Venture Travails

The decline in venture investments over the last three quarters has finally halted. However, the picture remains fairly grim. Across Europe, only 75 companies received venture funding in the third quarter of this year, well below the 106 deals competed during the same period last year. The picture doesn't get much better in terms of value: the unquote" Private Equity Barometer, published in collaboration with Candover, reveals that Q3's €317m of venture funding was less than the €422m recorded in 2008 but up 28% on Q2 this year.

Southern European venture activity has historically been lower than in the European venture hubs of the UK and France. The industry in the region gained traction in the late 1990s, just before the dotcom bust brought activity to a grinding halt. "We had to wait until the dotcom collapse fully subsided in 2004 to see a renewed interest in the industry. Things were just picking up when the financial crisis hit," observes Cedric Latessa, investment manager at DFJ Esprit.

Venture is not an easy business. While (in the past) buyout shops could sit back and, in the worst case, ride ever-growing multiples, venture is often capital intensive and requires patience. Many industry insiders describe it as a labour of love and pursue it with more idealism than economic expectations, in order to nurture innovation and drive change. They see venture's malaise anchored in a dearth of capital, rather than a lack of opportunity: "Southern Europe has interesting ideas and projects to offer, but suffers from a systemic under-funding," says Fausto Boni, partner at 360 Capital Partners.

Increasingly, governments and the EU offer tax incentives to boost their local venture ecosystems. In France, for example, the government offers high-networth individuals tax breaks to invest in the sector through FCPIs (fonds communs de placement dans l'innovation) which offer tax-free gains as well as allowing monies invested to count against taxes owed to the state. In the UK, the breaks are even more widespread: everyone, not just HNWs, is able to invest in venture capital trusts, which offer a 30% tax break. Such schemes supplement the direct government funding pumped into the sector.

That elusive critical mass

To improve the quality and number of opportunities in the venture space, EVCA is preparing to ask European governments to raise a €1.5bn pan-European fund-of-funds, which should replace all other funding for start-ups. The goal is to improve the sector's sustainability by weaning companies off public funding and drawing more private capital to finance innovation. This Risk Capital Action Plan (RCAP) 2020 initiative would see the release of €300m every two years to fund managers with the condition that the recipients match the funds they apply/ qualify for with private sector funding first.

This initiative would also provide regulatory support, with a focus on the unintended consequences of crisis-driven regulation. The initiative's predecessor RCAP which ran from 1998-2003 directly and indirectly contributed to €75bn in investments in 30,000 high-tech businesses and SMEs across Europe. On a regional level, in Italy at least, efforts to encourage the development of venture capital have been scarce. Boni insists: "Venture can create jobs from scratch; this has been our experience with three or four of our portfolio companies, which over the last decade have generated some 800 jobs. But most (economic) support is instead going to traditional industries which are 'destroying' jobs as they shrink. Given these financing challenges, it is difficult for a venture capitalist to generate a track record and attract financial support. It's a vicious circle."

The region's under-funding problem also affects the number and quality of the projects, in turn depressing the interest the space garners. The Iberian market is dominated by the Spanish - Portuguese venture is negligible - but has seen its quality diminish over the last 12 months. "There have been two types of venture investors in Spain.

On the one side, we have actors with a public interest who have backed more earlier-stage projects directly from their balance sheets. On the other, we have a handful of private venture capitalists who are doing a limited number of deals in companies with at least some revenues." says Latessa.

Culture vulture?

Due to these factors, Southern European venture is still in its infancy and continues to suffer from the dispersion of efforts. Another contributing factor are the entrepreneurs themselves. Many say the absence of a strong managerial culture among entrepreneurs has slowed the propelling of innovation and technology until a larger stage. This may be changing: "There has been a progressive, albeit protracted improvement in the quality of the management teams. The entrepreneurial culture has thus become more familiar with the way venture works and is becoming more and more attractive to senior management," notes Boni.

A product of the venture shortage has been a dearth of investing in cash-intensive R&D. This too may be changing, particularly in Spain, where there is some venture-funded biotech R&D taking place. The perceived aversion to invest in technology seems to be slowly eroding. This presents good opportunities to venture funds, as Latessa explains: "In Spain we are witnessing a very interesting investment environment. More and more projects are created from day one with a multinational team, very often Spaniards who have lived abroad coming back home and/or expatriates with global ambitions. There are interesting projects, particularly in the software, internet/media and mobile telecom sectors."

Labour's rewards

Patience is a virtue and one that may prove rewarding. Take for instance the case of Italian online insurance broker MutuiOnline. Seed funded by Nestor 2000 (360 team) in July 2000, the company was successfully floated on the Milan Stock Exchange in 2007, raising €250m and netting a tidy profit for its backers. Yoox could be next. Backed by 360, the company is said to be preparing a listing on the star segment of the Milanese stock exchange in early December.

This would be one of the few (if not the only) IPOs in the European IT space this year. Spain may not have any recent stars, but industry experts remain optimistic about prospects for the Spanish market. The limited number of local financing for local entrepreneurs provides many opportunities for international funds. "Currently in Spain, firms seeking to raise above €5m are very likely to look for international backers with the financial power and a wider network to help them realise their ambitions. This is very sound for the Spanish industry as we (international venture capitalists) bring to the table a different and complementary set of skills to the management teams and their local investors," observes Latessa.

A good example of a company with international backers is Spanish software developer NTRGlobal, which in June last year raised a €22m series-C round led by Kennet alongside Atlas Venture and existing investors Debaeque Venture Capital and Elaia Partners. It is likely that as Southern European markets evolve, they will attract more foreign interest. In the meantime, however, the world belongs to those who persevere and innovate.

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