Venture back into start-ups

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The merest mention of the term venture capital (VC) tends violently to polarise opinion. Most professional fund managers are apt to label VC as the last refuge of an equity scoundrel, while most ordinary investors in VC-backed enterprises, such as Facebook, are likely to sport a hangdog look, counting their huge losses.

And it's probably best not to make any mention to most investors of the dotcom crash of 2001, when all manner of VC-backed start-ups crashed in value after making wildly inflated claims.

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Yet I believe that this scepticism isn't entirely justified. Investing in early-stage companies, especially those in the technology and biotech sector, can in fact be hugely rewarding.

Talk to the really big endowment funds, such as the Wellcome Trust or its university peers in Oxford and Cambridge (and not forgetting their transatlantic cousins running funds for Yale and Stanford University), and you'll discover that they've been increasing their exposure to VC as a whole and especially to technology-related funds.

We're all entrepreneurs now

This growing enthusiasm is being echoed by a constant drum beat of UK government initiatives, spearheaded by the government's "StartUp Britain" campaign. Apparently we are all entrepreneurs now, keen to get a slice of that generously state-subsidised Enterprise Investment Scheme (EIS) money. For the junior version of the scheme Seed EIS tax relief amounts to 50% of initial contributions, up to £100,000 a year.

These schemes are designed to help start-ups of all shapes and sizes, not just technology-based outfits. Mind you, a cynic might contend that such generous tax reliefs are necessary largely because nine out of all ten start-ups fail.

The government seems to be particularly focused on technology start-ups. This is largely because successful early-stage tech firms, which have usually been spun out of an academic research programme, have the ability to create truly global products. Valuations can potentially amount to the hundreds of millions. Cambridge-based chip firm ARM, valued at £19bn, is an example of what's possible.

What's even better is that in certain areas (notably design-based engineering, biotech, photonics and telecoms tech and semiconductor engineering) Britain has genuinely world-class, academically backed clusters of excellence, most of them centred around just a few university cities, such as Southampton (engineering, especially photonics), Bristol (a microchip hotspot), Oxford (biotech and nanotech), Manchester and, of course, London.

If you are willing to focus on these university-backed spin-outs, then the potential for big capital gains is huge, especially if you pick the right companies. But therein, of course, lies the challenge: how to tell a photonic clunker from a potential orphaned therapy with world-class potential?

Picking a winning high-tech fund

That challenge is made even harder by the sad reality that most mainstream fund managers almost completely avoid this space. Only a few hardy small-cap managers are brave enough to venture into early-stage listed companies.

It's also not made any easier by the fact that there are very few listed VC funds of real merit. Indeed, the list is getting smaller by the month. Widely respected tech fund Eurovestech, for instance, recently delisted, blaming market apathy and a lack of patience from investors.

Luckily, a few hardy pioneers are still willing and able to brave the cold winds of the public markets and invest small investors' money in exciting, world-class, early-stage technology companies.

The most adventurous route for investors has traditionally been through the small number of technology VC trusts (VCTs) around. Oxford Technology (LSE: OXT) (under Lucius Carey) and Foresight (LSE: FTV) are probably the best of a rather poor bunch.

These VCTs have some obvious tax advantages, and the Oxford and Foresight funds have made solid progress over the last few years, but it's probably fair to say that a great many VCTs really aren't much into the idea of investing in either tech companies, or early-stage businesses, preferring an asset-backed care home or pub.

I've always had a soft spot for a more buccaneering group of university spin-out specialists clustered around Imperial Innovations Group (LSE: IVO) and the IP Group (LSE: IPO), both of whom have excellent academic links and fairly extensive pipelines of new companies, many of which have listed on the London markets.

My own view and I am invested in both outfits is that these investments are only for patient, long-term investors willing to wait around for the next big ARM to emerge from within their growing portfolio of world-class companies.

If there was an option that could be called remotely lower risk', it would probably be the small clutch of investment trusts that invest in various specialised bits of the technology space.

The Biotech Growth Trust (LSE: BIOG) is probably the most successful fund that invests in more mature biotech firms listed in America, Britain and Europe. However, very few of its portfolio companies could be described as early stage'.

Wealthier investors willing to stump up an initial investment of £25,000 could talk to their broker about the VC private deals offered up by a Manchester-based outfit called Aquarius Equity Partners (this is properly adventurous stuff but their track record is impressive so far).

In the more mainstream technology arena, you have the excellent Polar Capital Technology Trust (LSE: PCT), run by Ben Rogoff, but this is really focused on US-based tech giants. More adventurous types might want to take a closer look at the equally excellent Herald Investment Trust (LSE: HRI), which has a strong track record of investing in smaller UK-listed technology firms.

In a similar vein, investors might also look at Spark Ventures (LSE: SPK), which has managed to salvage a decent reputation from the ashes of the dotcom fiasco, when its shares shot up as anything vaguely internet-related attracted stupid valuations. A lean noughties' has been followed by solid progress in the last few years as its portfolio of companies has finally started to create value for patient shareholders.

My bottom line: I think all adventurous investors willing to sit tight for the long term should consider allocating anything between 5% to 10% of their equity-based portfolios towards either VC funds or technology more generally. I have investments in Imperial Innovations, IP Group, Biotech Growth Trust and Spark.

If you're keen to add a bit of VC spice to your portfolio, take a look at the table below. It lists the funds I have mentioned here, along with the relevant ticker code, market capitalisation and the percentage price changes over periods ranging from one month to seven years.

My start-up fund tips

Data provided by ShareScope