Venture capital in Scotland - here's my take...

I had a very enjoyable trip to Edinburgh last week to take part in the “Building an Entrepreneurial Company” programme of Entrepreneurship Masterclasses, delivered in a partnership between Scottish Enterprise and Highlands and Island Enterprise (HIE). Edinburgh is a fantastic city and it takes no time to get into the centre of town from the Airport (potentially even less imminently as the much awaited and somewhat beset tramline is due to be completed next summer).

On various occasions, I have acted for Scottish companies on their funding rounds. I have also acted on several M&A deals involving Scottish companies. I guess I had always seen the Scottish scene as a fully integrated part of the overall UK venture capital market. However, I had not fully appreciated some of the Scotland-specific challenges and opportunities and my visit left me chewing on the distinct character of the venture funding ecosystem in Scotland.

What is so distinct about it, I hear you ask. Here are some of the takeaways I drew from the most recent report on the Risk Capital Market in Scotland, as prepared for Scottish Enterprise by the Young Finance Company:

- Investment levels in Scotland are resilient. By comparison to the London-centric venture capital market, risk capital investments in Scotland held up pretty well during recent years of economic uncertainty, especially in the deal band size of £100k - £2m. Whereas many of us experienced deal flow in England dropping off a cliff in 2009, activity in Scotland proved to be more resilient, and indeed 2010 was a record year for risk capital investment in Scotland;

- Institutional VC/ growth capital investment activity is curtailed north of the border. The available evidence suggests that Scottish companies find it harder to secure large investments from VC houses. VC houses investing in Scotland tend not to do so on a regular basis - there are not too many formalised links between Scottish companies/ angel investors and VC/growth capital investors (which tend to be London-based);

- Scottish angels are a force to be reckoned with. Scottish angel investment activity is in rude health. The angel market has matured nicely and is benefiting from the SEIS and EIS reforms;

 - Scottish Universities deliver spin-outs. Scottish Universities remain excellent from a research perspective, but also create proportionally more spin-outs than universities in other parts of the UK;

- Intervention is coherent and responsive. Government intervention in the risk capital market seems to be to be well thought out, proactive and ambitious in a good way. The agencies, such as Scottish Enterprise and HIE, are nimble and constantly looking to develop opportunities for Scottish companies. Speaking with their delegates in Edinburgh, I was struck by their passion for the companies and entrepreneurs they work with - they look after the interests of their clients as if they were their own and are genuinely striving to "walk in their shoes". This impression was supported by what I have since read about the approach of these agencies, which seems to be marked by responsiveness to trends and a determination to remain "fit for purpose". No doubt this culture of iteration is one of the reasons why the Scottish Co-investment fund remains a torchbearer internationally and many other countries have set up their own similar institutions seeking to replicate the "Scottish model";

- There is genuine sector strength in life sciences and renewables. Scottish venture funding is squarely focused in particular on life sciences and renewables. While there are pockets of excellence in digital media (such as the Dundee computer gaming hub which was catapulted to global prominence with the success of Grand Theft Auto) and the Oil and Gas industry around Aberdeen has spawned opportunities, it is really those two industry sectors that characterise the asset class in Scotland; and

- Exit data is underwhelming though. The exit climate for Scottish companies has been challenging: in 2011 the average age of an investment at exit was 10 years.

What might this mean in practical terms then? Here's my take on this:

- Things are different in Scotland. The Scottish market is segmented from rest of UK. In my view it has become a quite distinct market. Since my visit to Edinburgh, I traded some perpsectives with some VC clients who had made some investments in Scottish companies. Their view was that the distance to Scotland was not a barrier in their investment appraisal process, although as it happened their Scottish investments had produced underwhelming returns and for that reason there was a barely stifled groan when the geography was mentioned!;

- VCs should ensure they have good links with the Scottish market to ensure they are not missing out. Researchers suggest from their discussions with Scottish investors that "the chances that good businesses are being rejected are slim" but I am not so sure - indeed the recent efforts by the public agencies to propogate links to non-Scottish sources of finance suggest that the profile of Scottish investment opportunities needs raising in the wider market. It is a real boon to the Scottish market that the Business Growth Fund HQ is in Edinburgh and I suspect that they will be at the forefront of a reawakening of institutional risk investment in Scotland. In particular, it seems to me that better links between Scottish angels and English-based VCs would create considerable mutual benefits (not to mention transatlantic links, building on the fantastic links and shared heritage between Scotland and the US - if there is not already a showcase of Scottish technology and investment opportunities at the Open golf championships, this would seem to me to be quite a low-hanging fruit to pick);

- The distinct sector focus is both a strength and a challenge. The sector focus on both life sciences and renewables means that opportunities in Scotland tend to be at the capital intensive end of the venture investment spectrum, while the UK-wide trend has been to move towards less capital intensive opportunities amidst disappointing venture returns in recent years. This tentative conclusion is supported by the exit data - VCs want a 3-5 year timeframe to exit. An average 10 year investment age will draw a shudder from many institutional investors but should not be surprising given the nature of the sector focus. Also, given this really clear sector focus, it would make sense for the Scots to follow the lead of London's "Tech City" and consider whether some geographical branding could help raise the profile of one or more clusters of excellence (watch this space for Edinburgh as Cell City!!); and

- Crowdfunding may be big in Scotland. Alternative funding mechanisms (which are geographically agnostic e.g. crowdfunding) can work well for Scottish companies. Is it a function of the distinctive Scottish funding market, I wonder, that Edinburgh craft brewery Brewdog recently spurned VCs et al to raise £3m in a crowdfunding offer in the space of just two months?

All told then my visit was a real eye opener. I am very keen to maintain links with my new contacts, and I will be keeping an eye out for opportunities to help others to understand a bit more about the risk capital investment scene noth of the border.