Reading the runes for venture capital

One of the UK’s most high profile and longest-standing investors in early-stage technology companies, Prelude Trust plc, is shutting up shop, citing falling asset value, a dearth of exits and the inability to raise new funds. Eleven years after listing on the London Stock Exchange, the Cambridge-based firm is selling off its portfolio of 18 unquoted investments for £24.2 million, giving the cash back to investors and winding itself up.

More cheerfully, a band of former executives from Elan Corporation in Dublin have announced the first close, at €75 million, of the inaugural fund of a new venture capital firm they have founded, Fountain Healthcare Partners. This, the largest life sciences venture capital fund to be set up to date in Ireland, and will invest largely in Irish start-ups.

It has taken more than three years to reach the first close, but Manus Rogan, founding partner, noted that the original ambition was to raise €40 million. He now expects to reach a final close of €100 million by the end of 2008.

The life sciences sector in Ireland is at a turning point, Manus said, “The market is at a time when it needs further funds to scale. There is now a strong cluster of private companies that need to raise money.”

Different views

The same can, of course, be said of the UK. So it is perplexing that an experienced venture capital investor like Prelude has such a different view of current prospects from counterparts across the Irish Sea.

The facts are that Prelude has been a slow process of attrition of net asset value (NAV) over the past few years, accompanied by an increasing discrepancy between NAV and the price commanded by Prelude’s shares. Now a series of setbacks have pushed the company over the brink.

These including the postponement of the IPO of investee company Kiadis BV on Euronext in Amsterdam, because of market conditions, writing off investments in three companies - structure-based drug design specialist De Novo Pharmaceuticals Ltd, m-Spatial Ltd, a mobile phone location services company, and Si-connect Ltd , a semiconductor designer - that needed more money but had failed to make sufficient headway to justify further investment, and falling US sales of nutrigenomics test kits by Sciona Ltd.

During its lifetime Prelude has made a number of successful exits. For example, it invested a total of £2.2 million in Oxford Biomedica plc during 1998 and 2001, realising a total of £5.0 million through the sale of its shareholding between 2003 and 2005. In June 2003 Prelude exited internet security company nCipiher taking £2.7 million for the £1 million it invested during 1999 and 2000.

And Prelude holds a current portfolio that may have significant value, according to chairman Michael Brooke, in his letter to shareholders explaining the decision to sell up. For example, Oxford Immunotec Ltd recently started marketing its T-cell-based tuberculosis diagnostic in Europe and is in the process of obtaining US marketing approval.

However, said Brooke, “There have also been disappointments and failures, a risk associated with early stage technology investments; some investments have taken longer than expected to mature and create value; exits have been difficult to achieve and companies have in some cases required more funding than originally envisaged.”

Technology companies underperform…

In recent years, technology companies have underperformed the FTSE all-share index, limiting demand for Prelude’s shares. Since 2001 the shares have traded at a significant discount to NAV, making it impossible to raise more money.

Prelude listed in London in September 1997 raising £20.8 million and raised a further £29.1 million in 2000. The net value of all the portfolio companies at 31 December 2007 was £41.4 million, down from £46.7 million at 30 September 2007.

While it seems likely that the investee companies have growth potential in the long term, Prelude does not have the cash reserves to support them. “The capacity to invest in new companies as well as supporting the existing portfolio is governed by [our] ability to generate funds through realisations,” noted Brooke. He added ruefully, “Such opportunities are not expected to be material in the near term.”

When it was first established, Prelude concentrated on acting as lead investor in early stage companies, but in 2006 changed its strategy and made smaller investments in later stage companies with revenues.

Following the sale to CIP V, a fund advised by Coller Capital, shareholders can expect to receive 86 pence per share. This compares to a price of 72 pence at the time of the announcement.  Prelude says it has the agreement of 48.2 per cent of the shareholders and will attempt to persuade the others at a meeting on 20 May.

A big hole to fill

Meanwhile Fountain Healthcare has been tracking 50 start-ups that have spun out from Irish universities and companies and is now poised to make its first investments. Manus says the firm has a big vacuum to fill. “To date their money has come from sources such as business angels and grants, and there is not that much VC money available,” said Manus.

Institutional investors that have put money into Fountain include the European Investment Fund, the Ireland’s National Pension Reserve Fund and Enterprise Ireland. A number of high net worth individual investors also participated. “We have been very pleased with the level and quality of investor participation in the first close. There was clear support for our investment strategy,” said Rogan.

Along with Manus the founders of Fountain – Aidan King, Ena Prosser and Justin Lynch – are former members of Dublin-based Elan corporate VC group. The team has invested in 25 life science companies, including Acusphere Inc, Allergy Therapeutics plc, Idun Therapeutics (bought by Pfizer), Atrix Laboratories (bought by QLT Inc), and Sirna Therapeutics (bought by Merck & Co).

Fountain is pitching in at a later stage of development from Prelude’s original focus. Although he did not rule out investing in seed rounds, Manus said the focus will be strictly on products. The firm is interested in specialty pharmaceuticals, biotechnology, medical devices and diagnostics companies with products that have a clear and defined pathway to commercialisation, value enhancement and exit. It will invest €0.5m to  €7.0 million per company over several rounds.

Money into manufacturing

Ireland has seen a high level of inward investment in life sciences over the past four decades. Thirteen of the top 15 pharmaceutical companies, and 15 of the largest 25 medical device companies have bases in the country. But these are largely manufacturing operations that do not involve R&D, and the sector has been slow to spark entrepreneurial or spin-out activity.

Following the closure of so-called “screw driver” operations in the information technology sector in the wake of the dotcom bust, the inward investment agency IDA Ireland, has been trying to anchor inward investments to put down deeper roots. It has tempted companies to set up R&D labs and encouraged them to carry out collaborative research with Ireland’s universities.

At the same time the government has made significant investments in basic research. From 2000 to 2008 it put in over €8 billion, with a further €8.2 billion to be invested between 2006 and 2013.

Manus says this will spur the formation of more companies, creating a pipeline of potential deals behind the existing base of start-ups.

Prelude was hit by the double whammy of being quoted at a time when technology companies are out of favour, pulling down its market capitalization at a time when it was denied stock market exits for the companies in its portfolio  

Fountain does not have the same double exposure, and it will be three to five years before it needs to find the first exits.

The experience of Fountain’s principals will no doubt enable them to deliver some successes. And like Prelude, it seems inevitable that Fountain Healthcare will have disappointments and failures. No matter the state of the capital markets or investor sentiment, venture capital will remain a risky business.