Over the past couple of months, there has been much talk of the invasion of the US early stage venture capital firms, bringing over Silicon Valley-style investment to the European market and using London as a launch pad into Europe. The arrival of US VC houses in Europe has had some effect on the investment climate, although players remark that there are fewer US VC’s that have recently set up here than the hype would lead one to believe. Much of this activity has to a certain extent been over exaggerated and with an increasing level of sophistication and expertise developing this side of the Atlantic, prominent London players suggest that it is more a case of learning from our US counterparts, than adopting their style of investment.
A study published by GrowthPlus and Arthur Andersen has found that the UK is doing more than most of its European neighbours to stimulate entrepreneurial activity and is even ahead of the US.
In March this year Silicon Valley venture firm Benchmark Capital, which recently set up its London office, launched a $500 million fund, Benchmark Europe 1 to back high tech start-ups in Western Europe. The fund closed oversubscribed at $750 million in June.
The expectation of the fund is to attract a high calibre of investment proposals by delivering Silicon Valley-style investment principles directly to the European market – via the firm’s London office that was set up in autumn last year by general partners Eric Archambeau and George Coelho. As the fund concentrates on growing its investment portfolio, there are plans to expand the London office by recruiting new partners in the coming months.
Eric Archambeau comments on the decision to tackle the European market from this perspective: “We came to London at a very interesting time the market was unstable and we were waiting until the time was right to start investing. Now that valuations are back to reasonable levels, the time is right.”
The company is employing a method of investment that is reminiscent of the early nineties model of Silicon Valley. Archambeau talks of a “technology-centric” environment. “There are great opportunities for entrepreneurs out there Europe has ripened over the last ten years.”
Whereas in the past, most high tech opportunities were to be found in Silicon Valley, today there is worldwide potential. Europe is rich in high tech deals. The players understand their sectors and have developed a management know-how that they are applying to their investments. He remarks that this was not the case ten years ago where players didn’t appreciate the cultural aspects of small companies, such as the need to focus on marketing and development issues that were traditionally attributed to Silicon Valley style of investment.
Looking at the current investment climate, Archambeau is of the opinion that there is not likely to be a repeat performance of the Silicon Valley of the early 1990s where a successful company was built up from scratch in two to three years maximum. However, Benchmark is optimistic about prospects for big success in Europe. “We are really confident about our model. The fund was way over-subscribed by existing US investors from previous funds. There was a lot of enthusiasm for Europe.”
But what was it that attracted Benchmark to establish its offices in London rather than elsewhere in Europe? Archambeau suggests that there is a need among US-based entrepreneurs to build a community of like-minded people who understand the Silicon Valley mentality over here. He adds: “Entrepreneurs who are looking for money are more likely to come to London than elsewhere in Europe. Markets such as Germany and France are not seed orientated. When you are early stage, you come here”. London has also been attracting other US start-up funds such as Accel Partners and Draper Fisher Jurvetson, who are just setting up offices.
The big difference between Silicon Valley and Europe, he continues, is that there are five or six pockets of entrepreneurial activity and almost none of this is in London, but in the surrounding regions. He cites the regions where the hub of activity currently lies as Cambridge, Ireland, France, Munich, Finland and Brittany where there are several major R&D centres for telecoms such as Alcatel, Siemens and France Telecom. He acknowledges that most of the opportunity in Europe is actually outside London, but adds that “you cannot be in one place and have it all.”
One of the main attractions of London for VC’s is the fact that the majority of talent for management is London-based. “There is an immense pool of management talent in and around the capital. If you are looking for a chief executive officer, you go to London – people are willing to move here for jobs.”
Alisdair Warren of technology venture capital firm, nCoTec also regards London as an excellent hub for networking with the VC and financial community. “London is a very good beach-head to the rest of the UK and Europe. Not because the majority of the companies you invest in are based in London, but because there is a high concentration of other VC’s with whom it is important to build relations with for partnerships and syndication.”
