One of the hardest aspects of private equity is picking out a company which will flourish and pay back your investment. The ability to do this is what makes venture capitalists successful, and the Baronsmead venture capital trusts (VCTs) can be counted among these.

The market for the best entrepreneurial businesses is not huge and there is a limited supply, says Andrew Garside, partner at Isis Equity Partners, which manages the Baronsmead VCTs. So we have to look to tie up relationships with the best businesses, which have the choice of growing through resources, banks, a VCT or another private equity source. We seek entrepreneurial businesses with strong growth characteristics which can grow by getting market share, looking for the three ‘Ps:’ market position, people and platform.

People in the company are important: we have a very active involvement although we don’t run the company. The people need to want to have a relationship with us. The businesses we back also face growing pains and we help them break through these barriers by building a management team which will take them through the next five to six years. Therefore we recruit more senior and higher-quality staff than the company had previously.

Platform refers to the infrastructure which helps a company develop its services, for example information technology or the sales force. Often we spend year one or two encouraging the company to invest in its business, adds Mr Garside. The companies we invest in are often lean, under invested and over reliant on their founders. We have to persuade the founders to take on more people.

In addition to these broad criteria, Mr Garside and his team also look at factors specific to each industry sector.

The search for businesses involves sector research, as well as building up a network of contacts among entrepreneurs and chairmen, and Mr Garside and his team meet around 200 companies a year. That pro-active approach means you have a better chance of getting the investment you want, he says.

Unlike some private equity investors, the Baronsmead VCTs do not back very early-stage companies or start-ups. We typically back companies at the end of the first phase of their development, and help them get to the next phase, explains Mr Garside. Early-stage investing has a mixed track record but we want consistent returns. Our whole model is built around maximising returns and consistency — two members of our investment team work with the company — one on the board, and one to support. They know the sector they are involved with and its growth problems.

The right mix

As well as selecting the right companies, it is necessary to put together the right mix in the VCT portfolios. Our funds have diversified portfolios, generally with stakes in around 60 businesses, says Mr Garside. In our generalist VCTs this will typically be 20 private equity investments and 40 Alternative Investment Market (Aim) stocks. The private equity allocation is larger and we are significantly more involved with these businesses — they typically give us the majority of our returns.

The VCT portfolios are diversified across the sectors which Mr Garside and his investment team target. These include consumer-facing businesses, healthcare, business services, financial services, IT and media, and energy and environmental. The sectors give broad coverage of the UK economy so the funds are not constrained if one area does badly. But we have no fixed-asset allocation across these, as it is so much better to focus on the opportunities, says Mr Garside. You can get very different sub sectors within each of these, for example, in consumer.

A recent rule change allows VCTs to invest outside the UK, in European companies. However, Mr Garside is not rushing to invest the Baronsmead funds outside the UK. We believe a key driver of our returns is our closeness to the companies we invest in, he says. If we didn’t actively manage the companies we could lose shareholders’ money, so we focus on the UK.

But he would support one of his existing investments if it wished to expand into Europe.

Andrew Garside CV

Andrew Garside joined the new investment team at ISIS in 2005 and leads new investment activity in the financial services sector. Prior to joining ISIS, he worked at private equity house 3i.

Before moving into private equity, he spent two years as a consultant applying computer simulation to operational businesses.

Mr Garside has a BEng in general engineering and management studies from Brunel University.

Opportunities and drawbacks

Despite banks not lending much at present, finding investment opportunities is still not easy. I think the biggest issue is not banks but the confidence of entrepreneurs, says Mr Garside. In the current climate it is easier to raise capital than invest money. Less active bank lending is a double-edged sword — it can dim confidence though creates larger demand for finance at the smaller end.

As the economy recovers from recession, however, businesses will need growth capital, although their investment plans may be on hold for a year or two.

Another issue facing businesses is government spending cuts. If your investment supplies the public sector then it will face some challenging times, says Mr Garside. But at the same time the cuts will force innovation and not necessarily technical, for example, the cost per hour of care at home is cheaper in the private sector, so local authorities may outsource this.

It is difficult for VCTs to find qualifying investments on Aim, as they cannot invest in companies with assets of more than 7m, ruling out many companies on this market. As a result Baronsmead AIM VCT is changing its investment mandate to become a generalist vehicle with a similar remit to the other four Baronsmead VCTs. This is the best strategy for the long-term future of this fund, says Mr Garside. Investing successfully in Aim is increasingly hard for VCTs and we have to find a way to give its shareholders a better return.

The renamed Baronsmead VCT 5 plans to raise new funds of 20m.