European venture: patience rewarded

Europe's venture story is one of patience - at long last - ready to be rewarded, according to the asset's longest-standing backers. "Strong returns are in the offing in Europe now and they're appearing faster than ever," says John Holloway (pictured), director at the European Investment Fund (EIF). This is a relief, since global venture has returned just 6.9% in the decade to 2012, according to Cambridge Associates - roughly akin to that of a mutual fund, but with less liquidity.

With €3.8bn invested across more than 260 European VC funds, the EIF is Europe's largest venture cheerleader and thus understandably bullish. But the fanfare is backed up by data from Cepres: European venture returns (median) stood at 15.6% for 2009-2013 vintages (unrealised based on cashflows), up from 11.48% between 1998 and 2008. And EIF has recorded positive net IRRs for the three years 2007, 2008 and 2009, and suggests that GP reports point to strong years since then.

"In 1999/2000, there was too much capital and there were not enough exits in Europe. It took a while for that to be rebalanced," explains Sonali De Rycker, partner at Accel Partners. The impact of this is a shake-out, according to Warren Hibbert of Asante Capital, an advisory firm that placed Sofinnova, Creandum and Abingworth: "Many have trended towards acting like European later-stage/growth capital managers - only a select few have been able to deliver on the promises of venture returns over the past decade or so. There is a prevailing conservative mind-set in Europe - ‘how do we save every euro and every deal?' - which works well on the buyout side, but doesn't apply well to venture. Whereas we're now seeing the experienced venture firms that remain adopting more of a ‘Sand Hill Road' approach to managing their venture portfolios - ‘how do we access the best ideas, kill the losers quickly and run hard with the winners?'"

European venture is worth looking at again, but VCs are trailing entrepreneurs

Accel's fundraising success suggests increasing faith in European VC; the GP beat its target to raise $475m earlier this year in just eight weeks. "The venture ecosystem in Europe has become much more sophisticated over the past few years and we're seeing world-class companies and talent, repeat entrepreneurs, industry clusters, angel investors and more venture capitalists. At this point, venture in Europe should be about accessing great European talent and making it a global success story," De Rycker says.

By and large, this is happening. Says Holloway: "We are seeing a transition of successful entrepreneurs from the first wave of venture (circa 1999) into investors. The upshot is a completely new breed of VCs in Europe - they are experienced and understand entrepreneurs." For example, Skype co-founder Niklas Zennström set up Atomico in 2006 and, in addition to smart money, he provides pulling power for other investors. Brent Hoberman, of Lastminute.com acclaim, set up PROfounders Capital; Xing's Lars Hinrichs is behind HackFwd; MessageLabs' Ben and Jos White now run Notion Capital and Mans Hultman of QlikTech set up Zobito - to name a few.

And others go on to create new start-ups, an erstwhile US phenomenon that seems to have finally caught on in Europe. According to Anne Glover, CEO and co-founder of Amadeus Capital Partners, less than a fifth of Amadeus's businesses in its first fund were led by serial entrepreneurs; this increased significantly to more than two thirds nine years later with Fund III. These start-ups are thinking beyond Europe, too: "Europe is home to many of the world's most innovative companies," says Marcos Battisti, MD of Intel Capital. "In the past 10 years, these innovators have begun thinking internationally, which is crucial for European businesses whose home countries are often the size of a single state in the US," he says.

Amadeus has just hit a first close on $75m for a fund looking to back businesses that are based in mature markets but whose products will be targeted to high-growth markets such as Africa, the Middle East and Asia. The Amadeus IV Digital Prosperity Fund is seeking $150m with global telco MTN Group as its cornerstone.

US invasion
With entrepreneurs in Europe more polished, state-side VCs are taking note. "We were at the vanguard of bringing in US VCs to Europe and it is now more commonplace," says Glover.

Some local players suggest the European market is underserved by local VCs, like Advent Venture Partners' Mike Chalfen: "US investors are flying in to back some of the most promising start-ups, which proves there is a vacuum."

EVCA data backs up the "underserved market" theory, suggesting in a recent report that US VC investment (in dollars) in European start-ups increased 165% between 2009 and 2011, mostly providing later-stage capital. And this trend looks set to continue, with 82 funds currently seeking $13bn in the US against just 27 vehicles raising a measly $2.3bn here (EVCA).