Looking at the VC community in London, he adds that a noticeable segmentation of the marketplace that is occurring. There won’t be so many
giant players in the mould of 3i and Apax, but there will be a cluster of smaller players such as nCoTec who pick a niche sector and specialise in it. This marks a change of approach that is not as impersonal as some of the larger players. In general, VC’s in Europe are becoming more involved with their portfolio companies and assuming much more of a hands-on approach.
A new wave?
Michael Elias, managing directorKennet Capital, takes a slightly different stance when looking at the so-called frenzy of US companies invading Europe. Elias is of the opinion that the press has over-emphasised the extent of the US invasion into Europe. “There have been reports over the past year of the wave of US VC’s setting up in Europe – I haven’t seen them. There are a few out there that are still mainly in start-up mode such as Benchmark Capital, Accel Partners, Draper Fisher Jurvetson and Spectrum. The phenomenon, however, is over-hyped in terms of number of firms and the effect they’ve had on the venture capital market.”
He adds that Europe is a very complex market and you cannot just take US investment techniques and enforce them upon a totally different culture. Europe is heterogeneous. It is not simply one market, but a mix of different countries and cultures. He underlines the strengths of the VC players in London.
Firstly, there is broad spectrum of
VC professionals that understand technology investment. In the past, investment banks committed capital to companies of which they had no industry knowledge. Today, a more sophisticated style of investment is emerging from London and its neighbouring European countries. Notable employers of Silicon Valley-style investment, Atlas and Amadeus, know and understand their core sectors of investment.
Secondly, VC’s in Europe are increasingly building a bond with their portfolio companies. There is a real involvement with the company – with board meetings every month, whereas in the past it was almost every six months. This active involvement is an attribute of US VC’s that has now infiltrated into the European way of investment, says Elias.
However, it is not fair to say that the European way of investing is assuming more of a US approach – Elias touches upon a certain ruthlessness of investing in the US that hasn’t come over and hopefully won’t. The US market is highly competitive and many players remark that Europe is becoming increasingly competitive. However, this competition is nothing compared to the state of play in the US. Elias says that unfortunately the situation is changing. “With fierce competition, you lose the congeniality that has developed in the European market. There is a much stronger bond between European VC’s than there is between their American counterparts.”
Broadview, which focuses exclusively on the IT, communications and media industries, has its roots in the US, but is positioned in Europe and sees itself as adopting a mixed strategy when it comes to tackling investments. Last year, the company stepped up its operations in Europe with the acquisition of Electra Partners Europe’s half of their joint venture investment in Kennet Capital. Kennet Capital is now a wholly-owned subsidiary of Broadview.
Broadview prefers to focus on the active hands-on, team-orientated approach typical of US investment expertise. The recruitment of a management team and senior personnel relatively early in the investment cycle is the key to much of the success in the US. In the US, a chief executive officer, vice president marketing and finance director will have been appointed within months of making an investment. This is apparently an aspect of where Europe has its weak points. According to the Gresham Monitor, a survey of the middle market by Gresham Trust, one of the problem areas at the moment is a shortage of skilled staff, especially in the sectors of management, IT, design, sales and production.
Targeting early stage
Traditionally a later stage investor in the US, rather than seed and early stage, private equity firm, Carlyle Group towards the end of 1999 launched Carlyle Internet Partners Europe (CIPE), a A730 million European-based venture fund focusing specifically on start-ups. Lori Belcastro, who joined the London office in September 1999 to help launch the project believes that next generation Internet is leading to unprecedented value creation opportunities with bandwidth expansion, flexible networks and the inter-connectivity of devices altering the face of communications as we know it. She adds that the UK and the continent are already beginning to enjoy the benefits of regulatory liberalisation, emergence of common standards and the growth and mobility of capital.
Belcastro also touches upon the advantages of co-investing either with their US counterpart or with the company’s European buyout fund. This strategy of cross fertilisation between funds is the element of a US background that Broadview also considers advantageous.
