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ANNEX A FUND PROFILE - SCOTTISH CO-INVESTMENT FUND

Objectives of fund

SCF's business plan, prepared in 2003, shows the following objectives for the Fund:

"The objective is to increase the amount of equity based risk finance available to growing SMEs in Scotland to enable them to realise their full potential, while improving the business building skills of early stage companies and their support network".

SCF provides equity funding to SMEs of up to £500,000, with a further tranche coming from selected Co-investment Partners so that the maximum deal size is £2 million. Co-investment Partners can be institutional investors, professional fund managers, smaller unregulated fund managers and investors, business angel syndicates and private individual investors. SCF will co-invest with existing funds and investors as well as new funds to be established, and new investors to the Scottish market. The public sector funds must be matched on at least a £1 for £1 basis with the private sector.

Deals are brought to SCF by the Co-Investment Partners and the relationship with investee companies is maintained primarily by the Partners, although SCF signs a separate agreement and is able to maintain direct relationships if it wishes.

SE has committed £20 million to SCF (including arrangement & nominal management fees) which, with the ERDF contribution, is expected to invest over £40 million in the current programming period in early stage companies in Scotland. It is anticipated that the SCF will have the following outcomes:

• Increase the amount of equity based risk finance available to growing SMEs in Scotland to enable them to realise their full potential
• Ensure Scotland-wide access for SMEs to viable venture capital funding, making equity based investments in smaller amounts
• Demonstrate to potential investors that commercial returns can be made by funds investing in the SME "equity gap" thus promoting the private sector venture capital industry
• Increase the supply of quality Fund Managers operating in the "equity gap"
• Attract new investors into the market that have not previously invested in this sector of the venture capital market.

Eligibility

Industry sectors eligible for SCF Investment include:

• Technology
• Creative Businesses
• Electronics
• Manufacturing
• Pharmaceuticals
• Biotechnology

Geographical coverage

Any business with its head office resident in Scotland or which conducts a material part of its business in Scotland may apply for equity finance to SCF Co Investment Partners.

Financial resources

The financial resources in the fund are shown by the following profit and loss account and balance sheet, contained in the SCF monitoring report for SEP. In addition, there is substantial private sector leverage through the portion of deals financed by Investment Partners, as shown below.

The strategy for the year 2005/2006 was to increase the spend profile across Scotland and increase the number of SCF partners. At a Scotland level during the period 1 ^st April 2005 to 31 ^st March 2006, 62 investments in 56 companies were made by the Fund totalling £10.19 million. The SCF partners invested £14 million and further private sector leverage of £7.16 million in the same deals bringing total private sector investment of £21.16 million, over twice the public investment.

An investment summary and balance sheet for SCF can be found on the following page.

Table A.1: SCF Investment Summary and balance sheet - Scotland level - for the period from commencement to 31 ^st March 2006

Source: Monitoring report to SEP

Investments

The Scottish Co-Investment Fund made 125 investments totalling £17.33 million in 84 companies in the period April 2003 to March 2006 to augment a private sector investment of £40.70 million. The table below shows the cumulative spend of SCF from April 2003 to March 2006.

At 31 ^st December 2006 SCF had made 162 investments totalling £22.95 million in 100 companies in the period April 2003 to December 2006 to augment a private sector investment of £54 million. The value of investments in the period from March 2006 to December 2006 was therefore £5.62 million and the private sector contribution was £13.3 million, and 37 investments were made including 16 new companies.

Table A.2: ERDF area investments (£)

Table A.3: All investments (£)

Table A.4: Sectoral breakdown of these investments

Financial results

Given the early stage nature of the investments, SCF expects that exits from investments, and the consequent investment returns, will be made about 8 years from investment. This is a reasonable assumption. However an average annual return of 20% is expected. All returns will be re-invested by SE through a continuation of the SCF and / or future initiatives of importance in supporting and developing the investment sector for SMEs.

As indicated elsewhere in this report, a target of 20% IRR appears ambitious. The accounts to date, at an early stage in the investment period, show provisions of £1.45 million, or about 8% of investments. Such a provision is not unexpected at this stage of the development of the fund, but clearly will need to be offset by substantial gains if a positive result is to be obtained.

