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Institutional Investor Profile: Guy Fraser-Sampson, Founder and Managing Partner, Mowbray Capital

Fraser-Sampson on bringing a home-run mentality to European venture, on the futility of trying to market time private equity, on the value of revisiting both succesful and unsuccesful fund investment decisions and on the danger of putting your eggs in too few baskets.

Why did you decide to set up Mowbray Capital?

‘When I left Horsley Bridge it was with the intention of putting together an investment programme dedicated to European venture. While I accept that traditional European venture capital has underperformed in the past, I strongly believe that the market is now slowly beginning to change.

‘Over the last couple of years I have become aware of a growing number of nascent European venture capital teams that recognise that what is required is hands on entrepreneurial experience and the application of a US-style approach to venture investment. I launched Mowbray Capital to take advantage of the opportunities that these new firms are set to bring to the European venture market.’

What do you mean by a US approach to venture investing?

‘I think that what we have seen so far is not venture capital being practiced in Europe and venture capital being practiced in the US, but two completely different forms of investing. It starts with the types of people involved. In the US, venture capitalists will have often been successful entrepreneurs themselves, with personal experience of founding and developing technology companies. In Europe, by contrast, most venture capitalists have a background in investment banking or consultancy and simply don’t have the skills required to build companies from a very early stage.

‘I think another key difference is that in America there is a recognition that it is home runs that drive venture returns. Typically in the US, something like four per cent of portfolio companies by cost will produce around 80 per cent of your ultimate value. It really is quite dramatic. Europeans have never felt comfortable with such a binary model. They would much rather be able to generate three times cost value across the entire portfolio. But that simply isn’t going to happen. Experience has shown that in all likelihood 50 per cent of your companies by cost will fail and you have to look to those big hitters to make home runs.

‘I would say that the third key difference between traditional European venture investing and US venture is that Americans have a far greater recognition that you need to focus on seed stage investments. Firstly, because it gives you the opportunity to mould the company into what you would like it to be, and secondly, because the earlier you are investing in a company the lower your entry valuation is likely to be.

‘But although these differences continue to characterise much of European venture at the moment, I firmly believe that the US model will increasingly be adopted. It won’t happen everywhere and it won’t happen over night, but it will happen.’

If US venture is performing so much better, why invest in Europe?

‘I totally accept that US venture capital has outperformed European venture capital up to this point. The figures are very stark. But what people ignore is that those US returns have been driven by a small number of firms and that it is incredibly difficult to gain access to those top-performing funds. And if you can’t gain access either directly or indirectly, you are not going to see anything like the advertised industry benchmark returns. In fact, you are going to see something much closer to historic upper quartile European venture capital returns. And, the historic European venture returns are not a good guide to future returns, for the reasons we are discussing.’

But are there not fundamental and insurmountable differences between the US and Europe that have contributed towards the different level of success in their respective venture markets?

‘I really don’t believe that there are fundamental differences between the US and Europe. One of the things that I find most frustrating about European venture capitalists is that they are far quicker to make excuses for mediocre past performance than to look at what needs to be done to turn the situation around. I have very little patience for that type of self-justification. European venture capitalists have to be prepared to compete on the world stage. And if they can’t do that then frankly they shouldn’t be in the business and LPs should not be investing with them.

‘The only difference that I would concede to is that it is far easier to grow a company to a significant size in the US without stepping out of the domestic market. In Europe that is obviously not the case. European venture capitalists have to be prepared to adopt the Israeli model of relocating and repositioning companies so that at the very least they have the appearance of a global perspective from a relatively early stage.’

What would it take to persuade LPs en masse to buy the European venture story?

‘That’s a very difficult question. The majority of institutional investors in Europe don’t really understand venture capital because for the most part they are generalists, often with a background in quoted investing. I think the problem is that most investors have tended to treat European venture capital as something of a whipping boy for problems that have in many cases been caused by other things.

‘Most institutional investors also mistakenly believe that European venture capital has underperformed quoted equities. In fact, the reality is quite different. Upper quartile European venture funds have actually outperformed the FTSE for every vintage year save one since 1990. Take 1993 as an example. If you had invested £10 in upper quartile venture in that year, by 2003 it would have been worth in excess of £100. £10 invested in the FTSE index would have grown to just £21 over the same period. Investors just don’t realise that even in its present imperfect state, European venture can be relied upon to significantly outperform the public markets.’

What type of funds are you looking to invest in?

‘We have no specific allocation policy as I believe that that leads to suboptimal investment decisions. We are also largely sector agnostic, and will look at opportunities across the board in IT, telecoms and life sciences.

‘We anticipate investing in a large number of young and / or small firms, as it is this type of group that tends to be most willing to adopt the US model. But I wouldn’t want people to think that our entire portfolio was going to be made up of first time funds. There will be a fairly natural progression from the portfolio of the first fund of funds, which will include by necessity more traditional European venture capital funds alongside these exciting new managers, to a situation in one or two fund cycles time when hopefully the landscape will have changed quite dramatically. By that point we hope to have many more US style groups to choose from. I am also hoping that we will see a lot of US funds themselves reviving their plans to come to Europe.’

Will you be looking to invest in pan European or sector specific funds?