Broadview Capital Partners runs a
$250 million late stage private equity fund that invests in the same space as Kennet Capital. However, Elias stresses that Broadview’s US buyout fund and start-up focused Kennet II in Europe are not intentionally linked. Although it is an added bonus if a later stage investment crops up in Europe that can be passed onto the US fund and vice versa for the early stage opportunities in the US. First round investments from Kennet’s first fund have also gone on to receive later stage funding from the US fund.
There are mixed views on the phenomenon of the deflating incubator bubble. Indeed, there is evidence to suggest that they are fast losing their appeal with terms such as “stinkubator” doing the rounds. Much of the VC community remains skeptical about the future of these players.
Last year saw a frenzy of launch activity in the incubator/accelerator arena, prompting what many are anticipating as a major shakeout in an overcrowded marketplace. There are tough times ahead with companies that have seen rapid European expansion such as GorillaPark battling with tough times and out looking for more capital. Crescendo Ventures may invest again, but it is uncertain that there will be another investment round from Cable & Wireless.
Belcastro of CIPE envisages that there will be a maturing of the sector with one or two players rising to the top and achieving greatness and the rest will slowly disappear. Gerard Montanus, partner at Atlas Venture agrees that if an incubator is focusing on e-commerce, then it will inevitably be having a tough time. However, for high quality players focusing on technology, there is more of a chance of survival.
Atlas has always combined its US strategy with its European approach to investing through its global fund. Montanus remarks that he has not seen any slow-down in new propositions in London. Internet investments have witnessed a downturn in commitments, but in terms of technology deals, opportunities are good.
He sees it as very positive that there are more US VC’s crossing the Atlantic. “Having a transatlantic presence is key if you want to be a successful international VC player,” he says. An advantage of the US companies is that they are highly focused, very often with more industry experience than a number of UK-based players. These VC houses are also bringing over knowledge of the US market place. Many of Europe’s VC’s do not have an in depth knowledge of what is going on in the US and in an increasingly global marketplace, it is important to have this knowledge to become established as a credible investor.
The year ahead
Industry experts agree that over the year, there will be fundamental changes in business opportunities. There will be some terrific opportunities, but a lot less going on. According to Broadview, M&A activity is down and the IPO window is shut. Technology companies aren’t going public either here or in the US.
This year is going to be much tougher for funds that are in the harvest period of their cycle (three to four years into investing). Funds that are in the beginning of their cycle and are just starting out are in a much better position to invest. The situation has improved since last year when prices were high. Michael Elias at Broadview says that Kennet’s $250 million second fund was launched at the right time and is in a good position, reviewing investment opportunities, not having made any commitments to date.
Kennet II is focusing on enabling technologies and infrastructure that sits behind telecommunications networks. Wireless technology will account for approximately 40 per cent of the fund’s total investments.
As in most of Europe, there is an increasing focus on quality. The rate of deployment of cash has clearly dropped in the first quarter and investors are
being more prudent with their capital. They have realised that if you are investing in a start-up, you will have to support the company for a few years. It is not likely to have a speedy exit and other investors may be less inclined to come in on a second round.
As a result of this, VC’s are also thinking of the number of investments that they are making. The more deals they do, the more money they will have to commit in the future for further rounds and so, many are choosing to focus more on their current portfolio, rather than committing to new investments. Limited partners are also thinking carefully about investing in funds. Some players remark that new funds are finding it almost impossible to raise money and even the more experienced funds are finding it difficult.
Eric Archambeau of Benchmark is optimistic for the future. By extracting the best elements of Silicon Valley expertise and applying it to the European market, he anticipates that within two to four years there will be a boom of successful companies deriving from this style of investment. However, as others investors remark, it is not only a US lesson that is being learned today. In London, there is a new air of sophistication and level of experience from European VC’s; an element that is becoming an extremely important factor in an increasingly global marketplace.