How 3i keeps a close eye on its cash, and clients

In the world of investment trusts, 3i stands alone. Most of its counterparts invest mainly in public companies with a few unquoted selections to add spice, but 3i barely touches quoted companies and then only as an incidental to its main business of spotting winners it can eventually bring to the stock market.

This means its managers are much more hands-on, and become much more directly involved with the businesses they invest in. It is not enough for them to glance at the annual report, supplemented by the occasional visit to the company. They are usually on the board, and 3i often has a controlling stake.

That makes 3i a very different animal from other investment or unit trusts, for private individuals to consider buying shares in. It has been a winning formula. Since 3i went public in 1994, its shares reached a peak of nearly three times the investment trust sector average at the height of the dotcom boom, and it is still ahead.

At 42, Jonathan Russell, is a 3i senior director in charge of its buy-out operations. He says: "When I came here from London Business School 16 years ago, I saw it as a training ground and I never thought I would be here this long. But I'm still learning loads, and the challenge goes on. It's constantly creating different things for you to do."

The group sprang from an attempt by the post-war Labour government to encourage investment, and was originally called Investors In Industry, hence the later abbreviation to 3i. It maintains the three-way theme by dividing its operations into three parts: investing in hi-tech start-ups, buying shares in established private companies, and taking over companies as part of a management buy-out. They require different skills and so tend to have different people specialising in them, but the combination of the three is powerful.

Mr Russell says: "Obviously, hi-tech was a great place to be in the late Nineties and 2000, when the equity market put very high valuations on those sorts of businesses. What we have always done, and continue to do, is to put small amounts of capital in young businesses at quite an early stage – £2m here, £2m there – and from that a number emerge as being potentially very interesting businesses. But we didn't get involved in buying expensive assets at the height of the boom because we were investing at an earlier stage. We benefited from it, though, because we floated a number of businesses then and did very well."

The 3i approach in this area is to invest on global technology lines because, if it is investing in an interesting piece of software in Munich, it wants to know it is not miles behind an equivalent piece of software in, say, Singapore.

"We've got ageing populations and shortages of manpower, and therefore investing down efficiency lines, such as IT, software, communications and healthcare-related products makes sense, taking a five to 10-year view," Mr Russell adds. "It's about 20 per cent of what we do. When you get it right you make shedloads of money, but the numbers can work against you and you've got to kiss a few frogs to get a prince."

The organisation takes these ideas from start-up to fruition, which demands a series of managers capable of seeing an idea through the trial stage and production and marketing and sales, hired for each project.

The so-called growth capital operation invests in existing businesses, taking an equity stake, where they have a particular project 3i wants to fuel to grow and they cannot or do not want to do it through debt. They want to take on equity but usually still want to be in control.

"You might be funding an acquisition, you might be buying out one shareholder when the other two shareholders are staying, you might be sorting out a family succession issue. You've got a big change in the business that needs money from outside that can't be met with traditional bank debt."

In 2001, 3i put £24m into Ministry of Sound, the nightclub, music magazines and events group so it could keep growing. Dan Adler invested on behalf of 3i. He says: "Ministry of Sound is a high-quality and fast-growing business and we are delighted to invest in James Palumbo and his team. With our support, we hope they will develop Ministry of Sound into a globally recognised media brand." Other big recent media investments were the Pinewood and Shepperton film studios.

Mr Russell says: "If you look at our investments in southern Europe, we are investing growth capital into family businesses that need our sort of money. You've got to invest in those businesses with a long-term view. They are capable of terrific growth, but you're in a minority position, so you've got to be prepared to work with other shareholders or with family members, and that's a skill in itself. We don't lean towards any particular industry: it's a huge range, from a textile business in Italy to a metal-bashing business in Germany."

The third investment area for 3i is management buyouts, which involves buying a company, incentivising management by giving them equity, having a clear growth agenda and driving the business through to flotation or sale.

The most spectacular MBO success last year was Go, the low-cost airline, in which 3i invested £83.5m for a 62 per cent stake as part of a buy-out from British Airways. Last May it was bought by easyJet for £374m, of which 3i's share was £231m.

Mr Russell says: "We want to acquire a range of businesses across Europe, where we think there's a real opportunity to grow a business to create value and realise a profit in about five years. That needs a different set of skills, because you're buying an entire business, you've got to take a different view of management and you are more heavily involved in the performance of that business than you are through a growth capital situation."

Shares in 3i have nearly halved from their peak of 946p last winter. This means that, instead of trading at a premium to their underlying asset value, they are at a substantial discount and yield a useful 2.6 per cent.