The Herald Business - - Cover Story - Words by Roland Main

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 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

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