Sue Whitbread talks to Richard Moore, Co-Head of the Investments team at Calculus Capital, about how the company operates and why its 20 years of experience is invaluable in helping the group to deliver effective EIS and VCT solutions for advisers and their clients
Learning from experience
Calculus are pioneers of the EIS industry, having launched the UK’s first approved EIS Fund in 1999, it is the longest established EIS fund manager. At its heart, Calculus offers growth and scale-up capital to later stage, world class businesses.
Its focus has remained consistent over the years: building diversified portfolios of smaller, UK growth businesses and creating value for investors. Drilling down a little more, advisers will see that Calculus is a diversified, later-stage growth investor. Over recent years the firm has increasingly focused on the healthcare and technology sectors as this is where they believe prospects for well above average growth potential are coming from. This also conforms with the government’s enhanced terms for ‘knowledge intensive companies’ announced in the autumn 2017 budget. These companies, often in the healthcare and technology sectors, have seen a doubling in the amount of EIS funding they are allowed to take; from £5million to £10million.
In 2019, the firm expects a continuation of the long-term shift towards businesses in technology and healthcare, although they are still committed to the principles nd practice of diversification so other sectors will be represented in portfolios.
As Moore explains, “This year sees our 20th anniversary so we’ve been around a long time. I’d say that our USP is definitely focused around the age and experience of the firm, especially given the ever-changing scenario for EIS. This first-hand experience becomes increasingly important in ensuring successful growth investing.’
Going For Growth
EIS and VCT schemes enjoy generous tax breaks of course. However, the quid pro quo of providing that support is that the Government wants to direct the investment towards growth companies and those focused on the knowledge-intensive sectors. As Moore comments ‘each year they tweak the rules a little bit, to make sure that funds are going to businesses which are going to grow, employ people and thereby boost overall economic growth. The good news for us is that this has always been our strategy.
‘We’ve always worked within the spirit of the EIS rules, investing in companies that genuinely have the opportunity for growth, are growing their top line and employing people. They simply need the financial investment to help cover the costs whilst they do that. This brings challenges which require a particular skill set to help overcome them. Often the company is quite small – perhaps just 25 or so employees in the smallest case. Because of our experience, we understand the challenges and growing pains which the management team will go through as they grow their business – and their cost base. They need hand-holding, they need support. The fact that we’ve been following this strategy of finding businesses with exciting growth potential and seeing them through that process for a number of years, we think is crucial. It’s partly an intellectual challenge but I don’t think there’s any substitute for experience, both theirs and ours. They don’t all work out of course. That’s the nature of EIS investing. The experience that we have in identifying the companies that have the best chance of success – and helping them through it – is absolutely key.
The Due Diligence Process
So when it comes to doing their due diligence, lifting the lid on different business propositions for possible inclusion in their funds, which companies do they decide to invest in and why?
When it comes to due diligence and research, Calculus operates an intensive and rigorous process. Moore explains: ‘it’s useful to consider this process in terms of data and scope. Each year we probably review between 500-600 opportunities, although we’re looking to make just 5 or 6 new investments. We say no to a lot of businesses, and we can see early on what isn’t going to work for us. Our experience and longevity means that we get a good feel for what is out there at the moment, what is getting funded, what is likely to work etc. I think that volume really helps us to identify the stronger businesses that we like the look of.
‘We then operate a two stage process.. One of the key determinants is how ready the company is to engage with us and provide us with information. Sometimes we see a young, exciting, entrepreneurial team who haven’t been through the process before and they don’t have the proper data. The fact is that we do need to see numbers and data to really get to understand the business. This first stage takes on average 6-8 weeks but throughout that time we are going through our intellectual process to decide whether it’s a company we want to invest in and if so, on what sort of valuation and what sort of structure. This is a very important period for us, when we do our own research and spend a lot of time with management.’
The Calibre Of Management
For Calculus, a key factor behind making a good investment is assessing the calibre of the management team and, according to Moore, this means spending time with them to really understand how they operate. ‘We will go and meet with them on site and spend a lot of time going through accounts, the sales pipeline, getting a product demonstration, and even having them pitch to us in product/sales mode as if we were a customer. A lot of it is core data – the detail we need to help make our decision. In that initial period we are building up our view of the company, its market position, its product and its opportunity to deliver on what the management is presenting as its plan. If we do see an opportunity, we then go to our investment committee with a formal proposal, although they are constantly updated throughout the process so they are always in the loop. We present them with a detailed analysis which they will thoroughly test. We will also arrange for the management team to present to the committee as it is important for the committee itself to have direct experience of meeting and hearing them. If after that we are happy, we’ll make an offer.
