Features
How to spot the winners
Paul Havranek

07/02/2000
Sunday Times - London
News International
1TK
E League 10
(Copyright Times Newspapers Ltd, 2000)

Now that the headlong rush for anything with a dotcom label is over, capital providers need to return to more traditional yardsticks to pick out the companies, likely to succeed, writes Paul Havranek of Cazenove's venture finance advisory unit.

Traditionally, young innovative British businesses have had to endure a long and arduous journey to the stock market. It usually began with private funding followed by several years of profitable growth before flotation could even be contemplated.

Now that first-mover advantage is often perceived as an overriding business principle - epitomised by the dotcom business-to-consumer (B2C) flotations - there has been a compression in the timetable from start-up to flotation. In the rush to invest in virtually anything with a dotcom label, traditional business criteria have, to some extent, been overlooked. Although speed of execution and the need for early relationships with City advisers will remain essential elements of a start-up's strategy, we believe the underlying approach to business principles should shift back to the pre-dotcom era. This follows the recent correction in the technology segment of the stock market, with some dotcom companies losing 80% or more of their value in a few months.

Investors are returning to the standard ways of appraising businesses, examining the management's experience and the company's profitability, or at least the possibility to achieve it in the future. Companies of the "old economy" are also back in fashion. Indeed, the lines dividing the old and new business worlds are becoming increasingly blurred and soon the concept of "e-business" will be replaced by simply "business". This is already evident in the number of established businesses competing against start-ups in various internet spaces.

As Jack Welch, chairman of General Electric, recently said: "Any company, old or new, that does not see this (internet) technology as literally as important as breathing, could be on its last breath."

We would argue that the recent stock-market correction was an essential step because it has led to a more reasoned, balanced, analytical and ultimately profitable approach over the long term. We are also confident that the development of the internet, the key catalyst in the recent surge of flotations, and the prospect of other digital channels emerging, will remain a powerful additional conduit for business. Internet penetration in Europe is still at an early stage, as the chart above shows, and its development is expected to produce many more exciting business opportunities.

One of the main benefits of the dotcom phase is the public's acceptance of an entrepreneurial culture in Europe. America was the natural home of the start up approach, but this is no longer the case. In Europe, one only has to look at the flow of talented graduates away from traditional jobs into the uncertain but exciting world of the start-up. Building on the Conservative entrepreneurial model of the early 1980s, the current government's endorsement of the new economy has created unparalleled optimism in the new workforce.

In the process, a new generation of capital providers has emerged. Britain continues to account for a large proportion of early-stage financing in Europe through its established venture-capital industry. More recently, the profile of the smaller-company technology-

biased Neuer Markt in Germany and the emergence of pockets of technological leadership, such as the Scandinavian wireless expertise of Nokia and Sonera, have laid the foundations for a decade of explosive activity in the telecommunications, media, technology (TMT) arena that will need funding.

The Cazenove venture finance advisory unit helps companies to realise their ambition of becoming fully quoted entities. Increasingly, investment advisory firms are fostering relationships much earlier in a start-up's life, as reflected in the emergence of "incubators", in addition to the traditional venture capitalists. Cazenove typically focuses on those companies that require second or third-stage funding, when seed capital has already been injected, a concrete business plan is available and original projections are being met.

At Cazenove we are less concerned whether a business is a business- to consumer, business-to-business, consumer-to-business, consumer-to- consumer or even business-to-government, than in understanding its strategic positioning. The quality of management is probably the most important factor we consider, for without this even the best business plan can fail. Another key issue is whether there are barriers preventing a proprietary model or idea from being replicated.

Thus an entrepreneur must answer two questions: What is the unique selling point of the business? And how can it be protected from both existing and new competition in the marketplace? If there is one lesson to be learnt from the impact of the internet on the business world over the past five years, it is that the visibility of a business's competitive advantage and model is global.

Despite the collapse of Boo.com, with expectations of more failures to follow, a milestone in the ambition of the start-up will always remain quoted company status. Freeserve represented the first of the new-style new-

economy flotations in Britain, and the scarcity of early stage, high-growth businesses led to excessive demand for similar stocks from summer last year to this spring. This was fuelled by a surge in the number of individual investors, many of whom were new entrants on the stock market. However, the weightings of institutions have been temporarily satisfied and, partly for this reason, more stringent business-appraisal methods have re-emerged.

We advocate a three-stage approach to strategic analysis:

oWe assess the dynamism of an industry, namely the rate of growth of the market and its potential size.

o We apply Porter's Five Forces model, which examines rivalry among existing firms, the threat of new entrants, the threat of substitute products or services, the bargaining power of suppliers and the bargaining power of buyers.

oWe do a simple strengths, weaknesses, opportunities and threats (swot) analysis to highlight the key issues for the business.

The Cazenove venture finance advisory unit is ideally positioned to assist in the business appraisal process from initial funding through to flotation and beyond. Besides providing advice on corporate, management and finance-related issues, we can access a wide variety of sources of venture finance from traditional venture capitalists, new incubators, wealthy individuals and, increasingly, institutions that have historically tended to invest only in quoted companies. In addition, numerous internet/ technology funds have been formed. One example is the Pounds 235m New Europe Access Fund recently raised by Cazenove Private Equity. The fund will invest primarily in second and third-round financings in the pan-European TMT and internet sectors.

Fundamental to the long-term health of a new business is that investor and company are matched. The investor will tend to focus on the risk/reward profile of the business; the investee will be more concerned about securing a long term supporter who can be a source of valuable advice as well as finance. Therefore, it is vital to ensure that the right type of investor is brought in to match the stage of development and nature of the business seeking funding. Knowledge of the latest developments in the wider technology market is also essential and alliances are being formed in the advisory world to extend this knowledge requirement. For example, a recent strategic partnership with Wit Capital Europe allows Cazenove's 50 global TMT analysts to draw on Wit's considerable new-technology experience in America.

The challenge of distinguishing between potential winners and losers in start-up and early-stage businesses of the new economy will be as great as ever. While popular retail interest in internet stocks reduced the reliance on the professional analyst in judging the success of a company, this early model has been superseded. It remains an exciting marketplace. We believe the growing range of sources of finance and expertise in Europe's financial centres will allow the best ideas from European entrepreneurs to flourish and rival the best of the American stable. In our view, this is the main benefit of the recent dotcom mania.

* For further information contact Paul Havranek (prhavranek@cazenove.com) or Richard Wood (rawood@cazenove.com) of Cazenove's venture finance advisory unit.

* Cazenove, the UK's leading investment-banking partnership, advises more than half of Britain's largest quoted companies as well as 300 small and medium-sized businesses. The firm is a leading distributor of equity IPOs, in Britain and internationally, having participated in issues totalling Pounds 180billion in the past five years. In the past 12 months, Cazenove has been involved in 50 offerings for technology companies.