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Institutional investor profile: Martin V Hansen, Investment Director, Danish Investment Fund

Hansen on the opportunities in the Danish market, on what proprietary deal flow should mean, on the virtues of appointing independent directors and on the need for differentiation among funds of funds.

The Danish Investment Fund was set up in 1993 to provide project finance loans to small, growing technology companies as a means of kick-starting Denmark's entrepreneurial economy. It also offered a guarantee scheme to fledgling venture capital firms as a way of helping to develop the industry. The fund's mandate has since changed to a more commercial focus, including making a financial return on their investments. As a result of this strategy shift, the Danish Investment Fund has now established a fund of funds and a direct investment programme as well as retaining its research and loan guarantee functions. The fund of funds has an evergreen fund of $250m to commit to venture capital funds that invest in Denmark. Hansen joined the fund in 2001 and was previously with Nordea, working on securitisations. He has also worked as Special Advisor for the Danish Ministry of Economic and Business Affairs.

What type of investments do you look for?
‘We invest in funds that invest in Denmark, so we're not focused purely on Danish funds - our remit is to make financial returns and we couldn't do that effectively if we restricted ourselves to local teams alone. We search and screen Scandinavian investors, for example, that invest in the Danish market and ask them to strengthen their Danish operations before we will commit.

‘We tend to work slightly differently from other fund investors in that we know the Danish market very well. We can work out where we see opportunities in the market and then try to find the fund that can fill the gap and take advantage of those opportunities.'

Do you create special mandates for venture firms?
‘No, we don't. We are only allowed to commit to funds in which there is at least 50 per cent private capital, so we have to invest alongside other LPs.'

What is your anticipated investment rate?
‘We currently have around $100m invested in funds and we expect to put out about $30m to $40m to funds this year. We are an evergreen fund and so we have overlapping commitments.'

How does your direct investment programme work?
‘We have made some co-investments, but our main focus is on making independent direct investments. We have the expertise on our direct investment teams that allows us to source and assess investment prospects on our own. That said, we encourage the direct investment teams to work very closely with the management teams in our funds. We believe that between the two areas, there is a huge amount of opportunities.'

Which areas do you think hold the most promise?
‘We spend a lot of time researching where there is demand for capital in the Danish market and assessing where the opportunities are. What we're looking at right now is how the innovation system in Denmark is put together to try and identify any gaps. One we have spotted is that between the publicly financed incubators and formal venture capital. We believe that gap can be filled by commercial venture capital firms - they will be able to source a lot of deals from incubators.

‘There is another gap. This is at the level of mid-sized buy-outs. There is a huge amount of companies in Denmark on the verge of ownership change. We see a lot of potential there for funds to come in, facilitate that change and find new management. There really aren't funds in Denmark specifically targeting that area of the market and so we do believe that there is a lot of opportunity there.'

How would you describe the state of the Danish market at the moment?
‘It is tough at the moment. The Danish market has not been immune to the downturn that has affected other countries and regions. Fundraising in particular is an uphill struggle. International investors are looking at track records very closely before investing. Here in Denmark - and to some extent in the whole of Scandinavia - we don't have many teams with a very long track record. It's a huge challenge for us. We are trying to find ways of mitigating that. We do make investments in first-time funds, for example, if we believe that the management has the right experience and profile. We have faith that we can indeed get a satisfactory return on capital by backing this type of fund.

‘Through our research we have worked out that the Danish market will need an additional $2bn of investment over the next five to six years - that's on top of what is already there. We have looked at how many companies there are in the market, what their current burn rates are, what they will need before they reach the point at which they could be sold. From this study, we have concluded that the Danish market needs to raise substantial amounts of capital. We need to work out how to ensure that happens. As I said, there is not a lot of room for pure Danish players in the market and so we need to attract international players to participate in Denmark. Our aim is to identify the opportunities in the Danish market and present them to funds based in the UK, Sweden, Finland, etc. That is tough. Many funds are spending most of their time working on their current portfolio companies rather than making new investments.

‘But that is our value-add for funds that we invest in - we don't just do due diligence on funds, we also do it on the Danish market. As the Danish Investment Fund we have to offer this as a service to ensure that the market develops. It is also a sign of our approach and fundamental belief. We don't presume that we can build up the competence needed to service the whole spectrum of the market. We believe that there are people out there that know more about this than we do - and we need to find those people.'

Do you think there are currently sufficient incentives for funds to invest in Denmark?
‘We believe that there is a huge potential for growth among many of our smaller companies. There is a lot of potential in our life sciences companies, for example, in the Medicon Valley. There are currently some larger Scandinavian players sourcing later stage opportunities there, but there aren't many funds financing the companies in the earlier stages. There is definitely a role and potential for us there.

‘Telecoms is another area. We have huge expertise in telecommunications in Scandinavia. Players looking for convergence between the homogenous European market and fragmented US markets will look to Scandinavia to see the technologies and services that are being developed.

‘So I think it's best to look at this as a Scandinavian play rather than a Danish play and that's what many funds are doing. We'd like to be the intermediary that helps those funds understand what is happening in Scandinavia.'

What do you look for in a fund manager?
‘We look at private equity investment as a long-term process. We don't just look to invest with a group for one fund. Our investment horizon is therefore much longer than the ten years a partnership usually lasts. When we invest, we look for people that we believe are able to stay together for a long time and that are able to grow the team as they become more successful. That means that we have to look at a lot of areas.

