Going Global

Silicon Valley, the heart of the US venture capital industry, is said to have a “20-minute rule”, in which any start-up company not within 20 minutes’ drive of the venture firm is unlikely to be funded. This claim is perhaps an exaggeration, but it does illustrate the importance attached to being local, when it comes to venture investment.

But a new trend is emerging, according to some, in which a handful of the leading US venture firms are moving away from being simply local. “These firms are becoming ‘globally local’, establishing an intelligent, local presence in emerging economies, and cultivating what I call ‘global DNA’”, says Lynn Forester de Rothschild, head of investment firm E.L. Rothschild.

While others agree that there are factors pushing some firms towards a more global approach, it is not clear that the trend applies equally to early stage and later stage firms. “If you’re an early stage investor like us you need to be available so you can help the portfolio companies grow in the early days and that makes the idea of flying around the world doing deals less viable,” says David Ward, who heads UK venture firm MTI’s Boston office.

There are also practical challenges to operating on a global basis and questions about the best way of exploiting opportunities in other parts of the world, particularly in emerging economies.

Despite these obstacles, Forester de Rothschild argues that there are a number of factors encouraging the emergence of global venture firms. One is the emergence of non-G7 economies, particularly China and India. China is predicted to overtake Germany next year as the world’s third-largest economy, she notes. “The next billion-dollar companies are more likely to come from Asia than from the West,” she says.

There is also the potential for replicating ideas in emerging economies which have succeeded in the West. Bruno Raschle, founder of fund-of-funds investor Adveq Group, says: “New business models that have succeeded in some countries may also work in others, such as Redbaby in China, which is basically using the business model of Amazon for baby products.”

He adds that investors in venture capital need to think about structural changes in the world economy when deciding where to commit funds. “For example, over 50% of world GDP is generated by multinationals and within 10 years more than half of these companies will be domiciled in Asia,” he says.

There are a number of steps firms interested in operating globally should take, says Forester de Rothschild. One is having local intelligence and networks. This means investment firms need local fund managers across the world in the same incentive pool: “Local managers are needed because they best understand local markets and complexities.”

Understanding the different business cycles can bring major benefits, she argues, as while one industry might be experiencing a downturn in one economy, it could be experiencing a boom in another: “For example, while new mobile phone sales growth has slowed to 5% per annum in Europe, seven million new handsets are sold each month in India.”

But to understand what is going on in different countries and regions it is important to have local fund managers in the various geographies who talk to each other and can spot the trends, says Forester de Rothschild.

There are also an increased number of exit opportunities available to global firms, she believes. For example, last year IPOs in Asian and European stock markets represented nearly three-quarters of capital raised on worldwide exchanges. At the same time share of US flotations dropped to 20% of global IPOs from 32% in 2004.

So who are the firms that are adopting this global approach? Forester de Rothschild highlights Silicon Valley player Draper Fisher Jurvetson, whose portfolio companies have traditionally been based in the US. However, the best returns from DFJ’s current fund have come from Europe and China. Skype’s US$4.1bn exit to eBay in 2004 gave DFJ a 35x return, while Chinese language search engine Baidu’s IPO in 2005 made the firm a 31x return.

One of the arguments for a global approach is that it can potentially protect a venture investor from backing a tech company in one market, only to find that another company elsewhere in the world is further down the road. One example of this, says Forester de Rothschild, is Global Silicon, a UK university spin-off that developed digital technologies aimed at the audio market. Venture firms invested US$18m into the company before they realised that a Chinese company was developing similar technology at a cheaper price. The UK company subsequently sold its assets and intellectual property to the Chinese competitor.

MTI’s David Ward, however, says that in almost every sector these days there are probably half a dozen companies globally working on similar technologies, with perhaps a couple in the US and one in China, India and Europe. “It’s very hard to patent intellectual property that is absolutely unique and not copyable for five years,” he says. He points to the growth of social networking websites as an example: “Just because a company like MySpace has competitors doesn’t make it a bad investment.”

Ward argues that the differentiator is not necessarily the technology but the execution: “It’s about how quickly and how well a particular company can bring the ideas to market.”

Ward is also sceptical about how relevant a global approach is to early stage investment, which MTI focuses on. He says his role is to support mainly UK companies expand overseas and, particularly, into the US. “These companies need help from someone on the ground but they are UK-originated deals and we would not generally try and compete with the Boston firms for US deals, but would consider co-investing with a local lead particularly in less competitive areas like materials science and med tech.”