‘In the instances where we get to term sheet stage, we go into a period of exclusivity in which we then incur a lot of time and external cost. At this stage we bring in accountants and lawyers to verify the details. We will often do our own commercial diligence internally, the most important element of this is speaking to the company’s customers. For technology companies, we’ll often do technology diligence too. We approach HMRC for advance assurance at this point, a process which takes a few weeks. During that time we do all the rest of the work we need to do so that when HMRC comes back to us, usually in around 8 weeks, then we’re in a position to complete. It’s quite an involved and a very detailed process to get to final investment.
The Investment Pipeline
When it comes to the existing pipeline of businesses, Moore sees it as a good mix. “We currently have two businesses that we’re looking to close on during Q1 2019. The frustrating thing is that the pipeline can be quite lumpy in terms of timing, we often see a few businesses coming through at the same time.
That’s life though. On occasions, we have seen two or three good businesses within the space of a week. We just have to find the resources to cope with the workload and make sure we give each one our fullest attention.
It’s important for us to stay firm and true to our beliefs during the quieter time, so that we really focus on whether or not a company is worth investing in.’
Despite the action to remove tax breaks for capital preservation schemes, the Government remains firmly behind EIS and VCT investing. According to Moore, this has been a positive change for tax-efficient investment, as money will now have to be focused on investing in genuine, entrepreneurial, growth companies.
But does he have any fears that future Government changes could undermine the scheme’s effectiveness? Moore thinks not. ‘We think the schemes work well and, whilst changes can never be foreseen, it is important to note that every country in Europe has some form of governmental incentive for investing in / supporting SMEs.’
So, if he could influence changes to the schemes, some suggestions he voices would be higher limits, both lifetime and annual, in order to allow for proper scale-up. He believes that with the present limits, EIS & VCT investing can only partially address the “equity gap”.
The Role of Advice
Nowadays, there is far greater awareness of the schemes and their benefits, however, some investors remain wary of SEIS in particular, seeing them as too high risk. In Moore’s view, EIS & VCTs are better positioned to manage risk and with the added benefit of independent reviews available, this can provide some additional comfort around the pros and cons of the specific providers.
Despite the action to remove tax breaks for capital preservation schemes, the Government remains firmly behind EIS and VCT investing.
So how can advisers continue to educate their clients about the investment opportunities in EIS? With a growing expectation amongst clients that their advisers have sufficient knowledge around these products, Moore stresses that this is why Calculus continually offers teach-ins for advisers and advisory firms specifically on EIS & VCT.
When it comes to the ongoing confusion over the UK’s Brexit plans, Moore doesn’t think that this has affected the future of EIS. He believes that the Government’s stated commitment to EIS and VCT schemes post-Brexit is supportive.
So does he see any clouds on the horizon, such as trade wars, a slowing global economy, interest rate rises etc. that might spoil the party?
One concern that Moore has, further confirmed recently by the government, is that the UK isn’t producing enough qualified people for the skills required to drive growth and innovation, particularly in science and technology, although they have announced funding to address these issues.
With the end of the tax-year rapidly approaching, it is looking likely we will see even more adviser and investor interest in VCT and EIS schemes than ever before, Calculus are well-placed to continue delivering effective solutions for clients looking to capitalise on the opportunities which investment in this dynamic sector can deliver.
About Richard Moore
Richard joined Calculus Capital in 2013. Prior to this he was a Director at Citigroup, which he joined in 2005, and previously worked at JPMorgan and Strata Technology Partners; resulting in over 14 years of corporate finance experience and a large base of industry contacts. Since joining Calculus, Richard specialises in advising companies in the technology industry and has worked with a number of our portfolio companies including Cloudtrade, Avvio and ActiveOps. Richard began his career at KPMG where he qualified as a Chartered Accountant, and remains a member of the ICAEW. He has a BA (Hons) in Politics and Economics from Durham University.