3i Group PLC

Profile of 3i, discussing the company's renewed interest in early-stage investing and possible resumption of US operations.

• Address: 91 Waterloo Road

• London SE1 8XP

• Phone: [phone]

• FAX:[phone]

• Web Site: www.3igroup.com

• Contact: James Martin, Director, Technology Investments

Early in the decade, just as as it appeared well on the way to becoming a global venture capital player, 3i suddenly retreated from early-stage investing, both in the US, where it had established operations in Boston, and in its home territory in the UK. Then, with apparently equal suddenness, 3i reversed itself. It's re-emphasizing early-stage dealmaking, and it may get back into the US venture market.

The basic reasons behind the original retrenchment and subsequent about-face tell a lot about the evolution of old-line European investors as well as about the rapid globalization of the start-up industry—in particular the creation of an entrepreneurial New World foothold in the heart of the Old World.

3i began life as Investors in Industry, a piece of British industrial policy designed to stimulate the UK's post-war economy by putting mostly public money into capital-hungry for-profit companies. (Even now, with £4.5 (US$7.4) billion in assets, 93% of its investment portfolio is in the UK.) Because individual banks initially balked at the British government's attempts to enlist their financial backing in this recovery effort, 3i was formed by the Bank of England and the leading British clearing banks to spread the risks of what was seen as a socially correct, but economically questionable, venture. 3i, in fact, proved highly successful and grew to a portfolio of over 5,000 companies in the UK, which traditionally included a fairly broad mix of retail, industrial, and family businesses. With the VC boom of the 1970s and 1980s, 3i became more adventurous in its technology investments, even opening a US office.

As Thatcherite Britain began rolling back much of the socialist agenda of previous ministries, 3i itself began to change, aiming for a public offering. But its investment portfolio didn't suit a public profile: it relied partly on debt capital for its investments and would need a bigger income stream to service the debt. Early-stage companies wouldn't provide the near-term profits that dividends from later-stage investments could.

Closing Shop in the US

In 1991, 3i closed its US office. It retained an interest in about 20 US health care technology companies, in part through a limited partnership, Aspen Ventures, which took over the 3i portfolio.

Two events, however, seemed to change 3i's ideas about early-stage investing. The first was the company's 1994 IPO, which gave it an equity-based capital structure as well as a new set of investors interested in seeing 3i profit from the worldwide high-tech venture business. It became increasingly apparent, says Jim Martin, 3i's director of technology investments, that 3i was missing a tremendous market opportunity by closing itself off from the US market. To the extent that 3i wanted to build its health care portfolio, Martin says that it made obvious sense to pursue US investments, both to take advantage of the wealth of investment opportunities on the other side of the Atlantic, and to better assist 3i's European companies, many of which were looking to form alliances with US companies or even considering moving all or part of their operations to the US.

According to Martin, 3i is in the process of determining exactly how to go about re-establishing US operations, and he anticipates a formal announcement of 3i's re-entry into the US market by year's end. In this regard, he notes that 3i's existing US health care portfolio provides it with a pre-established network upon which it can build. Although no final decisions have been made yet, Martin says that he anticipates 3i will set up offices on both the east and west coasts.

Jim Martin says that the move back to US investing was part of a major shift in 3i's thinking about technology investment. Where technology was once viewed as an adjunct to 3i's other investment areas, it is now considered the core of the business—a business which is increasingly global.

What may appear to be 3i's re-entry into early-stage investing merely reflects an increase in European investment opportunities over the last five or six years, says Martin. He emphasizes that the UK—which is far ahead of other European countries in producing health care start-ups—has created a major biotech industry in a relatively short period of time, claiming three of the ten largest-cap biotech firms in the world (the rest being in the US).

Creating Biotech Infrastructures

Having seen what European industry can do to foster start-ups, 3i is attempting to speed up the process, in part by helping to create infrastructures to support a biotech industry in the UK and various parts of continental Europe.

Some time after abandoning its US operation, 3i opened a number of regional offices within the UK to develop and exploit local technology opportunities. Martin himself managed a Cambridge-based technology portfolio which dates back to 1988. According to Martin, that fund grew to over £100 million, produced returns in the 70% range, and became the most successful VC technology portfolio in Europe. Martin says similar efforts were made in other locales, such as Reading and London, and it soon became apparent that these investment programs could be pooled in a model that could eventually be replicated throughout Europe.

Martin says that what started in Cambridge culminated in the 1997 creation of the 50-person technology unit which he directs. The goal of the unit, Martin insists, is not just to look for investments, but to develop infrastructures which will support a biotechnology industry in Europe that he hopes can eventually compete with the US.

