Floats buoy fund raisers: Alison Eadie finds the venture capital market is perking up

A STREAM of stock market flotations has revived the venture capital industry, providing exits and boosting portfolio returns to investors in unquoted companies.

Figures from the British Venture Capital Association show that 36 out of 75 initial public offerings in the year to the end of June were backed by venture capital. More than half were former buyouts or buy- ins, and raised nearly pounds 3bn.

The new issue market has gathered steam in the second half. More than 30 venture- backed companies have floated since July, including Allders, BSM and Virtuality.

Ron Hollidge, chairman of the BVCA, said many venture- backed flotations went to a premium to their offer price and enjoyed a strong after-market.

The stock market is running well ahead of the unquoted sector. The Stoy Hayward/Acquisitions Monthly private company price index for the third quarter stood at 10.5 times earnings. The quoted FT-500 index was at a four-month average of 19.8 times. This 47 per cent discount of the private-to- public company index is the largest since the private index started at the beginning of 1987.

The lag provides an arbitrage opportunity for buyout funds. But a slower-than-expected recovery would stall the growth of management buyout companies and a stock market crash would remove the exit opportunity.

Arbitrage opportunities can be closed off by canny trade sellers. Tarmac floated Ruberoid on a p/e ratio of 14.3 times forecast earnings. Buyout funds that had looked at Ruberoid say the price was up to 30 per cent higher than they were prepared to pay.

Trade buyers are beginning to reappear as competition for venture capitalists, but the new FRS3 accounting standard has made it harder for them to shelter the costs of acquisitions. Having learned the lessons of over-expansion in the late 1980s, they are reluctant to use their highly rated shares for buying sprees.

The picture is likely to be one of financial buyers vying with each other. The MBO of the consumer products division from BP Nutrition in May was chased by four venture capital houses, each offering about pounds 250m.

The issues for the next year, says Ian Hawkins of Phildrew, are the availability of good- quality deals and management teams. He believes there are still enough companies strapped for cash in their mainstream businesses to provide a flow of sales, but buyout managers will have to work harder to secure the deals.

Ian Forrest, managing director of Montagu Private Equity, says vendor price expectations on some of the bigger deals have become unrealistic because of the booming stock market. He believes the market will get tougher as interest rates rise and the stock market comes off the boil. The industry will consolidate further and fund-raising will show 'a flight to quality'.

Prudential Corporation, the life insurance giant, is doubling its venture capital investment to pounds 500m. But for most venture firms, fund-raising is a continuing concern.

Last year independent funds - about 45 per cent of the industry - raised pounds 347m, the third successive year of decline.

Fund-raisers are now out in force. More than 30 venture capital houses, including most of the big buyout players, are doing the rounds of institutional investors.

Money is running out fast for some players. The Centre for Management Buy-Out Research at the University of Nottingham estimates that bigger buyout funds - above pounds 25m - have money to invest for 14 months, but smaller buyout funds - below pounds 25m - have only enough for another 41 2 months.

Institutions will only part with cash to players with strong track records. The expected failure of some to raise money will lead to further consolidation in the industry.

There is already a brisk trade in unquoted portfolios. This month Postel, investment manager of the BT and Post Office pension funds, transferred the management of nearly pounds 200m of unquoted investments to Granville, the investment banking and fund management firm.

Foreign & Colonial Ventures, which has absorbed two external portfolios, has generated a 150 per cent return on Hill Samuel's former unquoted investments. It expects a final return of 300 per cent.

So the outlook for the industry is mixed. While realisations are a cause for celebration, deal flow in the second half of this year has slowed. And demand for development capital has not materialised.

Mr Hollidge said companies had learned to live with a siege mentality and banks were being more helpful than a year or so ago, while John Platt, head of UK investment at 3i, said companies were putting off capital investment decisions until next year.

Institutional interest in unquoted investment has been reawakened by the strong issue market, but managers are keeping a tight hold of the purse- strings.

The BVCA's campaign to have unquoted equity recognised as a separate asset class faces an uphill struggle.

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