THE RAIN MAKER
WITH THE LARGEST TECHNOLOGY FUND RAISING IN EUROPE UNDER HIS BELT CALUM PATERSON HAS BIG PLANS FOR SCOTTISH EQUITY PARTNERS
In the testosterone-fuelled world of venture capital Calum Paterson is something of an enigma. He is not a shouter and bawler, does not demand things are done the day before yesterday and believes in fairness above all else in business dealings. Yet, despite not fitting any of the stereotypes of his peers, he finds himself head of one of the largest venture capital technology funds in Europe.
To say “finds himself” does Paterson and his team at Scottish Equity Partners a great disservice. It suggests some happy accident, some unplanned foray or a stroke of luck equivalent to a lottery win.
Nothing could be further from the truth. While SEP might have got where it is a little sooner than anticipated, this is exactly the stage Paterson saw the company playing on when he led the company’s formation in 2000.
The rain maker is a business term for a valuable employee who secures key business for a company. Paterson may be the boss but in the many successful fund raising presentations he has given across Europe he has proved to be SEP’s rain maker.
Ironically, though, the company’s expansion plans have been accelerated because of the relative weakness of the venture capital (VC) market. Considering its seeming ubiquity less than a decade ago, with an attendant decadent public image of champagne and Porsches, it is staggering how far VC has fallen in investors’ estimations.
The traditional rule of thumb was that one mega return from ten investments produced a good enough overall result regardless of how poorly the other nine performed. But in more recent times, spectacular returns have been conspicuous by their absence.
There has been a reckoning and only those that can show consistent performance and a knack of picking global winners can contemplate building funds of any size.
The question for those with the money to invest is: why give it to high risk VC funds when there are surely easier ways of making a fast buck?
Paterson argues that on the basis of long term value creation, venture capital, as part of the larger private equity class, is still an attractive proposition with the opportunity to deliver exceptional returns in risk-adjusted terms.
With VC, however, there has been a flight to quality. And SEP is quality. It has grown from five people in an office with rented pot
plants to a team of 25 in Glasgow and the City, including specialists that the rest of the industry would kill to get their hands on.
From Wolfson Microelectronics, the Edinburgh-based company that makes chips for the Xbox, which made SEP 70 times its original investment stake, through a raft of biotech and wireless f irms based in Cambridge and London, the company’s rate of return – through good and bad stock market conditions – has been remarkably consistent. And high.
This record has helped SEP raise £120m (and still counting) for a new fund that will add more than 20 companies to its portfolio. About half of this money has been raised from Europe which a few years ago would have seemed as likely as Gretna reaching the final of the Scottish Cup. And now, of course, Gretna is in the UEFA Cup. Britain is the biggest VC market in Europe, making up onethird of the total, and SEP has the biggest investment team focused on the UK technology sector. Viewed like that, SEP seems a natural home for the Euro millions.
Not that it has been easy to secure the funds. With VC in the doldrums and rival VCs competing for fresh investment, Paterson had to sell the story hard and has been on a constant whirl of flights between Glasgow, London, Helsinki, Paris and Stockholm for the past six months.
From a Scottish perspective, figures from the British Venture Capital Association (BVCA) show a drop in overall private equity and venture capital activity in Scotland in 2005 to 96 deals worth £114m from 105 worth £176m in 2004. However the European
picture was brighter. According to the European Private Equity and Venture Capital Association (EVCA), £41bn of funds were raised in 2005, more than double the figure in 2004, with hi-tech funds increasing substantially, though from a low base.
As well as performance, the other strand of the story Paterson has to tell is one of shrewdness. Despite its involvement in technology SEP never got sucked into the dot.com bubble that became a bomb, destroying so many investors.
“Our focus was always on companies with intellectual property, a demonstrable competitive advantage and entrepreneurial management,” says Paterson. “With many of the B2C (ie dotcoms) we struggled to get things to fit our investment model.”
Looking back, he says too much money was chasing too few good deals. Inexperienced managers let valuations spiral out of control and everyone got burned.
Yet at this time SEP had raised £100m and, while not wishing to blow it, Paterson knew he had to find good homes for it. “We did not have external pressure to increase the pace of investment at that time and we chose to maintain our disciplined approach. With the benefit of hindsight, that proved the right decision. Returns on many of the funds raised around that time have been pretty disastrous. One of the reasons we have been able to raise another signif icant fund is that our track record compares favourably with the rest of the venture capital market.”
By sitting tight and picking off a few choice morsels SEP began to gain a reputation. As the herd thinned out, bigger international investors started knocking on Paterson’s door looking to do deals with the Scots with the golden touch. Many of those discussions have blossomed into longer term partnerships with SEP co-investing with a number of them in more recent deals in London and Cambridge, which have seen the bulk of the action lately.
“It is important to be strategic but it is also important to be opportunistic,” says Paterson of the SEP style. “For example we have stepped in to help companies that have raced to market on valuations that are excessive and have been unable to meet targets. We have been able to refinance them on more realistic valuations, change management teams and build a solid platform for growth. A number of those companies have gone in different strategic directions but that is absolutely fine.”
This is the key to what SEP does. Paterson and his team do not write blank cheques. They expect to be involved in the business and bring in experts that can help in specific areas where incumbent management is weak.
Venture capitalists are, of course, blamed for many business ills. If they are not being castigated for handing over too little money for too big an equity share, they are accused of stifling entrepreneurial zeal and getting in the way. Another constant cry is they do not help start-ups enough at the outset. The question is even more pertinent for SEP as it started off as Scottish Development Finance, part of Scottish Enterprise, with a social as well as financial remit.
Paterson does not deny that venture capital involves cherry picking the best business plans. But he argues that this still involves embracing not avoiding risk and does not preclude early stage investment.
“A lot of our investment is in pre-revenue companies. We like early stage companies, businesses that have world class potential, and we are prepared to do small amounts of money initially, if that is what helps them.”
Another question Paterson has had to deal with is about SEP’s commitment to Scotland, now that it is an international player. This rather misses the point that, while it may have existed in another life in another form, it is a start-up business which has just raised its third £100m plus fund. If it were one of the portfolio companies it invests in, SEP would be
hailed as a world-beater and an example of how Scots can compete globally in the new economy. Frankly, nobody would give a second thought about where it spent its money.
“We are based here and have a strong appetite for investing in Scotland,” says Paterson. “We have a pipeline of opportunities here and that is very encouraging. We do not lower the quality bar for Scottish companies and the best contribution we can make to the Scottish economy is finding good companies and funding them.”
So where will SEP’s new funds go? According to Paterson the same combination of healthcare, information technology and energy that has made SEP’s name still holds plenty of potential. With European money comes the chance of European funding deals but Paterson cautions that one of SEP’s strengths has been its ability to get close to portfolio companies. That is harder to do if the North Sea is in the way, although he is prepared to consider it.
Renewable energy has Paterson and the team excited. “This is going to be a hugely signif icant area and will create some exceptional investment opportunities. We have always been active investors in energy- related technology so we understand the issues. Our strategy is to concentrate on the development of enabling technologies rather than providing project finance for alternative energy producers.”
So with all these new challenges Paterson accepts his role is changing. It is more about company leadership now though he still plays a leading role in investment decisions.
SEP, like many of its portfolio companies, is growing up fast. So how would he judge his own performance if he were a VC looking in at the company? “I think I would give myself six or seven out of ten,” he says with typical modesty. Judging by the response to the company’s latest fund-raising, his European investors rate him a good deal higher than that.
Where next? SEP’s Calum Paterson sees opportunities in renewable energy