Venture Capital Update


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Venture Capital Update

  1. 1. Venture Capital Update October 2006 Written by: Natalie Braun, Managing Director, SVB Capital and Mike Clovis, Associate, SVB Capital european venture capital: a new opportunity? U.S. vs. European Historical When eBay decided to purchase Skype Technologies SA for $2.6 billion last Venture Capital Returns year, investors around the world took note. EBay’s interest in a Luxembourg- as of 3/31/06 based provider of voice-over-IP services demonstrated that European startups can generate bold returns for globally minded investment partners. Before Skype and a handful of other successful deals, sending venture capital to Europe had long been considered unattractive. The venture market was nascent by U.S. standards and casualties were common, especially when the Internet bubble burst in 2000. Long-term venture capital returns in Europe have historically lagged U.S. returns. At 22.7 percent, the 10-year pooled IRR for all U.S. venture capital firms is considerably higher than Europe’s 5.8 percent return for the same period.1 A weak IPO market, limited availability of trade buyers, stringent labor laws, a perceived cultural aversion to risk, and a stigma attached to business failure created an impression that there were no attractive venture opportunities in Europe. Today, that is beginning to change. While the media fixates on India, China, Source: Thomas Financial/Venture Economics and Israel, Europe is quietly turning a corner. Globalization and changes in attitudes towards entrepreneurship and risk have paved the way for innovation and growth in Europe. At the same time, a group of respected European Venture-Backed IPOs Source: VentureOne venture capital update 1 october 2006
  2. 2. Investment in European Venture-Backed Companies Source: VentureOne European VC players has emerged, and the M&A on the rise European venture capital ecosystem has begun Mergers and acquisitions for European venture- to develop, including the appearance of serial backed companies have kept pace as well. In 2005, entrepreneurs. As institutional investors search for there were 163 European M&A transactions, attractive opportunities worldwide, they should not compared to 195 transactions in 2004. While the overlook Europe. number of deals decreased, the median transaction price increased from €17.8 million in 2004 to Clear path to liquidity €22.5 million in 2005. The trend continues in Europe’s elevated profile on the global venture capital 2006, with 67 M&A transactions during the first scene is partly the result of vastly improved exit half of the year. Of the companies that were opportunities, thanks to lower barriers to entry for acquired and merged during the second quarter IPOs and increased merger and acquisition activity. of 2006, the median amount paid approached Initial offerings on European venture-backed €20.0 million. This is highest median amount since companies in 2005 totaled €2.1 billion, up from €0.7 the second quarter of 2005, when it was €27.0 billion in 2004, an increase of 300 percent.2 This million.8 In addition to the eBay/Skype transaction, compares with U.S. venture-backed IPOs totaling recent notable deals have included the following: $2.2 billion in 2005, a 55 percent decrease from $5.0 billion in 2004.3 The top European IPOs of 2005 ° Bredband, a Swedish communications included the following: company bought by Norway-based Telenor for €650.o million. ° Q-Cells, a German maker of solar cells, raised €313.0 million and now boasts a market value 2005 VC Investment (Euros Invested by Country) of €2.5 billion4 ° TradeDoubler, a Swedish consumer/business services company that raised €138.0 million, and has a market cap of €4.3 billion5 ° Interhyp, a German consumer business services company that raised €103.0 million, and has a market cap of €462.4 million6 So far, Europe is on track to exceed the total number of IPOs for 2005. In the first half of 2006 alone, there Source: VentureOne have been 40 European venture-backed IPOs versus 69 for all of 2005.7 2
