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Planets aligned: The ingredients for a successful VCT investment

VCTA’s Chris Lewis and Pembroke VCT’s discuss their methodology for sourcing and evaluating investment opportunities

Chris Lewis and Fred Ursell

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Venture Capital Trusts (VCTs) play a vital role in nurturing young, innovative UK scale-up companies. However, sifting through and identifying the right startups for investment requires a meticulous approach.

Any investor, VCT or otherwise, will have a methodology for sourcing and evaluating investment opportunities. We see this process as an alignment of four planets – management, model, market, and finally money.

Building a strong foundation

The first of these, management, is a crucial consideration for VCT investors. We seek management teams with deep industry expertise, often individuals who have honed their skills in larger corporations, before spinning out to pursue an idea, often perceived as too risky to fund by more established industry players. The spin out often provides a new solution to an existing problem, thus tapping into a ready-made market.

Beyond industry expertise, a strong management team demonstrates a diverse skillset spanning essential functions, such as technology, marketing, sales, finance and enthusiasm. As VCT investors, our role extends beyond assessing existing strengths to identifying and potentially addressing areas for improvement. This might involve connecting the team with external providers or even assisting their search for a suitable non-executive director.

In today’s evolving business landscape, emotional intelligence (EQ) in addition to IQ, has become ever more important. While challenging to evaluate, spending time with founders outside of a boardroom can offer valuable insights into their leadership qualities, gauging their ability to navigate complex situations and inspire their team.

Seeking sustainable growth

The current funding environment quite rightly emphasises profitability, making our second planet, the model, a critical focus for VCT investors. We help businesses prioritise a clear path to profitability within a realistic timeframe.

Successful ventures must also demonstrate the ability to adapt and evolve. A prime example is the need for consumer brands to move beyond direct-to-consumer (D2C) sales and expand into retail or wholesale channels once market saturation becomes a concern. Healthy margins can provide the flexibility to implement such strategic shifts, ensuring the business can not only survive, but thrive, in a dynamic market.

A time and a place

Our third planet, the market, holds immense significance. Although the question “why now?” is often asked of founders, it highlights the critical role of timing. Businesses must offer a compelling answer, demonstrating why their solution is relevant now.

Identifying a market gap, addressing a growing need, or capitalising on an emerging trend are all key ingredients for securing investment. As investors we must acknowledge the inherent risks involved but prioritise ventures that operate in a large addressable market. While a healthy dose of optimism is always needed, it must be grounded in a realistic assessment of market dynamics.

Money: Fuelling growth

The final “M” is, of course, money. Guiding a business through its growth journey requires careful consideration of not just this funding round, but of future funding rounds too. As the business looks to expand its offering and secure larger customers, each round presents an opportunity to re-evaluate the alignment of the other three Ms – management, model, and market. Not only does this allow us to provide advice to the founders it also allows them to present the most compelling case to new investors joining in subsequent funding rounds.

As VCT investment managers, along with all other investors, we are ultimately aiming to manage risk by working alongside management teams to identify, evaluate, mitigate and overcome, wherever possible.

When the first three Ms – management, model, and market – align and demonstrate strong potential, only then does the money follow. This paves the way for a startup’s success, ensuring a win-win scenario, for both our investors and the innovative scale-up companies which we support.

Chris Lewis (pictured left) is chair of the VCTA. Fred Ursell is investment director at Pembroke VCT

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