Exits Help Perk Up Europe’s Venture Market –

Europe’s venture business, dumped in the gutter during the tech bubble, has come back to the point where VCs are at least thinking about looking at the stars.
“I don’t think we’ve ever been busier” than in the last six months, says George Coelho, general partner at Benchmark Europe. Coelho says the climate for venture investing has improved dramatically in the last year. That’s one reason his firm raised its second European fund ($375 million Benchmark Europe II), even though it has not yet had an exit from its first fund.
“There is a better climate, and part of that has been created by the fact that we’re starting to get an improvement in exits,” says Rod Perry, global head of venture at 3i. Perry notes that in each of the first two quarters of 2004 there were seven IPOs, and that through the first half there were an additional 80 exits through merger or acquisition.
Landmark
This year’s most notable IPO was CSR (formerly Cambridge Silicon Radio), the Bluetooth chipmaker. While not yet on par with Business Objects-whose $2.2 billion market capitalization makes it perhaps the most successful European venture-backed software company-CSR’s IPO is “a landmark deal” for European venture capital, Coelho says. The company’s backers included 3i, Amadeus, Gilde Investment Management, Intel Capital, Mustang Ventures and Razorfish.
On the M&A front, the year’s biggest deal for a venture-backed company was Yahoo’s purchase of Paris-based Kelkoo for 475 million euros (or $589 million). Investors in the profitable online shopping service, which was founded in 1999, expect to see a return of about five times their money, according to the European Venture Capital Journal (a VCJ sister publication). Kelkoo’s backers included Banexi Venture Partners, Sgam (Societe Generale) and Innovacom from France, Netjuice and BBVA from Spain and Kistefos of Norway.
Other notable acquisitions this year include the purchase of Germany’s Element 5 and Jamba!, and England’s Alphamosaic and KVault Software. Venture firms that cashed in on those deals include 3i, Doughty Hanson Technology Ventures, Earlybird Mosaic Venture Partners, Summit Partners and TTP Ventures (see M&A chart, page 10).
With a growing number of companies exiting their portfolios, a number of European VCs have picked up the pace of new investments. There doesn’t appear to be an overall increase in tech deals, but one sector that’s strengthening is semiconductors, especially chips for portable devices. CSR and Alphamosaic are two of the key players in that space.
Software is also showing signs of life after a moribund period, and this year has seen several U.S. firms buy European software companies as opportunities to expand their markets.
And, says Coelho, there is a “secret” European venture market driven by strong growth in consumer Internet plays like Kelkoo. “Europe does some dot-coms very well,” he says. Benchmark’s Net bets include Betfair.com, a UK-based gambling site; Digital Island, the UK’s Netflix; and yoox.com, an Italian consumer goods e-tailer. Coelho says the firm has passed on several richly valued German e-commerce ventures, which he nonetheless thinks will be highly successful.
It isn’t clear if the increased deal pace by specific venture firms is part of an overall increase in European VC investments. Q2 market survey data weren’t available as VCJ went to press. While European private equity overall had its second best year ever in 2003, as measured by funds invested, venture capital lagged, according to statistics from the European Venture Capital Association.
European VCs invested about 2 billion euros ($2.5 billion) in early stage companies last year, which represented about 31% of deals. That was down from 2.6 billion euros ($3.2 billion), or about 34% of deals, in 2002. Follow-on rounds attracted 6.2 billion euros ($7.7 billion) last year, down from 6.9 billion euros ($8.55 billion) in 2002.
As was the case in the United States, seed investing took a particularly hard hit last year. Those deals accounted for just 3.6% of the total deals done, down from 5.8% of deals in 2002.
Gray Is Good
The market for European venture capital is maturing, particularly in the United Kingdom, which typically generates close to half the venture activity in Europe. And there is a European discount, so it’s relatively cheap for U.S. VCs to buy into late stage deals.
That’s particularly true because many European tech firms want to get into the U.S. market, and they value American VCs. “We always welcome U.S. investors,” says Herman Daems, chairman of Belgian private equity firm GIMV and chairman of the EVCA. He notes that GIMV recently has worked with Greylock on a venture deal. “The whole technology business in both semiconductors and software is driven by global forces.”
3i’s Perry says success stories will help draw U.S. limited partners into Europe. And Coelho says he would be shocked if more large early stage U.S. VCs don’t follow in the footsteps of Benchmark and Accel Europe.
Others are skeptical. Steve Baloff, a general partner at Advanced Technology Ventures (ATV), which successfully made investments in Europe and Israel in the late 1990s, says he’s not sure it makes sense for ATV to start investing in Europe right now. He adds that it’s unlikely that his firm would invest in Europe unless it decided to expand and raised a European-specific fund.
Back in the 1990s, Baloff says, valuations in Europe were so low that it created arbitrage opportunities. While values remain lower in Europe than in the United States, he says the arbitrage potential is mostly gone.
Even those who are in the market say that it still faces challenges. Daems says it’s too difficult for European companies to go public. In the wake of NASDAQ Europe’s failure, he wants to work with established European exchanges, to help bring high-growth firms public. The difficulty of going public is a big contributor to why European venture returns have lagged behind those of the United States.
On a nuts-and-bolts basis, Europe is still developing some of the financing ecosystem of the U.S. Mezzanine rounds, crossover funds and bridge funding are difficult to do in most markets, and in many countries it is illegal to do a PIPE (private investment in a public equity). Among the larger countries, Italy and Spain have been slow to encourage entrepreneurs. France, already one of Europe’s three largest venture markets, along with the U.K. and Germany, this year changed its tax laws so that entrepreneurial companies do not have to pay taxes for eight years (though as with many European countries, laid-off employees still get a year of severance).
Big Differences
Daems notes that European startups face a fundamentally different challenge from U.S. firms: They must be set up to run international operations. “It will still be a lot more challenging to get a European startup to work, because of the complexity of operating in an international startup from the start,” he says.
But in a global market, being international from the start may be a good thing. Indeed, there are signs that historic returns may begin to favor European venture capital. For instance, while Europe’s VCs haven’t performed well in the wake of the tech bubble’s collapse, they’ve been better than their U.S. counterparts. Jean-Bernard Schmidt, managing partner of Sofinnova Partners, argues that European companies had less exposure to the bubble, continue to have a lower burn rate and that will help them in the long term.
“It will show up eventually in the returns,” he says. “One may find that European VCs stack up pretty well against U.S. VCs over the next 10 years.”
Notable Exits for European VC Investments in ’04
* Verisign bought Jamba!, a Berlin-based wireless content services provider $273 million in May. Summit Partners earned nearly a 7x return on the $40 million it had invested in the company, which sells ring tones and games for phones.
* Veritas purchased email archiving company KVault Software of Winnersh Triangle, England, for $225 million in late August. KVault’s backers included Cazenove Private Equity, Lehman Brothers and Mosaic Venture Partners.
* Broadcom acquired Alphamosaic, a U.K.-based mobile multimedia chipmaker, for $123 million in late September. Alphamosaic’s backers included Prelude Trust, ACT Venture Capital, TTP Ventures and Doughty Hanson Technology Ventures.
* Digital River bought German rival Element 5 for $120 million in mid-April. Element 5’s backers included 3i, Earlybird and IKB Private Equity. Hendrik Brandis, lead partner on the deal for Earlybird, told EVCJ that he expected the return on investment to be in the high double figures.

Source: European Venture Capital Journal.
Michael Fitzgerald is a Boston-based freelance writer who specializes in writing about technology. He can be reached at michael@mffitzgerald.com.