  3. 3. ° GWI, a German medical company bought by time, Europe is taking a cue from the U.S., where Belgium-based Agfa-Gevaert for €257.0 million. universities and research centers have learned to ° Softbank, a Japanese internet group, bought monetize the tremendous advancements taking place a 23 percent stake in Betfair, a U.K. online within their walls. European universities and research betting exchange, from some of the company’s centers — long-standing hubs for world-class existing investors for £355.0 million, valuing the innovation — are gaining experience in transferring total company at £1.54 billion. their innovative technologies to the private sector. As a result of the improved exit opportunities, some Growing entrepreneurial culture of the best-performing venture investments are now The VC market in Europe is maturing as a generation coming from the European Union. A study of 2,600 of more aggressive venture capitalists that emerged venture deals around the globe from the past three in the late 1990s begins to establish a track record of years found that, among those that returned more success. In turn, startups are benefiting from their than five times their initial investment, 43 percent experience, learning what business models work best, took place in Europe, and more than half of all and how to support and develop companies. At the deals that returned 10x or more were European.9 same time, the emergence of serial entrepreneurs who have experience launching multiple companies in Success breeds success Europe — combined with the return of entrepreneurs The convergence of several factors explains the from the U.S. — makes for an increasingly strong change in Europe’s venture investment climate. entrepreneurial culture. Add to this the presence of Globalization means that it no longer matters where U.S. VCs, like Accel Partners and Benchmark Capital, opportunities are located as long as there is access to which have been on the ground for several years, a supply of talent, innovative technologies, business plus others that are collaborating with European models, and capital. firms, and the foundation of expertise is growing by the day. Although Europe does not have a strong history of entrepreneurship, the tide is shifting towards European startups are also enjoying growing access an entrepreneurial mind-set as a young and to the capital they need, as evidenced by the increase ambitious new generation discovers considerable in seed and early venture investments by local and rewards in the pursuit of big ideas, inspired by U.S. funds. In 2005, over 1,000 European companies spectacular exits such as Skype. Europe is also received $4.6 billion; 34 percent of these were seed beginning to enjoy some of the fruits of the and early stage deals. The trend is continuing outsourcing boom. Central and Eastern Europe are in 2006. emerging as another source of low-cost talent for third-party R&D and manufacturing for companies around the world. At the same time, the availability Commitments to European Venture Capital Funds of seasoned and internationally savvy mid-level managerial talent is increasing, as more business professionals are willing to risk comfortable jobs with established companies to join startups. With this growing pool of talent, Europe finds itself with strong capabilities in several areas, including wireless software and hardware, as well Source: VentureOne as renewable energy technologies. At the same 3
  4. 4. Roughly $2.5 billion has been invested in almost London Stock Exchange’s Alternative Investment 400 European companies in the first half of 2006, 42 Market (AIM) exchange have fewer requirements. percent in Series A transactions.10 The AIM is much like the Nasdaq of the early 90s — an opportunity to access public capital and a market A friendlier regulatory environment? for smaller companies unable to generate enough Once these companies are ready for prime time, mainstream investor interest on the NYSE. Although Europe’s more accommodating regulatory environ- the AIM is still developing, it offers better liquidity ment is able to offer increased access to public than the LSE and the EURONEXT for companies markets. While U.S. public companies are governed with a market capitalization ranging from £75-500 by the stringent and costly requirements of million, and even better liquidity than the Nasdaq for Sarbanes-Oxley in order to maintain a listing on the smaller companies under £100 million. Nasdaq or the NYSE, companies that go public on Perspective ° Market trends in Europe tend to lag the U.S. With a firm belief in Europe’s world class by six to twelve months, and the activity level technological innovation, SVB Financial Group has picked up over the past nine months. SVB’s established its European arm, SVB Europe Advisors lending activities in the U.K. reflect this Ltd., in London in 2004; and opened SVB Alliant increase in activity. Europe, a subsidiary of its M&A and private ° The mix of Series A deals also means that placement advisory firm, in 2006. European VCs are back to company creation rather than supporting existing investments. The evidence of European innovation is every- ° The majority of European venture-backed where: in the leading universities and tech clusters; technology and life science companies are a small but nonetheless vibrant venture capital acquired by U.S.