A prime example of 3i's infrastructure-building efforts, says Martin, is the company's efforts in the Midlands' region, where 3i has offices in Birmingham, Leicester, and Nottingham. While it might be a bit of a stretch to call Birmingham Europe's future equivalent of Boston's Route 128, Martin says that he is looking to at least track the American success story by helping to transform Birmingham from a large, but outdated industrial center base to a hi-tech business community. One recent effort along these lines was a conference sponsored by 3i in July of this year for the Midlands technology community, at which the company announced a target of £75 million in Midland region investments over the next three years.

Martin says that 3i's infrastructure-building efforts extend throughout the continent. In addition to its well-established operations in Germany (where it just opened its sixth office) and France, where Martin says the biotech markets have begun to explode, 3i plans to establish a presence in Spain and Italy (where 3i is sponsoring a national technology conference to be held at year's end). While these countries may not yet be biotech meccas, Martin believes it is inevitable that they will develop industries, and 3i wants to create an early foothold.

A Typical Deal With Atypical Twists

3i's technology investment efforts have, according to Martin, already made it the dominant technology VC player in Europe, with involvement in roughly 50% of all deals in that region. For one typical deal he cites the company's investment in Weston Medical Ltd., manufacturer of a needle-free injection system (see "Weston Medical Ltd."IN VIVO, March 1998).

Martin says that in 1992, the company's founder, Terry Weston, knocked on the door of 3i's Cambridge office and presented the prototype of his device, which a 3i evaluation team found promising. Because Terry Weston needed a company essentially built from scratch, 3i put together a management team; created a business plan; and provided the seed and first two rounds of funding on its own. Such follow-up funding is typical for 3i, which, according to Martin, winds up investing an average of $2.50 for each dollar invested on day one.

Still, if typical in some ways, the Weston deal was also highly atypical for 3i. In the first place, Weston is a device company in a portfolio dominated by biotech and biopharmaceutical firms. Martin says that while 3i is certainly willing to pursue device investments, and includes 36 device companies in its portfolio, it's generally found the sector less attractive than biotech. (See "Medical Device Start-Ups in Europe—The New Entrepreneurs,"Start-Up, June 1998.)

Secondly, Weston was a seed-stage deal for a company which now largely avoids them. Given the number of its investments, 3i can't afford the management time seed-stage companies require, and prefers instead to join in at the first- round stage.

In this regard, Martin contrasts 3i's investment style to that of Atlas Venture, a firm with which 3i has worked closely. (One of Atlas' American partners, Allan Ferguson, headed the 3i office in Boston until it was disbanded, and still manages the Aspen Ventures portfolio of 3i investments.) Atlas, Martin says, takes a very hands-on approach, often concentrating on one or two companies in a particular sector and working with them as an active partner.

Ferguson concurs with Martin's view of the two firms. Atlas, he says, acts more like a standard US fund in that, unlike 3i, it is represented on the boards of over half its portfolio companies. Ferguson attributes the difference, in part, to the different managerial makeups of the two companies. He says that 3i is heavily weighted towards financial managers, whereas he and most of his colleagues at Atlas are specialists with operations experience in health care companies.

Not that 3i has completely eschewed seed investing. Along with a few direct-investment exceptions like Weston, 3i has helped set up or joined in separately managed seed funds which can serve as feeders for its deal flow. For example, it put £11 million into UK Medical Ventures Management Ltd., a £40 million seed fund set up by the UK's non-profit Medical Research Councilto help commercialize MRC's portfolio of health care technology (see "Her Majesty's VC," Start-Up, January 1998). 3i also recently formed a fund with Scotland's Roslin Institute to commercialize the Institute's intellectual property.

On the other side of the start-up spectrum, Martin says that for the time being, 3i also stays away from pre-IPO, mezzanine-stage funding. Like most European VC firms, he says, 3i has essentially been priced out of these rounds by large pension funds and insurance companies which have driven up the prices.

The Prodigal Son Returns

Once 3i moves back to the States, Martin thinks that it will be critical for 3i to play to its strength as a global VC firm by becoming more proactive in working with European companies traded on the US markets, and in making itself available to US companies that are pursuing European opportunities and could benefit from 3i's network of European contacts. Martin would also be interested in forming alliances with large pharmaceutical companies looking to commercialize technology through spin-offs; something which 3i has successfully done in Europe (e.g., 3i's funding of AdProTech PLC, a SmithKline Beechamspin-off [See Deal]).

It will be interesting to watch 3i as it attempts to rebuild a US base which it acknowledges should never have been abandoned in the first place. After all of Jim Martin's talk of 3i's strong, well-established European base and its efforts to capture more of the European market by building technology infrastructures from the ground up, the move back to the States sounds like a very different proposition indeed. Instead of being one of a handful of major European players, often playing in largely open fields, 3i will be jumping into well-established markets on the east and west coasts. Still, with its new, more aggressive US-style of investing, a direct US presence is a prerequisite to its global ambitions. —JD