‘The teams that we back have to understand their own competences and what their limitations are. They have to know when they should bring in other people, not only on the advisory board, but also as a complement to the existing team. Some teams have a habit of thinking that they know everything and that they can go forward forever. These are teams that we would avoid. Also, we like groups that work with people in partnership for a year or two before they take them on so that they really understand their strengths and weaknesses and, importantly, they know whether they will be able to work together over the long term. So, self-awareness in a team is very important to us.

‘We also look for specialisation. We don't believe that generalist funds will survive in this market. Growing companies in today's environment takes a lot of time, it takes a lot of knowledge and experience. It also takes a lot of skill to articulate to management teams what you really believe needs to be done in a company - and then to ensure that your message is well received and is subsequently implemented. Only if a fund has the specialist knowledge required to do this will it have credibility among entrepreneurs. That is a value-adding approach.

‘We look for a very clear investment strategy and we will spend a lot of time holding the management accountable to that strategy. We don't like funds that say they will do everything from seed investments through to pre-IPOs. We need to understand why they think they can do their investments better than anyone else - I haven't met anyone yet who can provide a credible explanation as to why they can make both good seed and later stage investments. It just doesn't make sense to us.

‘We need to understand why groups believe that they have superior knowledge of a particular industry. We need to be  convinced that they are able to see value in deals where others might not. If they are simply content to source deals through other VCs, then we are not interested. We can do co-investments ourselves in that case.

‘Operational experience is also important to us. A lot of people talk about this; we feel strongly about it. We like to see people who have taken companies public within the same industry for which they are raising a fund because they understand the nuts and bolts involved in the company creation process. They also understand how the management will play the board of directors and their investors and what to look for when they start doing that.'

How does a fund prove to you that it has proprietary deal flow?
‘For us proprietary deal flow does not mean finding deals that other players can't. For us it's more that a fund can see and understand where the value of a deal is while another fund may not. Proprietary deal flow is about understanding better than anyone else where a company's potential lies. So I want a fund to convince me that when they look at an investment, their experience, their previous investments and their network will enable them to examine a company and look through the fact that it might not work right now, but still see the potential if steps X, Y and Z are taken. They have to have company creation skills. That is what they have to convince me about.'

What kind of involvement do you think fund managers should have with their companies?
‘This is an important question for us at the moment. What we're talking about is how to get efficient corporate governance into portfolio companies. If you sit on the board, are you able to distinguish yourself from the management team and not get too involved? How do you prevent yourself from taking the management's view in all cases? It is possible to get too close to an investment. I think the best way of ensuring that doesn't happen is to appoint an independent director to the board. I think there needs to be that layer between the venture capitalist and the portfolio company. But you have to ensure that the cost of that distance isn't too great. You have to be sure that you are keeping up to date with the developments in the company and understand the operational and strategic issues by having frequent consultations with the independent director - and with management, but outside the board room. In other words, appointing an independent director on your behalf should not detract from the venture capitalist's responsibilities - it should simply help you maintain objectivity and allow you to ask the questions you might not think of if you were too close.'

What is the biggest mistake you have ever made?
‘The biggest mistake that we made was investing in a fund that at first closing did not have sufficient capital. We expected the team to be able to attract more capital once they had made a few investments, but that didn't happen. In the end, we had to close down the fund - we knew at the time that we were taking a risk and so we ensured that there were contingency plans in place. Even then, closing down the fund wasn't easy. Despite the fact that we had already told the managers that if they couldn't raise enough capital, we would have no choice, they didn't really believe that we would go through with it. We stood firm but overall, it taught us that if a fund does not raise enough in its first closing, then we should not commit.'

What irritates you about private equity?
‘One thing that amazes me is how easy it is for funds of funds to reject a fund. They will often say no, for example, just because it is a first-time fund. They will reject it before they have even sat down and assessed the team and the market opportunity. I'm not sure that they always understand what fund managers can bring to the table before they decline to invest. Many of them are simply not prepared to take that extra layer of risk into their portfolio. But if you look at some of the more successful teams today, I would rather have been in their earlier funds than in their fourth or fifth. Their returns were often better in their formative years.

‘I think that funds of funds will have to become more geographically focused or otherwise specialised if they are going to make the returns that their investors expect. The fund of funds industry is going to have to develop along the lines of differentiation and customisation - it's what their LPs will demand.'

How do you think the market will change in the future?
‘I think we will see increasing specialisation among private equity firms in general - so we will see more regionally focused or sector/stage focused funds. That is already happening. I think that we will follow a trend that we have seen in the US in that firms will not specialise only in seed deals, for example, but they will invest in the early stage of a company's life and ensure that they have the capital reserves to see it through its development. That is why operational experience will be key in tomorrow's market.

‘In Denmark specifically, I see a huge opportunity in the mid-sized buy-out market. If I was to give a tip to experienced, UK-based funds, it would be to look at that market very closely.

‘In Scandinavia, we have a maturing market. We have lived through the bubble and we are coming out of the downturn that followed. As companies are laying off people, we are seeing the emergence of entrepreneurs that are very knowledgeable about what is going on and that have a clear strategy of how they are going to create valuable companies. That will have a clear impact on the sustainability of the companies that are established going forward. But we have to see more international capital in Scandinavia. We need to understand what it takes to attract UK-based and US-based funds to the region, not only because of the capital they bring, but also because of the experience and the skills they have. They can help the region understand how you build a business from a national company into a regional and finally a global player.'

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