-based businesses. community, which is beginning to produce some global players; and a resurgent entrepreneurial About SVB in Europe environment. SVB Europe Advisors and SVB SVB Europe Advisors Ltd. is part of SVB Global, Alliant Europe are part of an emerging group of a member of SVB Financial Group. SVB Alliant service providers bringing more infrastructure Europe is the U.K. subsidiary of SVB Alliant, the and support to the venture community in Europe. M&A and private placement subsidiary of SVB After two years located in London and several years Financial Group. Both organizations are part of building relationships throughout Europe, we have SVB Financial Group’s global network. seen a steady sea change in the way European VCs approach their business, even taking on some best With dedicated teams serving China, Europe, practices from the U.S. and other regions. We India and Israel, and 27 U.S. offices, SVB Financial continue to feel bullish about the prospects of Group helps technology companies and private European venture capital and the entrepreneurial equity firms navigate foreign markets and identify environment overall: opportunities internationally and in the U.S. More ° The afterglow of Skype is still visible in the form information about SVB Financial Group and its of firms like Index Ventures and Mangrove, subsidiaries can be found at which routinely syndicate with leading U.S. VCs. 4
  5. 5. The AIM has acted as a magnet for the small and Where to begin mid-sized companies it was designed to serve, While Europe is a legitimate part of the global holding more than 2,000 IPOs since its formation VC world, European funds have yet to convince in 1995, and raising €29.0 billion.11 Even some U.S. institutional LPs in the U.S. to take the region startups are gravitating to Europe for a friendlier IPO seriously. One of the reasons for this lack of interest environment. Mayfield Fund took Mountain View, is that institutional LPs make their investment California-based PolyFuel, Inc., public on the AIM decisions based on historical returns, which have not exchange in July of this year, and Hyperion Partners been attractive in Europe. To complicate matters, the introduced New York-based Allied Healthcare on European market is fragmented, with each country the same exchange last year. dominated by a few relatively small players. Such fragmentation, though, has led to some promising Increasing risk tolerance pockets of regional expertise that could ultimately In addition to globalization, a change in attitudes prove attractive to more U.S. investors. The presence toward risk is benefiting European venture capital. of Nokia in Finland and Ericsson in Sweden, for This is driven in part by LPs increasing pressure on example, has created fertile ground for mobile European VCs to adopt U.S. VCs’ best practices. In communications, while Ireland has developed addition, experienced entrepreneurs and local VCs, a strong software business culture, and the research led by the example of U.S. colleagues, are developing centers clustered around Cambridge University a higher tolerance for risk, willing to be more patient have led to a vibrant community of semi- and allow their big winners to mature to achieve conductor companies. higher exits. They are no longer settling for lower multiples for the sake of realizations and low capital We believe that Europe should not be ignored loss ratios in the near term. as a part of a diversified international portfolio. However, investing in individual European funds is The development of a VC ecosystem plays an complicated and raises many questions. For example, important role too. A number of significant how do LPs determine the best countries in which local VCs have emerged over the last 10 years, to invest? How do they decide which area will generally cooperating rather than competing with produce the best returns? How do they deal with each other and sourcing increasingly high quality different cultures and languages associated with pan- deals that are shared within this elite group. European investment? Furthermore, the emergence of professional service providers such as venture debt, investment banking, And how do they enter the market when there are and legal firms specializing in venture-backed few funds to consider, and those with a proven companies is strengthening the market. track record of success are often oversubscribed or impossible to join? In the midst of these changes, a number of government programs are effectively supporting early-stage When investing in individual funds is not the most investment and venture capital. For example, attractive or the most viable strategy, one alternative since 2002, nine Regional Venture Capital Funds way for institutional LPs to ease into the European established by the U.K. government have raised market and avoid these challenges is through funds of £250.5 million and invested in more than 200 funds. This approach allows LPs to participate in the companies to date.12 market without having to become experts themselves while spreading their risk across multiple funds and various geographies. 5
