Investor Talk: Octopus Investments’ Alex Macpherson
Octopus' ventures chief talks EIS, hot start-up trends, and what he looks for when weighing up an investment
Alex Macpherson is one of Britain’s most experienced and respected investors, having bought and sold his own growth consultancy, and headed up Octopus Investments’ ventures division for the past four years. In addition to his daily quest to unearth start-up companies with talent and vision, Alex writes a regular blog on investment matters, and helped to judge the winners of this year’s Fast Growth Business Awards.
We spoke to Alex at Tech Entrepreneurs Week about creating the changes to the EIS scheme, the hottest trends in the start-up community, and what he looks for when running the rule over a potential investee.
Can you elaborate on the content of your speech at Tech Entrepreneurs Week?
The message that I was trying to get across to an audience was about the interaction between investors and the entrepreneur. It’s about entering into a relationship, and when we make an investment we want a partnership over a period of time.
There’s a commonly used phrase that an investment is like a marriage, and you’re looking to take the business forward together. But the reality is we will want a divorce at some point in time! An investor is looking to realise the investment, because they will have people behind them who want their money back.
The best relationships can be forged with serial entrepreneurs, because they can build a long-term understanding. For example, since we first invested into LoveFilm, we’ve backed four businesses founded by ex-Lovefilm employees. There’s a degree of comfort there, because they know what we’re about and vice versa.
You also talked about entrepreneurs maximising their chances of investment, didn’t you…
Yes, I talked about entrepreneurs reaching out to the investor community. Entrepreneurs should treat the VC community as a customer base – if you only want £100,000, don’t come to a VC who normally looks at £10m investments. It’s also important to stand out from the crowd, making sure you have relationships. Over the last three years, we’ve looked at about 12,000 businesses, and around 2,000 of those came to us because of some form of connection – perhaps an introduction, or through the venture partner network we have. Those businesses tend to command our attention.
So if you’re looking to attract attention, find a route in, build the relationship. We have an open office session every Wednesday, we advise anyone can come and see us, even if you’ve just got an idea. Remember that a relationship is not linking me in, it’s not thrusting your business card into my hand – you have to be proactive and intelligent about it.
You’ve come out in favour of the seed enterprise investment scheme (SEIS) changes. What benefits will these have for UK start-ups?
I think the enterprise investment scheme (EIS) tax break is a very compelling tool to help create an eco-system for investment, and the SEIS, particularly with very early stage seed businesses – a university spin-out, for example – is a great initiative, because it enables the angel investor to invest in a very tax-efficient way.
SEIS will also draw attention to EIS in its own right, and encourage people into that marketplace to provide finance to entrepreneurs.
What else should the government be doing to encourage investment?
The big area for me is the regulatory environment, specifically around red tape, employment law, and entrepreneurs’ tax relief. We already have a wonderful tax break for people starting businesses, but if your stake falls below 5% you’re no longer included, and it’s often the guys who are less heavily involved who go off and start new businesses. This should be extended.
What trends in the start-up community are you particularly excited about?
We tend to look at trends and focus on them quite closely. If I start at the top, this whole feeling of austerity, and I’m not sure whether that’s a trend as such – we’re particularly interested in businesses which can bolster top-line revenue for bigger companies. A great example is in retail – if you look at the high-street, online sales are up 26%, so providing tools for online retail could be really interesting for us. Similarly, businesses which enable cost reduction and greater efficiency are attractive, because they present an easy buying decision when it comes to the FDs, they can see good return on investment immediately.
And what specific sectors and spaces are you looking at?
We’re really excited about telemedicine and remote care. We see this area growing dramatically over the next few years, as the authors look for ways of improving compliance with drug taking and how people are being monitored, which can be handled remotely.
During your speech at Tech Entrepreneurs Week, you hinted that VCs sometimes receive unfair criticism from entrepreneurs. What did you mean by that?
I think it’s fair to say that on several occasions in the last 12 months entrepreneurs have expressed their frustration (and often exasperation) at not successfully raising funds for their business. When this frustration is communicated publicly via a blog, a column or Twitter, there is a risk that a negative perception of venture capitalists will pervade our community. Whether or not this criticism is unfair will depend on a case by case basis, but what I think is not sufficiently understood is that most venture capital houses make only a few investments each year and only into businesses which fit a narrowly defined set of criteria – we say no almost all the time – but are approached by thousands of people each year. For an entrepreneur who thinks his business is fantastic (as all do), this rejection is hard to understand, particularly when his or her business could become a “nice” business, but a “nice” business is not a business that can deliver the type of returns required by venture capital investors. When this frustration is vented, is this fair? Possibly not.
Some entrepreneurs might say that VCs drive too hard a bargain when they are negotiating an investment. What would you say too that?
Negotiating reasonable terms on making an investment is critical. We want our entrepreneurs to win. When we invest into a business we are entering into a partnership with the entrepreneur, so it would be counter-productive to de-motivate the very people who will be executing and delivering the business plan. There has to be a sense of partnership, a commitment from all stakeholders. We want our entrepreneurs to be very successful, building big businesses making a lot of money.
Finally, what key things do you look for when running the rule over start-up companies?
We look at the team – the people. That remains the driving factor, which applies both to the entrepreneur and also to the people, their tenants as such.
We look for behavioural characteristics within the individuals – urgency, drive, vision, the ability to make decisions – and the blend of functional skills, such as sales, finance, and in the case of the CEO, leadership. The team has to be able to communicate the vision to us, and give us the confidence that they will execute the strategy and business plan.
The secondary element is scalability. How is the business going to create or define a market segment? Things like recurring revenue are important – the business will ideally have higher margins than the sector average. Customer retention is also significant, and high churn is a big red flag. We’re not interested in investing in declining sectors, so we may not look at outdoor advertising at the moment, but digital and online retail are exciting.