When U.S.-based venture capitalists charged into Europe, they were full of big talk. Three years later, they’re as meek as Mike Tyson after an old-fashioned butt whuppin’ by the U.K.’s self-described “pugilist specialist” Lennox Lewis. All American venture funds are investing more slowly in Europe after the market knocked the wind out of them. In addition, two VCs – Benchmark Capital and Softbank European Ventures – have refunded money to their LPs after realizing they were too fat to put up a proper fight.
U.S. firms are finding a slowdown in Europe that is hauntingly familiar. Venture capitalists invested $11.5 billion in Europe last year, down 38% from a high of $18.5 billion in 2002, according to the European Venture Capital Association (EVCA) and PricewaterhouseCoopers. The number of companies VCs invested in declined 24% from 9,182 to 7,014 during the same period.
The contraction in venture capital investments is even sharper than the decline in overall private equity deals, which fell 30% from $33.1 billion in 2000 to $23 billion in 2001 (see chart below). The overall number of PE deals also declined less than VC deals, dropping 22% from 10,440 to 8,104, according to the EVCA.
The average venture deal dropped 25% from $1.6 million in 2000 to $1.2 million last year, while the average private equity deal shrunk 15% from $2.6 million to $2.2 million during the same period, the EVCA reports.
With LPs demanding more from GPs and European companies becoming increasingly skeptical about using venture capital, U.S. venture firms are having a terrible time finding opportunities abroad, says William Stevens, CEO of Europe Unlimited Venture Capital, which tracks European VC. Even though valuations are down considerably, deal flow is “going down severely in Europe,” Stevens says.
He adds: “U.S. VCs have become less active in Europe because LPs are less willing to give them money. They are saying: Things are bad [in the U.S.], why should we give you money to invest in a region you know less about and where we can’t monitor the investments as closely?'”
While most observers agree that the European venture capital business will prosper in the long-term, there is also consensus that not all firms have the skills to be successful. A report in the recently published EVCA 2002 Yearbook states: “Success is likely to require long-standing presence in these markets and carefully cultivated relationships. Considerable sector knowledge, experience in working with early stage companies, and substantial staying power will also be essential. Finally, the ability to operate in different countries and cultures is likely to be vital.” That assessment poses a major challenge to the U.S. VCs that stormed into Europe in the past few years, bragging that they were going to teach European VCs how venture capital is supposed to be done.
The first U.S. firm to acknowledge there was a problem across the pond was Softbank, which handed back $250 million of $600 million to its LPs in September 2001. It also shuttered offices in Munich and Paris and hasn’t made a new investment since.
“I’m not sure when we will start investing again,” says David Sola, a managing director at Softbank European Ventures. “A bunch of funds have had to change their plans. The technology market is a mess and things in general are not what they used to be. VCs really have to work now.”
Next up for an LP refund was Benchmark. It announced in May that it would cut its Benchmark Europe Fund I by 33% from $750 to $500 million, citing a dramatic decrease in both valuations and the amount of capital needed to start new companies. It also said it would add two more general partners to its European office, bringing the total GPs in the overseas fund to five.
Benchmark Europe I has committed about $140 million of its capital, including money needed for follow-on rounds, says Andy Rachleff, a general partner in the firm’s Palo Alto, Calif., office. He declines to say how many deals the European fund has done, but he says the fund’s goal is to invest in about 45 companies, for an average of about $10 million per deal.
Don’t be surprised to see more fund cuts, especially since U.S. LPs are getting used to refunds.
Perhaps American VCs should have taken a cue from international private equity firm 3i Investments, which has been investing in Europe for more than 10 years. When the venture business started to go sour, it increased its emphasis on buyouts. “The venture end of the business is much tougher that it was previously for American and European investors,” says Paul Waller, an executive director with 3i Investments Europe. “It’s been a roller coaster. A lot of these [VC] investors got a lot more tech exposure than they should have, and it’s almost impossible to raise venture money. Buyout funds are much easier to raise right now.” The firm’s fifth European fund, which it hopes to close by the end of the year, will focus strictly on buyouts. Typically, 3i funds invest about 25% in venture deals, 55% in buyout deals and another 20% in alternative deals.
The move by 3i is in line with growing interest in buyouts throughout Europe. While the total dollar amount going into buyouts declined from $13.6 billion in 2000 to $10.3 billion in 2001, buyouts accounted for 45% of the private equity pie last year, up from 41% in 2000, according to the EVCA. In contrast, the VC share of the PE pie fell from 56% to 50% in the same period. “A lot of corporations need cash and what better, quicker way to get it?” Stevens asks. “Companies are willing to sell chunks of their businesses at bargain prices right now, especially in the telecom and tech industries.”
Despite their lackluster performance, Softbank and other U.S.-based firms took the right approach toward Europe, but they were confronted by elements that made the terrain harder to navigate, Sola says. Most firms hopped across the pond thinking that they would invest throughout Europe, but cultural differences and the language barrier made that a difficult task.
This Is Not America
“In America, when someone who works in a lab announces they are starting their own company, people say that’s great,” Sola says. “In Germany they say: What are you, crazy? You’re the head scientist; why would you dare risk the failure?’ In America we chalk failure up to a learning experience. They are not brave entrepreneurs, which makes it harder to find fundable companies.”
Other U.S. firms say they’re still bullish about Europe. Benchmark, for example, hasn’t seen a decline in good deals, Rachleff says. “Quite the contrary,” he says. “We’re seeing revenue-stage companies at startup prices.”
A spokeswoman for Carlyle European Venture Partners agrees. “We’re seeing good deals, but you have to seek them out – they are not just right in front of you,” says Daniela Zuin. Carlyle has slowed its pace and it doesn’t expect its $692 million venture fund to be fully invested for another 10 years. But it has no plans to cut the size of the fund, Zuin says.
DFJ: All Is Well
While at first glance Draper Fisher Jurvetson’s ePlanet Ventures seems like it is having some trouble, Timothy Draper, a founder of the firm, insists that its $690 million global fund (raised in December 2000) is doing exactly what it set out to do. According to Draper, the firm has invested in 29 companies, including seven in this year alone. However, about one third of the fund’s portfolio is invested in Internet-related companies, which doesn’t bode well in today’s market. The heavy Internet investing is not surprising: When the fund was raised its goal was to invest in IT startups located in Europe and Asia. The fund has since diversified its strategy and is taking advantage of deals in the nanotechnology and biotechnology spaces. “We’re not as caught as some other companies, and we are very much in business,” Draper says. “We will probably make another two to five deals in Europe this year.”
Kevin Commolli, a managing partner at Accel Europe, says Accel has no plans for a fund cut, either. “We have adjusted to the current market,” he says. But he declines to say how many deals Accel has done or how much it has invested in Europe. The firm’s $500 million European fund, which was raised two years ago, will be fully invested in three more years, Commolli says. “We were very bullish when we started, and we are definitely here to stay,” he adds. “We’re seeing good deal flow, and we expect that to continue. We didn’t come here to dabble in the market.”
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