Adapt to survive
Many European VCs still around today have changed their spots in the past 15 years. For example, Sofinnova has a strong reputation but has specialised in life sciences after spending most of its life as both a life sciences and tech specialist. "Many firms are splitting up or shutting one discipline as they realise certain sectors don't always make good bedfellows," Hibbert says. Advent Venture Partners' first three funds backed life sciences and ICT companies, whereas the latest vehicles have been dedicated solely to early-stage life sciences. The latest fund was raised in 2010 and topped up to £101.3m last year.

Other funds retain a sector focus but shift their stage focus - usually towards lower-risk, later-stage investments. "This makes economic sense," says Glover. A few have remained early-stage, including Amadeus, DN, Earlybird, Holtzbrink and Index. "The commitment to remain early-stage is real testament to the belief in disruptive technology. With early-stage, it's about doing great deals, not just the easy deals," she says.

Indeed, DN actually prefers early-stage, according to the firm's founder Nenad Marovac: "Investing in later-stage is incredibly risky for a small fund since the businesses are still unproven, have high burn rates and often a lot of VCs involved, making it harder to have an influence. Pricing is also often very unattractive given the competition for growth deals." He suggests some later-stage investments proved most disastrous for his firm because when they got into trouble they required too much capital to help them. He says: "That is very difficult for a small firm. Alternatively, our early investments such as Endeca (sold to Oracle for $1.1bn) and Shazam among others have worked out really well." DN Capital is currently raising its third fund and has already closed on two thirds of its €100m target.

An increasing number of GPs are adopting a mix - de-risking the early-stage deals with some later-stage ones. Polaris, for example, has expanded into doing both growth capital and seed investing from the same fund. The idea is that the growth deals give LPs security that a handful of riskier seed deals can be pursued as the vehicle is effectively de-risked.

"It is our goal to have one of our first few deals a ‘quick-to-exit' business (meaning three to five years)," Glover explains. "This allows us to retain some proceeds for reinvestment and helps to avoid getting cornered at the end of the fund's life." She admits the first and seed funds managed this but the second fund, owing to a difficult backdrop, was less successful.

Smart money
And as the entrepreneurs and GPs come of age, so too have many LPs. Says Holloway: "Since 2006, LPs are more selective about teams. There's little DPI to base it on but, if we're to believe the valuations our GPs are telling us, then TVPI has not been bad since then."

Government support schemes, once accused of backing commercially unviable endeavours and so propping up zombie GPs and dragging down industry returns (average), are now credited with more commercial acumen. Among others, Holloway points to Finnish Industry Investment, Capital for Enterprise and CDC Enterprises in France as three such examples. "Commercial due diligence and sophisticated teams are now in place within these bodies so they're effectively professional funds-of-funds. This has the bonus of increasing returns and sustainability - both crucial to the future of venture."

There are also two initiatives aimed at creating new Europe-wide funds-of-funds. The first is from the European Venture Fund Investors Network (EVFIN), a platform launched in 2011 to respond to European VC's plight, and is said to be looking to channel public money into a new vehicle. Backed by nine national initiatives, including Capital for Enterprise, CDC, KFK in Poland, KfW in Germany and SRIW in Belgium, as well as some commercial groups, including Capital Dynamics, its stated aim is "to create a self-sustained European VC market..." and it recommends "intermediating between European VC funds and institutional investors... best achieved by increasing the number of funds-of-funds financed and managed by national operators (public and private) with the financial support of the EIF or the European Commission". In short, the efforts appear to redirect existing public funds into a new vehicle.

EVCA, on the other hand, is looking to increase the size of the total pie available to invest in European venture by convincing Brussels to provide funding that will be matched by private sector money - effectively providing a leverage effect to the private funds, which should help generate momentum for backing European venture.

EVCA secretary-general Dörte Höppner says: "It is vitally important for jobs and growth to bring the private sector back to venture capital and broaden its investor base. The European Commission's funds-of-funds proposal is the smart use of public sector capital to enable institutional investors to invest in innovative, European firms and we strongly support it. European VCs have teams with a combination of skills comparable with any Silicon Valley outfit. These teams are not inexperienced, just undercapitalised."

