EIS Industry Report 2018/19

48 49 DEAL FLOW FINDING OPPORTUNITIES There appears to be no shortage of UK companies seeking investment. The challenge, of course, for investment managers, is picking the companies that will generate a strong return for investors. Where are the deals coming from? UNIVERSITY SPIN-OUTS University spin-outs are frequently cited in the IMs of EIS managers. Four of the 10 top-rated universities in the world are British. Interestingly, they’re not just centres of academic excellence. 47 Cambridge University alone has spun out 15 companies valued at more than $1bn. Two are now worth more than $10bn. University spin-outs are not limited to the “golden triangle” of London, Oxford and Cambridge. Investment manager Mercia, for example, focuses a substantial amount of its EIS investment on spin-outs in the Midlands, north of England, and Scotland. It currently has partnerships with 19 universities. Spin-outs are particularly prominent when it comes to medical applications, as well as AI and Machine Learning projects. These are companies that require a substantial amount of R&D. They will often be viewed as knowledge-intensive companies, and will potentially have access to a higher threshold of EIS funding. IN-HOUSE RESEARCH TEAMS Aside from third-party deal flow opportunities, investment managers themselves will, of course, source companies to invest in. As a general rule, the larger investment managers by AuM (assets under management) will have a greater capacity to conduct more in- depth research. Advisers and investors should not be put off by managers that have a high fundraising target. Larger fundraising targets mean that managers can be involved in bigger ticket deals. When there is a larger amount of investment involved, managers will need to do a greater amount of research on the underlying companies. In reality, the capacity to do this will mostly be left to the larger managers. Managers with a large portfolio of investments may also source introductions to other investment opportunities from their current investments. DIRECT APPLICATIONS Many companies seeking investment approach investment managers directly, submitting their business plans for review. This, of course, requires a significant amount of due diligence on the part of the managers’ research teams. Many of the applications will no doubt be unsuitable for prospective EIS investors. CO-INVESTMENT EIS managers will often co-invest with institutional investors, or large angel investors. Many EIS managers will also have a formidable contact book of venture capital and private equity firms that they will co-invest with. Filtering the opportunities Filtering through all of the potential deal flow opportunities creates a significant due diligence challenge for investment managers. Many managers will receive several thousand applications for funding, yet they will likely only make a handful of investments in a given year. The process of selecting investment opportunities takes up a vast amount of time, and this is likely to have become more burdensome with the shift to growth capital strategies. This is an issue that advisers and investors should be mindful of. If managers are receiving thousands of applications, how are they selecting the winners? On the other hand, the extra due diligence requirements that managers have to put in place as a result of the risk-to-capital condition can certainly be seen as a positive. Dermot Campbell, CEO at Kuber Ventures, said: “One consequence of the reforms is that advisers are now having to undertake due diligence of the type that was largely unnecessary before the changes, given they had assembled the mass-produced schemes and knew pretty much everything about them. Another, which is connected, is that genuine growth investments carry risk, by definition. When set against that for the now defunct capital preservation schemes, the failure rate will almost certainly increase.” 48 “There are many different types of small businesses, not just technology businesses, that need investment to succeed and can’t get this funding from banks.” — LAURENCE CALLCUT, PARTNER AND HEAD OF SALES, DOWNING Considerations for Investment / Deal Flow