Adventurous Europe

Given the current state of the US economy and the weakening of the dollar, an exit via an IPO is no longer an attractive option. In Europe however, exits are performing better than in the past. For example, European VCs scored high when Index Ventures and Benchmark sold MySQL to SUN Microsystems, a $1bn deal netting the investors an IRR of 70% with a 16x money multiple.

The prospects for European venture exits are good even with the IPO window temporarily closed. An example of this route was the acquisition by AOL of DFJ Esprit-backed buy.at last February; a next generation marketing affiliate specialised in producing campaigns. The deal, which took place in February this year, was priced at a non-disclosed but substantial premium. Similar exits also include Index Venture's sale of last.fm to CBS ($280m) in June 2007 and its sale of Skype to eBay ($2.6bn) in September 2005.

Although perhaps less spectacular for the time being opportunities are also coming from emerging markets; in Italy Innogest sold its stake in Singular ID to Singaporean subsidiary of Indian pharmaceutical company Bilcare, generating an IRR of 200% after only five months. According to Cedric Latessa, investment manager at DFJ Esprit, "the economic slowdown translates to trade partners reducing R&D expenditure which provides venture with profitable exits as they are looking for new growth opportunities."

Survival of the fittest

Historically, European venture capital has often relied on IPOs in the US or trade sales as a means to achieve high returns on investments. Venture data collected by CEPRES suggests that performance was significantly better for companies that received venture backing in 1996-2000 than those in 2001-2005. (see box, right).

Yet according to industry experts, North American LPs who were investing in emerging markets are now realising the potential of European venture. On the entrepreneur side, LPs are attracted by the innovative technologies being developed and by the quality of the returning entrepreneurs who are more ambitious in their vision and who are aiming to go regional or global; 10 years ago, they were happy to develop a concept nationally.

On the VC side, the investing attitude has significantly shifted. Today's VCs don't beat around the bush; the past hesitation to prune out underperforming portfolio companies is gone. The culture and approach to investment has evolved and VCs bet on innovation, but when a particular investment fails to meet its milestones funding will be cut, regardless of which investment model is employed. According to Fred Destin, partner at Atlas Venture: "The entrepreneurial community in Europe still has a tendency to get upset when companies fail, even though many of the companies backed by the venture players are early-stage and inherently risky. It is a perhaps a very Darwinian way to look at it, but these failures are just a fact-of-lie for disruptive new businesses."

The US ventures to Europe

These signs of maturity along with an interesting financial upside on the exit investment and exit front explain why in a recent survey by placement agent Almeida Capital, almost 70% of North American respondents rated European venture as attractive. The same survey revealed that over a quarter of global LPs intend to increase their allocations to venture this year, with just a tenth intending to decrease it.

However, European venture funds remain modest in size and thus are not necessarily monitored by LPs; translating interest to hard cash is difficult given the limited size of many of the venture funds raising in Europe. Aggressive LPs often seek to make sizeable investments (EUR30m) yet most of the venture funds raising in Europe at this time are limiting in size, reducing placement opportunities for investors (see funds box).

Proximity to the investment must also be factored in; there are many attractive opportunities available locally less the trouble of endless travel and language barriers. "Financial upside is obviously the primary investment criteria when it comes to venture, but not the only one that is relevant. Venture is often an intensive investment requiring not only a hands-on approach by the VC but - almost equally important - necessitates access to an extensive network of contacts which is often cultivated locally," says Frank Schmitt, vice president at technology focused investment bank GP Bullhound.

In spite of the existing contradictions, the industry remains optimistic. Investor confidence in European VC is improving as the post-2000-2004 survivors have earned their stripes and graduated. Today well established pan-European players such as Accel, Atlas, Benchmark, DFJ Esprit and Index bring in the right combination of financial and sector expertise. They exemplify a mature and aggressive market with perhaps fewer players than a decade ago but who are considerably more active and experienced. The result: technology clusters (see box) are growing across Europe and producing higher quality projects than a decade ago. And in comparison with Silicon Valley, the pressure on pricing is less of an issue, which is a clear advantage.

The difficulties experienced by the sector in the 2000-2004 period have contributed to this evolution. Back then, seasoned entrepreneurs were scarce and business angels and bankers lacked the sector expertise required to develop a global vision for the projects.

In the words of Destin "what began five or seven years ago as a 'labour of love' has evolved into what is today a mature ecosystem where the top 10-15% of European VCs and entrepreneurs are on par with and have nothing to envy Silicon Valley."

Innovation Clusters and Funding

It is inaccurate to think of European venture capital in terms of regions. A more accurate description would be that of technology/innovation clusters with the golden triangle (London-Cambridge-Bristol) ranking in first place followed by Paris, Berlin-Munich and Stockholm-Copenhagen. In terms of aggressiveness, the further one moves south the more conservative investors' attitude becomes.

In recent years, European, national and regional programmes have been investing directly and indirectly in the creation of technology incubator. But even in less risk averse markets such as Germany, it has taken close to a decade for incubators to develop into technology clusters an attracting investors for that EUR5-10m round remains a difficult task.

However, a different picture is emerging. In Spain, Madrid-Barcelona-Basque Country is showing growth although there are only a couple of independent (non-government backed) operators Adara and Natua managing funds over EUR50m. In Italy, State Street Global Investment is raising TT Venture, a EUR150m which reached EUR60m at first closing and that has 10% earmarked for seed, with another 35% for start up and 40% for development, meaning it has the ability to invest throughout a target's lifecycle.

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