European Commission funding to back the EVCA initiative could come from two areas of the 2020 budget: COSME (competitiveness for SMEs) and Horizon 2020 (research and innovation). Together they have €1-1.4bn set aside, with the idea being they would deploy some of the capital across a series of funds-of-funds between 2014 and 2020. The number and setup of those funds is yet to be agreed (there is the possibility to give an upside boost to the private capital), but the momentum and positive reaction from Brussels is testament to the efforts of EVCA since it published its white paper in 2010.

Even the smallest of investors, angels, have positively evolved in the venture space. There are more of them, many former entrepreneurs or VCs themselves, meaning they have the ability to bring expertise to the table and not just cash. Examples of "super angel funds" include Seedcamp, Startupbootcamp and Notion Capital.

But perhaps the most telling sign that European venture is back in vogue is the renewed interest of US institutions, which are putting their money where their mouths are: "In the past 12 months we've seen a far greater prevalence of US capital actively deploying with new managers," says Hibbert. He explains it is being led largely by the endowments in the US, which had been hardest hit in 2009. Since then, many rationalised their fund-manager relationships to focus on their very best existing and select new managers. They have also since seen their denominator effects reversed and so are now again looking to augment their private equity portfolios. "They're back in business, not just with money but actively deploying and, importantly, leading the crowd as far as cutting-edge ideas are concerned. Many are still looking for high-quality, lower mid-market groups in Europe and the US, but they're also open to first-time managers and new ideas - a paradigm shift to 2008-2010. They like the hunger of firms that are genuinely aligned and differentiated."

Make for the exit
Of course, it all comes down to the exits, and they are coming in at last. The week before unquote" went to press, French VC Auriga made a staggering 33x money on the sale of Paris-based Neolane to Adobe for $600m cash. The deal marks a 65x multiple on Auriga's initial €1.4m investment, made in 2002. Follow-on rounds saw XAnge and Battery Ventures also back the business. DN managed six exits in an 18-month period and Intel has had more exits in the past three years in Europe than in the previous seven. US trade is increasingly looking to American targets; Oracle bought up two of DN's businesses, while Latin American wireless business America Movil and Mexican tycoon Carlos Slim pumped $40m into Shazam for a 10.8% stake - another DN business. IDG had seeded Shazam while Kleiner Perkins Acacia, DN and Institutional Venture Partners are also backers.

Adobe's interest in the French target highlights a growing trend for US trade buyers to look to Europe for certain sectors. "We are hearing from US investors that they find real innovation in terms of IP in European businesses. They feel Europe has a tremendous wealth of publicly financed R&D," says EIF's head of venture capital Matthias Ummenhofer. "Valuations are high, but they're justified in certain sectors in Europe. In fact, it has been suggested Europe is surpassing Silicon Valley in music, finance and software platforms," he suggests, pointing to Shazam, Spotify, Klarna, Clear2Pay, Wonga and MySQL as examples of excellent European venture-backed businesses.

US trade buyers looking to Europe often benefit from a discount in pricing, according to Battisti. "It will catch up one day but for now, European targets are attractive from a cost point of view. This is because of the perceived risks associated with currency and rigid labour markets."

LPs are waiting less time to see the upside, with hold periods dropping from 10-12 years. Getting products to market in the US, for example, may be quicker following a few years of bottlenecking owing to onerous US Food & Drug Administration (FDA) restrictions. Earlier this year, the FDA announced it would speed up the approval process for certain drugs, suggesting early-stage investments in the biotech space are more likely to pass the trial phase. The FDA's warming to the idea became apparent last year, when the regulator's approval rate was up a third on 2011.

Might the increasing momentum around European venture be the embryonic stages of yet another bubble? "Absolutely not," says Holloway. "This is because, while valuations are up, the short memories do indeed remember the excess of 1999-2000. We've survived excess, collapse and a phoenix-like rebirth. It's been very hard work, but the exits are coming and the LPs are following. By 2019, two decades on from the last bubble, we'll have an extremely healthy venture community in Europe."

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• Topics
• Venture
• Industry
• European Investment Fund
• Accel Ventures
• Amadeus Capital
• Advent Venture Partners
• Sofinnova
• DN Capital
• Holtzbrinck Ventures
• Index Ventures
• Polaris Private Equity
• CDC Entreprise Innovation
• Capital Dynamics
• EVCA
• Intel Capital
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