‘I would have no difficulty investing in country specific funds as long as they recognise the need to reposition their portfolio companies globally at some stage. I think that one of the problems with European venture capital is that certain economies, most notably France, Germany and the UK, have been what I would call seductively large. It has been quite possible for venture capitalists to build a medium-sized company in these regions without going outside the domestic market. Whereas an economy like Israel is clearly so small that VCs have no choice but to move their companies to somewhere like the US. And ultimately, this strategy has been the more successful.’

Do you include Israel in Europe for investment purposes?

‘We do include Israel in Europe but we are not losing sight of the fact that this is a vehicle for European venture. We would only include an Israeli group in our portfolio if there was a genuine intention to reposition at least some of their companies in Europe. Out of a portfolio of around 18 investments in total, we would probably limit any Israeli related commitments to no more than three.’

Do you see Asia as a source of competition for European venture?

‘I do think that Asia is a source of competition for European venture, but I don’t think
it should be. I have never understood the love affair, which institutional investors, particularly in the US, have with the region. I have done business there myself and there is something extremely seductive about Asia. It is a wonderful place to be and the people are extremely appealing.

‘But you have got to remember that in many cases there is no proper legal system, particularly with regards pretty important things such as company law and insolvency. A contract in the Anglo-Saxon world is a legally binding document, precisely because you are expected to abide by it when it is no longer advantageous for you to do so. That concept is simply unknown in Asia, which is why I find it very difficult to understand why many investors would rather commit to Asia than to Europe, which has, after all, been a trading block for at least 2000 years.’

What do you look for in a good fund manager?

‘We are very open about the criteria that we will seek to apply when looking at venture groups. We will tend to favour groups that are manned by experienced entrepreneurs. We will favour firms with a genuine focus on seed-stage investment. We will favour groups that have a real home run mentality and we will also favour firms that recognise the need to reposition their firms on the international stage.’

How do you identify good investment opportunities?

‘I think there is a dramatic difference between identifying good venture funds and identifying good buy-out funds. The process of investing in buy-out funds tends to be largely objective and quantitative, whereas the process of investing in venture funds tends to be largely subjective and qualitative.

‘By that I mean that the drivers of buy-out performance, such as multiples expansion, earnings expansion and leverage, are well known and are easy to model. With venture, the drivers of value creation tend to be somewhat more nebulous.’

How do you actually conduct your due diligence?

‘It is an extremely time intensive business. First of all you need to establish relationships with the individual partners, and that includes getting to know them on a semi-social basis. It is then a question of researching them as deeply and as diligently as possible.

‘The most important element of my due diligence is probably my contact with the CEOs that a venture firm has worked with. And that really is a different process in Europe than in the US. In America a CEO will give you chapter and verse on what executives a venture capitalist was able to recruit, what key customers they were able to introduce and what impact they had on the whole product development process. In Europe you tend to get the telephonic equivalent of a blank stare, because at the moment, European venture capitalists often do little more than attend a monthly board meeting. I believe we have a definite advantage here not only because I have long experience of doing this myself, but also because we have Nick Sedgwick, a successful technology entrepreneur, on board as a partner who can speak these guys’ language.’

What advice would you give a new investor in private equity?

‘The advice that I would give to a new investor in private equity is not to attempt to market time the asset class. There is no good or bad time to invest in private equity because the money that you commit today will not be invested for four or five years, or in the case of venture for up to eight years. You cannot possibly predict what the market conditions will be when those investments are made or even more so when they are exited.

‘I would therefore emphasise the importance of a properly phased commitment programme, particularly for venture investing. In buy-outs, you could probably get away with making two or three commitments per year if your financial analysis was sufficiently good, and still pick upper quartile funds with reasonable regularity. But in venture that just won’t work. You really need to be committing to something like six venture capital funds in a year, giving you around 18 in a fundraising cycle. This is because there is a far greater disparity between the top-performing funds and the upper quartile in venture than in buy-outs. Venture capital is an upper decile game and diversification is crucial to managing risk. It is far too dangerous to put your eggs in too few baskets.’

What size of investment do you expect to make?

‘That largely depends on the size of the fund that we raise and because we are currently the only game in town, fund size is fairly open. I personally believe that the maximum you can put to work with quality European venture capital partnerships over a three year period at the moment is around E300m.’

What is the biggest mistake you have ever made as a private equity fund investor?

‘The biggest mistake that I ever made as a private equity investor was during a period when a particular fund of funds had not made a commitment for a few quarters. While I was reasonably comfortable about this, knowing European fundraising tends to be a very cyclical affair with many groups coming to market at the same time, I did allow myself to be unduly influenced in making a positive investment decision, which I was to come to regret. However, it was a very small commitment in the context of the overall Fund, so thankfully little real damage was done.

‘Obviously some funds don’t perform as well as you would hope. But I think you have to look at an investment decision on the basis of what you knew at the time. I make sure that I look at those funds that are underperforming every year and go back and revisit that investment decision. This is a very useful exercise and enables you to isolate common trends.’

How do you expect the European venture industry to evolve going forward?

‘I think that for those European venture firms that are able to raise money, the investments that they make within the next couple of years could well be the best performing venture investments ever. There is such a dramatic shortage of venture capital, particularly at the seed stage, that the terms that venture capitalists are able to exact with regards to entry valuations will probably never be better.’

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