Anne Glover, chief executive of European firm Amadeus Capital Partners, agrees that globalisation has impacted dramatically on the kind of support portfolio companies need: “With technology start-ups you need to be thinking globally from day one and looking at questions such as where you can find the right suppliers globally, the right customers, recruiters and so on.”

As a result of these demands, she says Amadeus has focused on developing the sector and functional expertise of staff so that individuals really understand global developments in their areas of knowledge. “Our portfolio companies are sourcing capital globally, recruiting and selling globally,” she says: “But the question is do venture capital firms need to be global? I think in the long run those with a deep understanding of the global market will be in a stronger position.”

But Glover adds that, despite this movement towards a more global approach, the market is still dominated by single country or regional funds: “I think these separate pools of capital will still exist in the future because investors want to make asset allocation decisions themselves and don’t want venture firms to do that for them.”

When it comes to examples of the global approach to venture, Lynn Forester de Rothschild cites companies such as OnMobile, a California-based business that develops software for wireless devices. “Infosys, India’s second-largest IT services company incubated OnMobile and Boston-based Argo Global Capital led its US$12m first round in 2000,” she says.

She notes that when the US telecom market dipped in 2001 OnMobile moved to India and this shift coincided with strong growth in India’s telecom market: “The company today is one of the leading value added service players in the Indian mobile, market.” The OnMobile move was forced on its Indian management as a survival strategy, she says, and fortunately enabled the company to take advantage of the different business cycle there. “But this should not happen by accident,” says Forester de Rothschild, adding that it should be part of a concerted strategy.

The main players in this global trend are the large US houses, such as Sequoia. The European players are generally too small and currently involved in consolidation. “Europe has been pretty tough for VCs in recent years and firms are focused on increasing confidence in the European market and on consolidation, rather than looking to invest outside,” says Simon Cook, chief executive of European venture firm Esprit Capital Partners.

But he recognises that there is a strong global theme emerging in venture more generally, and particularly among some of the Silicon Valley firms. In large part this is due to the evolution of exits, he says, noting that in the 1990s most of the exits were the NASDAQ exchange or US trade sales and that meant much of the innovation and investment took place in Silicon Valley.

Since 2000, he says, a number of US venture houses have begun to look outside their home market, while at the same time technology M&A became global. In recent years China, India and Europe have begun to develop healthy exit routes, he says, while the NASDAQ has been less active. “The market has responded to the emerging exit opportunities around the world, with some US firms in particular looking at other regions,” he says.

Cook argues that Europe is becoming an increasingly attractive destination for US firms’ interest. Europe is seen as potentially the next China or India, thanks to the significant number of exits in Europe over the last three years. “For every two home runs in the US, there has been one in Europe despite only having a tenth of the capital,” says Cook.

Cook adds: “US firms are looking to partner with the best firms in Europe, like Index, Mangrove and Esprit, as they have done in China, and a few will open their own offices in Europe, like Benchmark and Accel and often co-invest with local VCs.” He believes that only the top tier firms in Europe will form these partnerships: “LPs are being very selective about European VCs, but they are backing a number of groups and these firms will be the dominant players in Europe in the future, working alongside global VC firms.”

The way that a global strategy can actually be put into practice is one of the major challenges. Cook notes that the potentially global firms have adopted different strategies in doing deals in China and India: “Some have sent out a senior person and tried to build a team of local people around him, while others have formed partnerships with local firms. However you do it, it takes a long time to get a grassroots network and deal flow. In many ways venture is still a very local business.”

Antoine Papiernik, managing partner at European firm Sofinnova, says the firm has seen its focus shift dramatically in the past decade, from three-quarters of investment being made in France, to the majority now going to other European countries. Covering Europe from the firm’s Paris base is already a major practical and logistical challenge, he says. But he is unconvinced at the idea of opening offices in each country, or in other global locations: “That would raise issues, as we’d be more like a consultancy firm than a partnership.”

Nevertheless, Papiernik says that Sofinnova has been carefully following economic trends in China and India: “All of our senior staff have visited China, India or both countries. I think we will be doing something in China in the next two or three years, but I’m not sure what form that will take.”