Economic targets and outcomes

Table A.5: Economic targets envisaged for SCF in applying for ERDF funding

An analysis of performance against actual for each area is shown below.

Table A.6: West - Objective 2

Table A.7: West - Transition

ERDF targets - performance versus actual

Table A.8: East - Objective 2

Table A.9: East - Transition

Table A.10: South of Scotland

Table A.11: Scotland total

Additionality and displacement

In our survey of the Scottish Co-Investment Fund, as noted above, we asked Investment Partners why they brought deals to the fund. Typically, the Scottish Co-Investment Fund will participate to the extent of 25% to 50% in any deal which is brought to it by one of its partners. There is no direct measure of the additionality by SCF. The arrangement is that SCF participates in deals brought to it by partners. SCF must participate in the first round of finance to facilitate any 2 ^nd and subsequent round participation.

The telephone survey of partners gave 2 principal reasons for bringing the deal to SCF. One reason related to the size of deal. Where partners had a limit on their financing available, they wished to participate with SCF in larger deals. This extended the financial scope of the partners. This reason was the most common reason given by partners. For example, an angel syndicate commented that for deals above £0.75 million to £1 million it may be more difficult to put together a group of investors. Another investor commented that they normally had a limit of £0.5 million. For such investors, the participation of SCF allows the size of deals to be increased. A second reason relates to the desire to spread risk. One Investment Partners said that when it had deals which were not in the sectors it usually operated in, an option it sometimes took was to part finance the deal through SCF.

In both these cases, it is clear that the full amount of the deal would not be financed by the partner acting by themselves. The involvement of SCF is necessary for the deal to go ahead. To this extent, it may be said that most of the deals brought to SCF are additional.

Advertising and application procedures

In November 2002, a formal tender for Co-investment Partners was advertised through SE web site and through a voluntary notification in the European Official Journal with a closing date of 11 ^th December 2002 ²¹. A standard application form was used including a "hidden scoring system". In addition a short questionnaire was included that identified if prospective applicants were genuine "hands-on" early stage investors, demonstrated through the history of completed transactions (either as a firm or as an individual). The questionnaire was structured in two parts (i) finding the company and doing the deals, and (ii) running the business and making money.

Management and governance

The SCF has been established by SE as a separate fund with a separate bank account, managed by SE Investment Directorate. SESCF funds and ERDF funds are deposited in this account. SE receives its funding annually from the Scottish Government, which provided the full £20 million public sector co financing at the outset of the Fund.

Management costs

Management costs include both the costs of running the fund, and fees paid to co-investment partners. A summary of the management costs shown in the accounts of SCF is as follows:

Table A.12: SCF management cost (£)

Management costs are made up of:

• SCF Partners' arrangement fees - Scottish Enterprise pays their SCF Partners 2.5% of the investment every time they complete an SCF deal. If the SCF Partner completes a deal in an ERDF area, they are paid 3.5%. Partners are therefore paid between 2.5% to 3.5% of total SCF invested, and
• Scottish Enterprise management costs - these are our costs in running the fund, e.g., staff plus legal fees, plus promotional events (for example, to stimulate the deal flow in the West of Scotland). Scottish Enterprise employs a Fund Manager, a lawyer, an administrator and a portfolio manager (their most recent appointment).

Survey results

The results of a survey by CSES of SCF investee companies are shown below. The survey was sent to all current investments of SCF. A list of those investments is shown after the survey results.

1. What sources of funding were used in your business before applying for funding? (please tick all that apply)

2. What was the main purpose of seeking funding? (please tick all that apply)

3. How did you hear of this fund? (please tick all that apply)

4. Why did you decide to apply for funding from this fund?

5. What would have happened if funding from this fund had not been available?

6. How easy were the procedures for obtaining funding from this fund?

7. How easy were the procedures for obtaining any other funding required?

8. What has been the impact of this funding on the operation of your business?

9. Do you receive business advice as part of the funding? (please mark all that apply)

10. Changes in your turnover and employee numbers since the Scottish Co-Investment fund invested in your business

SCF investments

Table A.13: SCF investee companies and amount invested in each company

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