase in appetite for private equity. UK corporates committed more than 13 times the amount they did in 1996, while contributions from overseas corporations expanded by a multiple of nearly 8.5, taking corporate investors’ overall share of the 1997 fund-raising market to 12% compared with 3% in 1996. Although the BVCA statistics do not show the type of private equity funds selected by the different categories of investor, it is likely that the growth in commitments from corporate sources was prompted by the increased availability of venture funds with a strong technology focus.
Commitments to UK funds from institutions elsewhere in Europe reached an all-time high last year, increasing more than sixfold to GBP842 million. But the majority, 64%, of overseas capital flowing into UK private equity funds last year was drawn from North American – predominantly US – sources. Commitments from North America, at GBP2.359 billion, were three times greater than in 1996, and ten times greater than 1995 commitments.
It would be dangerous, however, to ascribe all of this massive growth in investment flows across the Atlantic to US institutional appetites for UK private equity, bearing in mind that many of the largest funds that raised substantial capital in the US last year have a pan-European, rather than purely UK investment remit. By the same token, the BVCA argues that 1997’s phenomenal fund-raising results do not necessarily imply there will be an oversupply of capital to be invested in the UK. The fact that capital is raised for investment over a number of years will also mitigate the effects of such a colossal influx.
Table 2: Relative Venture Capital Activity in the UK and the US
Early-stage to expansion-stage
venture capital investment GDP penetration %
US UK US GDP UK GDP
(GBPm) (GBPm)
Amount No Amount No GBPbn % GBPbn %
1995 3,932.6 1,056 580 795 4,603.3 0.085 704 0.082
1996 6,225.8 1,692 723 704 4,889.5 0.130 742 0.100
1997 6,752.8 1,852 1,066 767 4,868.1 0.140 788 0.140
Source: BVCA/VentureOne/CBI
Table 4: UK High Technology Investment Patterns, 1995-1997
Number of % of Total
Companies Companies
1997 1996 1995 1997 1996 1995
Computer-related 108 80 83 9 8 8
Electronics-related 53 37 51 5 3 5
Medical, health 68 51 58 6 5 6
Biotechnology 32 20 10 3 2 1
Communications 34 24 31 3 2 3
295 212 233 26 20 23
cont’d
Amount % of Amount
Invested (GBPm) Invested
1997 1996 1995 1997 1996 1995
179 96 129 6 3 6
103 69 184 3 2 4
206 146 163 7 5 7
31 38 18 1 2 1
171 104 101 6 4 5
Total 690 453 495 23 16 23
Source: BVCA
Table 5: Investment by Type of Venture Capital Organization
Amount Invested (GBPm) % of Amount Invested
1997 1996 1995 1997 1996 1995
Captives 200 237 642 7 8 30
Independents 2,099 1,765 1,004 68 63 47
Semi-Captives 767 804 494 25 29 23
TOTAL 3,066 2,806 2,140 100 100 100
Source: BVCA
Table 6: Geograpic Distribution of FUnds Raised, 1995 – 1997
Amount raised (GBPm) % of amount raised
1997 1996 1995 1997 1996 1995
UK 2,798 1,383 412 43 57 55
Rest of Europe 842 135 78 13 5 10
North America 2,359 822 235 36 34 31
Asia 261 55 5 4 2 1
Rest of World 236 50 19 4 2 3
Total 6,496 2,445 749 100 100 100
Source: BVCA
Table 7: UK Funds Raised, 1995-1997
Amount raised (GBPm) % of amount raised
Type of source 1997 1996 1995 1997 1996 1995
Pension funds UK 622 734 170 10 30 23
Overseas 1,397 519 191 21 21 25
Total 2,019 1,253 361 31 51 48
Insurance Companies
UK 1,160 221 131 17 9 17
Overseas 505 104 12 8 4 2
Total 1,665 325 143 25 13 19
Corporate Investors
UK 376 29 32 6 1 4
Overseas 428 51 18 6 2 2
Total 804 80 50 12 3 6
Banks UK 238 68 7 4 3 1
Overseas 467 153 42 7 6 6
Total 705 21 49 11 9 7
Government/ UK 10 56 4 0 2 1
academic
institutions
Overseas 234 82 63 4 4 8
Total 244 138 67 4 6 9
Private individuals
UK 164 68 43 3 3 6
Overseas 142 108 4 2 4 0
Total 306 176 47 5 7 6
Other sources UK 228 207 25 4 8 3
Overseas 525 45 7 8 2 1
Total 753 252 32 12 10 4
Total from UK 2,798 1,383 412 43 57 55
Total from overseas 3,698 1,062 337 57 43 45
GRAND TOTAL 6,496 2,445 749 100 100 100
Source: BVCA
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