Skies Darken for European Venture Firms –

It was never clear whether venture capital and Europe was a good match. Much was made in the past few years of the embrace by European entrepreneurs of a Silicon Valley-style attitude. While there are pockets still trying to cling to that notion, especially in the United Kingdom, the spirit that drove European VC in the 1990s has all but dimmed along with investment and returns.

Nothing illustrates that more keenly than the demise of Germany’s Neuer Markt (NM), which is slated to close at the end of next year. The NM was Europe’s answer to the Nasdaq. When it launched in 1997, it quickly became the market in Europe for technology related startups. Between 1997 and the end of 2000, it listed more than 300 companies, half of which were venture-backed.

In March 2000, the Nemax 50, the Neuer Markt’s main index, hit a peak of 9,665 points. At the announcement of its close, it stood at 349 points, a 96% drop amounting to a loss of $419 billion in market value. The New York-based Nasdaq has lost 77% of its value over the same period. One of the first two companies to go public on the NM, German mobile service provider MobilCom, saw its share price rise 2,800% in one year. The company’s fortunes have since reversed. Its stock is now almost worthless and even with a government bailout it faces a massive restructuring effort to save it.

German shareholder lobbyists say they expect as many as 30 of the remaining 264 NM-listed companies to go under before the end of the year. That would bring to 60 the total number of NM-listed companies to go bust this year. Shutting down the Neuer Markt is part of parent company Deutsche Boerse’s plans to divide theGerman market into two segments, which will be known as Domestic Standard and Prime Standard. The latter will house the surviving Neuer Markt companies.

The Neuer Markt’s primary role, providing mostly venture-backed startups a place to offer shares to the public, had all but stopped in recent months. Only one company went public this year on the NM. Other so-called new exchanges in Europe are experiencing similarly brutal slowdowns. The SWX New Market in Zurich has not had an IPO in two years, and officials with the Swiss market are restructuring it. Italy’s Nuovo Mercato and the French Nouveau Marche are also teetering, each down 93% from highs in 2000.

But even the abysmal performance of markets around Europe and the world, and an expectation that almost one-third of European VCs are expected to go under seems to have done little to crush the enthusiasm of some, according to a survey of 125 European VCs. In a striking disconnect, the survey finds the industry so upbeat it verges on delusional.

The survey, conducted by research firm AltAssets, found that European venture firms expect to bring home returns of around 17% over the next five years. Fully 52% of the firms surveyed thought themselves to be top quartile. U.K.-based firms were even more confident; with nearly three-quarters considering themselves top quartile.

“What is somewhat unexpected is the enduring optimism of so many firms,” says Chris Davison, head of research at AltAssets. “They know times are bad, but they think they can make the sorts of returns they generated during better times.”

They also think they will be able to go out and raise new funds. More than half of the firms surveyed expect to go out and raise money in the next 12 months. But as in the United States, venture capitalists in Europe are finding it much harder to raise new money, according to a second-quarter survey by the European Venture Capital Association, Venture Economics (publisher of Venture Capital Journal) and PricewaterhouseCoopers.

New funds raised by firms in the European Union (EU) plummeted 70% to $1.6 billion in the second quarter from $5.2 billion in the first quarter. And while EU private equity firms invested substantially more during the same period, the increase was largely due to buyouts. Private equity firms invested almost $5 billion in Q2, up 39% from $3.5 billion in Q1, fueled by several large buyouts that contributed to a 75% surge in the amount invested.

The actual number of companies receiving private equity investments increased by 2% to 1,260 in the second, from 1,236 in the first quarter. However, both the number of startups and the amount of capital they received declined from quarter to quarter. EU investors put roughly $300 million into 344 startups in Q2, down from $407 million in 437 companies in the previous quarter. Similarly, the amount invested in seed companies fell by 5% to $35.5 million.

U.K.-based VC firms were the most active, according to a specific report run by Venture Economics for VCJ. U.K. firms invested $1.27 billion in the second quarter, more than one-third of the total private equity invested by EU shops. That is still a big drop compared to the $2.73 billion U.K. venture capitalists invested during the same period in 2001.

The rest of Europe continued the downward trend by investing roughly half as much in private equity in the second quarter as it did in the same period a year earlier. German firms seem to have lost the most confidence in private equity, investing just $151 million in second quarter, less than half the $378 million they put to work in Q2 of last year.

Only Spain upped its investment in private equity. But the surge to $585 million in the second quarter of this year from $141.5 million in the second quarter of last year is due to buyouts.

What investment was made was spread fairly evenly across industries. About 25% of the capital went to consumer product related companies, 20% to communications/hardware companies, 11% to software/services companies and the remaining 17% to the “other” category.