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Sweden: high and low in the competition stakes

e-Commerce and high-tech fever are wreaking havoc with the status quo among Sweden’s venture capital players. A year ago, ECVJ reported that venture capital investors were flooding into Sweden hoping to take full advantage of the country’s established predominance in telecommunications and its related businesses. A year on, Swedish players report that things have cranked up by not one but several gears. The new entrants to Sweden’s high-tech venture capital arena continue to come in all different shapes and forms.

Long active corporate venturers such as Ericsson, (the mobile telephony giant), Telia, (leading Swedish telecom provider aiming to become an Internet communications company driven by IP-based services and technology), and Nokia, (a global mobile telephony giant concentrating its growth on wireless and wireline telecommunications) have all stepped up their activities. Ericsson, for example, last month announced a $75 million investment in what will become a separate fund management team targeting investments in the mobile Internet development space. Called Ericsson Venture Partners, the total fund will be set at $300 million because Ericsson’s commitment has been matched by AB Industrivarden, one of Sweden’s largest active ownership stock holding companies, Investor AB the Swedish long term active global shareholder in multinational companies and private equity investor, and the US investment bank Merrill Lynch. While observers note these corporate venturing activities are ,to a greater or lesser extent, defensive in their motivation, that is not to underestimate the impact such a flood of highly focused funding has on the market particularly since the concentration of experience of mobile and fixed telephony in Sweden means it would be a sensible supposition that at least some of this, and other such funds, will invest in the Swedish market.

In parallel with the step up in corporate venturing, there has been an explosion in the number of incubators that have set up in Sweden in the last year. Thomas Wernhoff at Euroventures says: “Incubators are appearing in various shapes, everything from the traditional VC organisation with institutional investors to private management companies.” One Swedish venture capitalist goes further to say: “Hundreds of incubators have been established in the last year and it’s very hard to keep track of them.” Sweden’s incubators are tending to focus on seed and pre-seed stage e-commerce investments, particularly in the B2B and B2C space, and it is agreed that they are not generally involved in pure high-tech deals. While their presence has no doubt muddied the waters, the lack of interest and probably ability to invest in the high-tech space is good news for Sweden’s pure high-tech investors such as Assarsstratetema and InnovationsKapital. They do, however, complain of hype surrounding high-tech and Internet-related deals putting upward pressure on pricing.

On the other hand the incubators have their own problems. One Swedish investor notes that Swedish incubators appear to already experience the phenomenon seen in the US where incubators have long been part of the venture landscape whereby it is widely understood that the best entrepreneurs don’t go to incubators. Apart from the difficulty of deciding what constitutes best’ it would seem too early in the incubator’s evolution to determine the quality of their investments and what growth potential those investments have. Another potential problem, spotted by Euroventures, is the move among some incubators to attempt to gain a stock market listing. “I think it’s a bad idea to have traditional venture capital funds floated because of the character of private equity: it can’t run according to quarterly reports. The day of exit results is what counts.”

The sheer size of Sweden’s group of incubators has led many to conclude that the road ahead will be bumpy something other markets with established incubator cultures have already seen. Staffan Ingeborn at InnovationsKapital says: “The incubator market just now is very fragmented and it’s pulling a lot of money into the market. Within the not-too-distant future many new players will leave this market. I expect that you will see a market correction within a year or two.” Thomas Wernhoff at Euroventures expects the shake out will probably start next year and go into 2002.

It seems likely that those incubators with an ill-thought-out or ill-fitting business model, of which there appear to be plenty, are having the inevitable effect of tarnishing the rest of the pack. And, as usual, the entrepreneurs taking advice and money from incubators are the ones that will face upheaval if the management either decides or is forced to exit the business. Some of Sweden’s strong business angel community have been drawn into the incubator scene, although many of these operations are described as semi-consultant and semi-venture capital in their approach. Outside incubators, Sweden’s business angel culture is alive and flourishing.

While the dynamics of the venture capital market in Sweden have undoubtedly changed dramatically over the last couple of years, Conni Jonsson at EQT Partners puts those changes into the context of the evolution of the private equity market as a whole in Sweden. Conni Jonsson at EQT Partners says: “In the first years of Swedish venture capital it was very easy to buy companies because there was very little competition caused by Sweden’s credit crunch. So it was easy for VCs to buy companies and give them an easy fix. Then in the 1980s there was a lot more competition on buy side. Today you need to be able to do something with companies, have a hands-on approach, resources, business models, and

people. It’s hard work, so we work with fewer companies.”

