During autumn 2009 Coller IP commissioned AngelNews to undertake an online survey and direct market research of UK technology and other investors in the business angel and venture capital market. The aim was to further understanding of the issues faced by investors in assessing the differing risks associated with making a technology investment and how much relative importance they placed on the key aspects of the underlying asset portfolio. The results are contained in this final report.
Overall the findings were more surprising perhaps in the overall picture they created than in the minutiae of the statistics.
93 responded to a survey with 23 respondents who completed the survey in detail. 10 technology VCs were interviewed, some of whom has a specific sector focus, e.g. CleanTech, some were dedicated early stage investors and others were more generalist.
The online survey respondents typically invested £10-100k, although some invested upto £1m, typically taking a stake of up to 25% the first time they invested.
“If our valuation model shows we should have 90% of the investment to make our expected return, we don’t invest and nor would we if it said we only needed 10%” was a quote from one Technology VC.
Smaller (typically private) investors who responded to the survey were typically spending less than £5,000 and up to a week on the total due diligence process including dealing with all the legals. Some VCs spent up to £25,000 on due diligence and up to 2-4 months in time although many spent less.
In terms of returns there was little or no correlation. The average IRR was 20-30%, with some investors achieving IRRs in excess of 100% on their best deals. But there is a 2:1 ratio of investments returning 0% or less: those achieving 100% or more.
The survey results identified that a 2-5 year investment period is satisfactory, but there was sufficient evidence to suggest that a 5-10 year realisation period, may be more likely to optimize investor returns, especially for very early stage funds.
Summary findings
There was a mismatch between what assets • investors told us they value and what they do and spend in terms of due diligence assessing those assets.
• Investors do not consistently follow a reliable due diligence process.
• Management tends to be the key risk considered by investors, but the time and money spent on assessing management does not reflect the degree of importance placed on it, especially compared with other issues e.g. the legals.
• Investors perceive the most risky time for a deal is in the first 12 months post investment.
• The general consensus was that many aspects of commercial risk are very important, but are difficult to de-risk at the due diligence stage.
• Private investors typically spend £5,000 or less on the complete due diligence process (including legals) and a week or less in terms of their own time. VCs typically spend up to £25,000 on due diligence and up to 2-4 months. BUT no correlation was shown in terms of money and time spent vs IRRs achieved for either group.
• There was a 2:1 ratio of those realizing 0% IRRs vs those investors realizing 100%+
IRRs.
• Whilst 2-5 years is a satisfactory investment period, for many deals sufficient deals performed well over a 5-10 year period to suggest that a five year exit period is not enough and that perhaps venture capital funds should have a longer life.
Summary conclusions
Current due diligence practices • are not providing the required impact on the returns achieved, so we suggest that there needs to be a re-examination of the way due digence processes are conducted, particularly the emphasis placed on the different aspects of due diligence.
• The angel and VC sectors are still cottage industries when it comes to due diligence, with everyone undertaking a bespoke process and there being no fixed idea of best practice.
• Until a standard best practice due diligence process is implemented by this sector, it will be difficult for investors, pre-investment, to compute reliably the potential returns they might make.
• There is no proof that investors can rely on management to deliver returns and therefore we suggest that a readjustment of the due diligence exercise needs to take place to spend more time and money fully assessing the management team and/or refocus due diligence onto business critical areas such as IP processes, business model and market forces.
• Investors should refocus spending on formal advice in the due diligence process. The lack of correlation in returns suggests that investors need to seek much deeper and wider degrees of professional advice to help them understand better the risks associated with their investments. This is particularly relevant in the context of commercial due diligence.
• Investors should look harder at how they can protect other types of intellectual property e.g. trademarks, copyright, design rights, trade secrets etc, in addition to patents.
• Questions need to be asked about the typical 10 year life of VC funds – there are arguments that they should have an investment period of 5 years, and a longer exit period.
Click on the link for the full details of An investigation into the due diligence processes of early stage technology investors