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This is a non-independent marketing communication commissioned by Schroder Investment Management. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
Every young innovative business that we invest in is unique. But there are some characteristics that we consistently look for. When seeking out ground-breaking investment opportunities, we look to back genuinely best-in-class products and services with high barriers to entry and which look poised for significant long-term growth. Our private equity businesses will be managed by a world-class management team, and we aim to invest alongside other like-minded, high quality co-investors.
Schroders Capital’s private equity team’s experience is crucial here, because over the course of the last 25 years, we have developed deep long-standing relationships across the venture capital industry, with investment ideas sourced from more than 50 leading firms.
As well as these over-arching business characteristics, there are certain consistent features that we find at different stages in a company’s development. Clearly, the unique attributes of each individual company mean they won’t follow exactly the same path, but we’ve created the infographic below to help visualise a typical life cycle, the characteristics we look for at each stage, and to explain how the risks and opportunities change as private equity businesses mature.
The venture stage
At the earliest stage of our involvement, we tend to be investing to support entrepreneurs in developing their business idea. We like to see an ability to rapidly scale towards the next stage, but inevitably not all of the businesses we invest in will succeed. At this stage, we believe in the ‘Power Law’, whereby a small number of investments will ultimately deliver the vast majority of returns. We therefore look to make relatively small initial investments (c. £4m), whilst ensuring we have a similar amount of capital reserved to provide more funding as a business develops.
The size of the company at this stage will likely be below $500m but we only invest in companies with more than $10m of revenue, which prevents us from investing in very early or pre-revenue opportunities. We would expect those revenues to be growing strongly, with growth rates often in excess of 50% per annum. Because of the risks, our expected returns from businesses in the venture stage are high and it is important to build an appropriately diversified portfolio to balance the winners and losers. Our target return in the venture stage is 3-5x our initial investment on a 5-10 year time horizon.
The growth stage
As a business successfully develops, it enters the growth stage, where we will be looking to invest to support a company’s continued rapid expansion, through internationalisation, product innovation and potential merger and acquisition deals.
Typically, by now a business may be 1-3 years away from having the opportunity to pursue an initial public offering (IPO) which would bring it to a public stock exchange. This is a traditional way for private equity managers to realise value from their investments. However, an IPO is not the only way we can realise value. We find that many of the businesses we invest in are bought by larger businesses within their industry before they IPO, which provides greater optionality for us than for most of our competitors.
At this stage, the business will likely have grown to be in excess of $500m in size. Growth rates may have moderated, but the business will still be growing strongly, with annual growth rates typically above 30% per annum.
As the business moves through this growth stage, it is effectively becoming a less risky proposition. Not risk free, but the prospect of a permanent loss of capital is much reduced, which allows us to potentially commit more to the opportunity, with typical initial investments around £10m, with a further £5m reserved for following on. Target returns from here are more modest but still attractive – we would target a return of 2-3x invested capital on a 5-10 year view but this is, of course, not guaranteed.
Late-stage / pre-IPO
The next stage of development sees a company approaching the point where it would cease to be a private company and join public markets through an IPO. This stage has seen a considerable amount of media focus over the last couple of years, which is often a sign that a market is in danger of over-heating, with too much capital chasing too few quality opportunities. Indeed, Schroders internal fundraising indicators have flagged risks for several years, with capital inflows running well ahead of long-term trends.
As a result, we have been avoiding making investments in late-stage / pre-IPO businesses, where valuations look less enticing, and a lot of capital is still at play. This is a key differentiator for us, with many private equity competitors focused almost exclusively on this pre-IPO stage. Our approach is therefore distinctive and provides investors with the opportunity to invest in businesses at an earlier-stage where prospective returns, in our view, look more likely to compensate us for embracing risk.
Schroders Capital Global Innovation Trust
Source: Schroders Capital. Portfolio weights reflect the future target, not the current position. Weights are therefore indicative and not guaranteed. A further c. 25% of total investments are targeted to be in listed equities, predominately IPOs from the current portfolio.
Life sciences
We should point out that life science businesses tend to follow a very different path to the one described above (see the blue line in the graphic above). Here, the process of clinical development is lengthy and potential returns may be many years away at the point of initial investment. Ultimately the rewards for success are high in life sciences, but so are the risks, so we tend to take a portfolio approach, deploying smaller amounts of capital in a more diverse set of opportunities. Initial investments are typically around £2-3m with up to twice that number set aside to ensure we can provide more funding to the business as it develops.
A good example of the opportunities we are backing in life sciences is provided by Anthos, a US-based, clinical-stage biopharmaceutical company. Anthos is developing therapies for people living with cardiovascular and metabolic diseases. Its most advanced program is focused on developing abelacimab, a next-generation anticoagulant with the potential to provide protection from arterial and venous thromboembolic events with a reduced risk of clinically-significant bleeding. The business is based on high-quality science and is in a strong financing position. Thromboembolic events account for one in four deaths globally and remain the leading cause of mortality worldwide, so the opportunity it is targeting is substantial.
In order to minimise the risks in this part of the market, we only invest in businesses if a clinical endpoint is clearly defined, and financing is in place for the business to reach that milestone. With patience and discipline, returns can be high, with target returns of more than 5x our original investment on a 5-10 year time horizon.
Conclusion
The private equity investment landscape is diverse, exciting and constantly evolving. The asset class has historically been seen as the exclusive domain of large institutional investors, but vehicles like the Schroders Capital Global Innovation Trust offer democratic access to all investor types. Clients can benefit from the peace of mind that comes from their investment being managed by an experienced team, which should bring greater comfort when investing in a relatively new and innovative market. We look to partner with best-in-class co-investors, and only invest when our quality criteria are met. This doesn’t guarantee success, but it does reduce the probability that a business will be blown off course.
We understand the risks and complexities that exist at different stages of a private company’s development. By avoiding the areas of exuberance and focusing on the parts of our investment universe that look the most attractive, we are confident we can deliver positive outcomes for investors.
Fund risk disclosures
Gearing risk: The company may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.
Investment risk: Long-term outcomes are more binary – extremely attractive rewards for success but some businesses will inevitably fail to fulfil their potential and this may expose investors to the risk of capital losses.
Overseas investment risk: The trust may invest in overseas securities and be exposed to currencies other than pound sterling – as a result, exchange rate movements may cause the value of the trust, individual investments, and any income paid to decrease or increase.
Private companies risk: The trust may invest in unquoted securities, which may be less liquid and more difficult to value, because they are generally not publicly traded – the lack of an open market may also make it more difficult to establish fair value.
Share price risk: The price of shares in the trust is determined by market supply and demand, and this may be different to the net asset value of the trust. This means the price may be volatile in response to changes in demand.
Small companies risk: As it can take years for young businesses to fulfil their potential, this investment requires patience.
Young companies risk: Young businesses have a different risk profile to mature blue-chip companies – risks are much more stock-specific, which implies a lower correlation with equity markets and the wider economy.
This is a marketing communication
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Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registration No 4191730 England. Authorised and regulated by the Financial Conduct Authority
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This communication is marketing material. The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy.
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Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.
Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.
The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors.
Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.