Leif Gustafsson of Baker McKenzie adds that increasingly the first cycle in a venture capital-backed business is the start-up stage, the second stage involves rolling out the investment across Europe, and the third stage is a merger to increase the company’s size and improve the backers’ exit position. Given the youthfulness of these venture capital-backed firms, primarily in infotech and e-commerce space, merging them presents great challenges.

With the increase in corporate venturing and business angel activities and the spread of incubators has come much hype, something Conni Jonsson at EQT Partners refers to as the theme of the day’, noting that wireless is currently that theme. Many view B2C as dead and B2B as questionable. Baker McKenzie notes: “I think that there is growing interest and demand for consumer goods, for example food, sold over the Internet. For the time being [investors] are scared and so it’s difficult to find capital for B2C.” The hype has caused prices on deals to rise. Roeland Boonstoppel at Crescendo Ventures says: “If you are not focused you will see very highly priced second- or third-round financings, which is the result of more money being available than there are good deals coming to the market.”

Staying focused’ at Crescendo Ventures (which does not have an office in Sweden but has made one investment there to date) means meeting on a quarterly basis for a couple of days to determine where the market is moving and what the forward strategy will be. This should enable the firm to get into investments in areas of interest before they become the theme of the day, which usually lasts for between three and six months before investors realise they are overpaying. This sort of planning led Crescendo Ventures to get into the optical market before it got too pricey this market has been the subject of much of Crescendo Ventures’ interest in Sweden, as well as in France and the UK, of late. Roeland Boonstoppel notes there are eight optical deals in Crescendo Ventures’ portfolio that were largely done before that market exploded. He says as a consequence, it is most likely that the firm will cherry pick another couple of deals before shifting focus entirely.

While the theme of the day is nipping at the heels of Sweden’s venture capitalists focusing on early-stage companies, in the mid market, players such as Euroventures and EQT Partners agree that the field has remained the same, with the same players, for the last six or seven years. Some highly focused interest, such as that of Crescendo Ventures, has come from outside Sweden. But where early-stage high-tech investments in Sweden are done by venture capitalists without a Swedish base they tend to be on a co-investment basis with domestic players. This is simply a function of the nature of such investments, and Sweden’s early-stage venture capital players seem happy with this status quo. It’s probably fair to say that much of the stability in the mid market is maintained by virtue of the fact that there are literally a limited number of opportunities in a country dominated by large multinational corporates which has a domestic population of just eight million.

One aspect of the Swedish mid market that has changed is the way in which the auction process is now conducted. The well-documented fiasco where Alfa Laval passed through the hands of Charterhouse Development Capital and UBS Capital earlier this year has pretty much put paid to the broad auction in Sweden. In the ten years since the auction has been an accepted part of business, broad auctions where 40 bidders were invited were the norm. Swedish Match and Alfa Laval have pushed banks holding auctions to reduce this to a narrow auction where just four or five are invited to bid. Typically there will be just one or two financial buyers, with the others being trade buyers. In the mid market, Conni Jonsson at EQT Partners notes: ” You can still find deals that are not in auctions but the sellers know what the companies are worth.”

In general terms, some venture capitalists comment on taxation issues of foreign participations in limited partnerships. However, as Staffan Ingeborn at InnovationsKapital says: “There are not too many opportunities for international investors to place venture capital in Sweden if they want to have a normal structure and tax transparency. Swedish venture capital is normally financed by Swedish investors.” The bottom line is that, at the venture capital end of the market, there is enough Swedish money to support these funds; however, the larger buyout and later-stage funds that by their nature are seeking larger amounts of capital have structures suited for international investors. This essentially involves making the vehicle tax-neutral for all participants. In recent months, Baker McKenzie notes that it has helped a number of international investors seeking to place capital in Sweden and notes particular interest from US and Finnish enterprises.

The shortage of people skills is something the venture capital and private equity community in Sweden has to contend with on two fronts although there is no shortage of engineering talent in Sweden. Roeland Boonstoppel at Crescendo Ventures notes: “It is hard to attract international management skills because not that many people want to move to Stockholm.” As a result, companies and their venture backers are faced with the inherent difficulties of running two operations in different parts of the world perhaps operations in Stockholm and administrative/ finance functions out of a city such as London where there is a pool of international management talent to draw on.

On the other side, the venture capital and private equity industry itself is feeling the squeeze. Experienced venture capital investors are hard to come by and they remain, as elsewhere in Europe, much in demand.