­How a top venture capitalist goes about making investments

Matthew Partridge talks to venture capitalist Hugi Clarke about venture capital trusts, the Enterprise Investment Scheme, and his firm’s investment style.

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The world of venture capital and private equity is regarded by many investors as perhaps being a little opaque and mysterious. We've therefore enlisted Hugi Clarke, a director of Foresight Group, to explain how it works and why investors should put their money into the sector.

Foresight Group is one of Britain oldest venture capital and private equity houses. It has been running for nearly 35 years, and mainly manages money from local authorities and financial institutions. But it also accepts some money from retail investors as well. Its retail offerings include a venture capital trust (VCT) and various schemes related to the Enterprise Investment Scheme (EIS).

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VCTs and activist investing

Venture capital involves buying stakes in small companies that are not listed on the stock exchange. Venture capitalists can invest at any stage from foundation to just before a firm is floated, but Foresight's VCT tends to invest in the middle of the process, at a stage Clarke terms "post revenue and post profit". In other words, not companies that are starting up from scratch, but those that are starting to make money. The idea is to help them scale up into much larger firms.

Like many venture capitalists, Foresight describes itself as an "activist investor". It takes an active interest in the firms that it invests in, taking a seat on the board and guiding and advising management. This activism is a selling point, says Clarke: "many of the firms that we invest in can get money from other sources, but choose us because of our track record and reputation".

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To spread the risk, the trust will typically have around 25 to 30 (currently 28) companies in their portfolio.

EIS for more adventurous investors

The Enterprise Investment Scheme is for more adventurous investors and is structured in a slightly different way. While the shareholders in the VCT are buying into a fund, those investing in Foresight's EIS product will be buying a stake in individual projects.

Many EIS products, which come with generous tax breaks, tend to be based around "low-risk schemes such as warehouse space and renewable energy projects". Foresight takes the opposite approach, investing in startups that are too small for its VCT fund. In many cases "these companies have just a handful of employees, or even just an idea or a prototype".

Clarke looks for companies that "have an upside of at least ten times the initial investment". This return, combined with the ability to write off losses on individual investments against tax, means that "if just two or three of the ten investments succeeds, investors end up well ahead". Investors will have to wait up to eight years to get their money back, but Clarke hopes that by then it will have at least tripled. This works out to an annual return of nearly 15% much higher than the long-term nominal return for the main stock exchange indices

A formula for success

There are some other differences between Foresight's EIS and VCT offerings. Venture capital investments tend to be in a range of sectors, while those firms that are involved in Foresight's EIS scheme tend to be focused around engineering. To make sure that these companies get the best possible support and advice, Foresight have a partnership with Formula 1 manufacturers Williams Advanced Engineering, which is reflected in the name of the fund the Foresight Williams Technology Fund.

Despite the differences between the two funds, there are also similarities. In both cases, Foresight looks for firms that are targeting a market that is large enough to support growth, and that can be rapidly scaled up. However, Clarke emphasises that people who will be running the firm are as important as the product "as there are lots of firms with a great products but a poor management". More specifically, he likes managers who understand the market and "are willing to take feedback and guidance, since "our process only works if the founders are willing to work with us".

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Clarke is also a big fan of "serial entrepreneurs", people who have successfully founded several firms. This is because "they have demonstrated that they are able to scale things from a small base". However, Foresight is still willing to take a chance on untested leaders, though it that case it will usually try to get someone with past experience involved to help out. In the case of Mowgli Street Food, an Indian restaurant chain that was founded by Nisha Katona, who was originally a barrister, Foresight arranged for Karen Jones, the founder of Caf Rouge to join the board as a non-executive chair.

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