  6. 6. A fund of funds approach can also allow LPs Europe as a part of a global investment strategy. And to gain access to the small number of closed or with word of early returns spreading fast, demand for restricted funds, and participate in emerging European venture deals is only going to increase. The funds whose identification and selection require time may well be right for giving European venture local knowledge. capital a chance. 1 Thomson Financial Venture Economics, 2 DowJones VentureOne, 3 DowJones Venture- The European venture capital ecosystem is quickly One, 4 As of 9/15/2006, 5 As of 9/15/2006, 6 As of 9/15/2006, 7 DowJones VentureOne. evolving. Current financial, demographic, and 8 DowJones VentureOne, 9 TLcom Capital Partners, 10 DowJones VentureOne, 11 AIM presentation, 12 EVJC, March 2006 cultural trends suggest it makes sense to consider investment strategy outlook SVB Asset Management, SVB Silicon Valley Bank’s registered investment advisor affiliate, publishes a weekly newsletter offering timely economic insight and analysis about the technology and life science markets, and the private equity and venture capital industries. * 6
  7. 7. second quarter 2006 u.s. private equity snapshot U.S. VC-Backed M&A Activity U.S. IPOs vs. M&As Source: VentureOne and Ernst & Young Quarterly Venture Capital Report Source: VentureOne and Ernst & Young Quarterly Venture Capital Report Fenwick & West’s 2Q06 Venture Capital Barometer Most Active Investors - 2Q06 Source: Fenwick & West L.L.P Average per share % price change from previous round of Silicon Valley companies receiving VC investment in the applicable quarter Source: VentureOne Complete report available at U.S. Venture Capital Investing Activity by Quarter U.S. Venture Capital Investing Activity by Year Source: VentureOne and Ernst & Young Quarterly Venture Capital Report Source: VentureOne and Ernst & Young Quarterly Venture Capital Report 7
  8. 8. Post Money Valuation Report ($M) - 2Q06 U.S. VC-Backed Liquidity Events by Industry Source: VentureOne Source: VentureOne and Ernst & Young Quarterly Venture Capital Report U.S. Deal Flow by Round Class Cumulative Fund Type Performance as of 3/31/06 Calculation Type: IRR Source: VentureOne and Ernst & Young Quarterly Venture Capital Report Source: Thomson Financial Venture Economics/ National Venture Capital Association Price Change Cumulative Vintage Year Performance as 3/31/06 Venture Capital Funds (only) Calculation Type: IRR The direction of price changes for Silicon Valley companies receiving financing in the applicable quarter, compared to their previous round. Source: Thomson Financial Venture Economics/National Venture Source: Fenwick & West L.L.P Capital Association 8
  9. 9. Equity Financings* for U.S. Venture-Backed Companies by Industry Group Cumulative Fund Type Performance as of 3/31/06 * Equity financings include cash investments by professional venture capital firms, corporations, other private equity firms, and individuals into companies that have received at least one round of venture funding Source: VentureOne/Ernst & Quarterly Young Ventura Capital Report Region Focus All Industries - 2Q06 Fundraising by Venture and LBO/Mezzanine Source: Thomson Financial Venture Economics/National Venture Source: VentureOne and Ernst & Young, Quarterly Venture Capital Report Capital Association * This update is for informational purposes only and is not a solicitation or recommendation that any particular investor should invest in any particular industry, security, or fund. SVB Asset Management, a registered investment advisor, is a non-bank affiliate of SVB Silicon Valley Bank and member of SVB Financial Group. Products offered by SVB Asset Management are not FDIC insured, are not deposits or other obligations of Silicon Valley Bank, and may lose value. SVB Europe Advisors Ltd. is a subsidiary of SVB Financial Group, is not licensed to conduct banking business in the United Kingdom and does not engage in unlicensed banking activities. Banking services are provided by Silicon Valley Bank, a member of FDIC and the California bank subsidiary of SVB Financial Group. SVB Alliant is a wholly owned broker-dealer subsidiary of SVB Financial Group, and a member of NASD and SIPC. Products offered by SVB Alliant are not FDIC insured, are not deposits or other obligations of Silicon Valley Bank, and may lose value. SVB Alliant Europe Ltd. is registered in England and Wales at 34 Dover Street, London, W1S 4NG, U.K. under No. 5572575 and is authorised and regulated by the Financial Services Authority. Silicon Valley Bank is the California Bank Subsidiary of SVB Financial Group. 9