Papiernik says that the firm is currently looking at a China deal, to test the water, but he stresses that personal networks are even more important in Asia than in the West and that this can make it even more challenging to operate there for an outside firm. “Developing those networks can take years. Anyone can open an office in Shanghai but it won’t bring much value in and of itself. I think our main aim would be to identify people out there that can help us to do business.”

It seems clear, therefore, that the model for a global approach to venture investment is still being developed. The larger venture firms that seek to go down this road will still have to operate in a very local way in the territories where they do business and the way they accomplish will be one of the major challenges. For the smaller venture firms in Europe, a global approach will continue to gain importance when it comes to guiding their portfolio companies’ growth. But as for the firms themselves the future direction for some may well be focused on alliances with bigger US firms in the European market rather than individual expansion beyond the Continent.

Global Private Equity

In many respects a global approach to private equity investing is more developed than for venture and the trend is particularly visible among the very large buyout houses. It could be argued, however, that these houses are taking more of an international than a truly global approach, as to be global implies a presence on every continent.

“Latin America and Africa aren’t really on the radar for these houses, although there are some exceptions, such as Bain in South Africa,” says a director at one of the larger houses.

He adds that probably the only truly global houses are Advent International and Carlyle, thanks to their huge network of international offices. When it comes to the truly international firms, with offices in the key global markets of the US, Europe and Asia, there are still only a limited number. From Europe, these include Apax, CVC and Permira. Among the US examples are KKR, Blackstone and Texas Pacific Group.

The drivers behind the emergence of these global/international firms are several. A key factor is that many of the houses’ portfolio companies are global businesses and so the buyout house, in order to service these companies, also needs to have international reach. There is also the development of deal technology and a number of the larger US houses effectively exported their proprietary expertise and technology when they looked beyond their home market to Europe and, subsequently, Asia for transactions.

David Silver, a managing director at the investment banking team of Baird Europe, says: “It increasingly makes sense to look beyond your home territory in private equity because many management teams are looking for a firm that can open doors for them in markets like China and India for finding new customers or sourcing. That’s true both for manufacturing companies and also for service businesses.”

He adds that it is generally the larger buyout houses that are in a position to operate more globally, thanks to the investment required in new infrastructure. “But it’s becoming increasingly common for firms to look beyond their historical markets, even for smaller private equity houses. Bridgepoint, for example, has grown to become pan-European and recently opened an office in Warsaw, which I imagine will be valuable for their portfolio companies looking to expand into Eastern Europe.”

Lynn Forester de Rothschild, head of investment firm E.L. Rothschild, highlights Carlyle, with its 25 offices in 15 countries. A good example of how it has applied a global model, she says, is its 2004 investment in Florida-based semi-conductor manufacturer Authen Tec. “Today the company has its sales and marketing in the US, design centres in Finland and France, and a manufacturing base in China,” she says.

She also cites Warburg Pincus, which decided in 2001 that it needed to expand beyond the US in order to succeed in the long run. By the end of 2001 it had opened offices in Hong Kong, invested in Indian mobile operator Airtel and the following year invested in Indian business process outsourcing company WNS. Airtel generated a 5.5x return on its US$300m investment two years ago, while last year WNS provided a 13x return.

“Warburg Pincus is a great example of cross-border intelligence,” she says, noting that the firm invested in Airtel only after having made similar investments in the US telecoms sector and anticipating future strong growth in the Indian mobile market.

One of the key challenges in operating more globally is how to manage the change. In the early days of US firms’ expansion into Europe some underestimated the need for local knowledge and expertise and thought they could simply fly in and do deals.

“They realised they would need permanent bases in Europe and a key senior appointment who would be linked into the central decision-making process,” says one buyout director. He adds that a team of locally hired executives would work with the senior appointment: “But combining those two elements is a challenge and becomes harder the further a-field you move.”

But not everyone wants to go global, or even to expand beyond their traditional markets. Steve Tudge, a partner at UK mid-market firm ECI, says that private equity is a “broad church” in which a range of models are suitable, depending on the size of the house and its market.

There is also a downside to trying to expand internationally, he argues: “Traditionally, private equity’s strengths have included being fleet of foot, pragmatic and creative in identifying opportunities. But being global inevitably brings more bureaucracy and new layers of decision making.”

Tudge says: “A global approach may make sense for larger firms who are dealing with international companies, but our investments are in UK-oriented mid-market businesses. We wouldn’t try and buy a mid-market company in Germany from the UK without local knowledge because we would be out of our depth, and so we stick to what we’re good at.