As London-based Apax Partners & Co. Ventures was working on the offering document for its euro 1.8 billion pan-European fund, the venture capital firm’s UK printer confessed it was still not yet able to reproduce the symbol for the new euro currency – a C intersected by an equals sign – despite the looming January 1 conversion.
Apax turned to its law partners, and specifically to its US affiliate, for help.
“Our printer had said they couldn’t do it”, says Clive Sherling, an Apax director. “Our US partners said, What does it look like?'” While Clive. Sherling’s anecdote might be a bit strong if applied as an overall metaphor to domestic venture capitalists’ knowledge of investing in Europe, one element rings true: all US venture capitalists have heard the hype, but far fewer have direct experience with the details of these overseas transactions.
At the same time, domestic venture capitalists are showing more interest, even if it’s only tangential interest, in international private equity markets. This is due partly to changes in those markets, particularly in Europe, that will make investment by US firms less difficult to evaluate, manage and profit from than in the past, and partly to indications by limited partners that more capital will be allocated in the future to non-US private equity exposures.
“This whole business is getting more global, and more firms are thinking about it – a lot of us have thought about it”, says Harry Rein, a managing partner Connecticut-based Canaan Venture Partners, who, like many US GPs, has decided not to pursue an international bent. “But I think that if you’re going to be an active private investor, you have to be near your companies, and a trip across the pond means you’re not close to your portfolio companies. You can partner, but then you’re not doing it yourself.” That’s not to say Harry Rein isn’t tempted at times, he adds, but the issue of proximity is too weighted for his liking.
“We see deals that are international; I’ve got one right now on my desk that, if it had been here, there’s more than a fifty-fifty chance we would have done it”, he says. “But it’s in London.” Disbursements to foreign companies by US venture capital firms have, for the most part, increased steadily since 1990, although 1994 saw a dramatic dip. In 1990, domestic firms dropped $179.9 million (ecu 151.4 million) into 63 non-US companies; in 1994, just $85.7 million was invested in 31 companies, according to Venture Economics Information Services.
Since then, however, the rebound has been pronounced. By 1995, $251.2 million left the coffers of US venture firms to support 145 foreign companies. Last year, the dollar value of investment doubled to $506.3 million, although just 131 companies benefited. On an annualised basis, this year should see domestic venture capitalists divert some $400 million to more than 100 foreign companies.
In Europe, a host of changes have contributed to those increased numbers, says John DiBello, a partner and chief operating officer of Boston’s TVM Techno Venture Management, which also has offices in California and Germany.
Investment Climate
“The climate has improved on several fronts”, he says. “When we started doing deals in the mid-’80s, our key competition was the German banks.” Those banks would extend loans to the same early-stage high-tech companies TVM sought, and, rather than give up equity to TVM, young companies preferred the loans. “Then there was the recession, and the banks pulled back”, John DiBello says. “That worked for us.” Besides a more receptive attitude toward private equity, investors in European companies also will find management talent more willing these days to join emerging companies, tax structures that in some cases can be very favorable to US investors and certain government loan programmes designed to stimulate investment in start-up or early-stage businesses.
In Germany, for example, the government has matching long-term, low interest loan and grant programs offered only to companies that are backed by venture firms, John DiBello says.
New sources of financing also have emerged recently, including a high-yield debt market that, despite its recent tremble, still is part of an overall trend toward more friendly financing options. “Europeans have become more used to high-yield debt; European investors had been more bond investors than equity investors anyway”, Clive Sherling says. “But, similarly, banks have grown used to the idea of recapping transactions to enable exits, something you didn’t see before.” For the US private equity firm, many of these changes have brought the European model of private equity investing closer to the US model – and that means the US firm can compete. “At the very large end, the KKRs and Blackstones and Carlyles can compete in Europe against the CVCs, Cinvens and Doughty Hansons on relatively level terms because everything’s done the Anglo-Saxon way”, Clive Sherling says. “And the small marketplace is also becoming a high-profile marketplace, and one where US venture capitalists can also compete.” And while there’s more local capital available for European investment than there has been in the past, there hasn’t necessarily been a build-up of firms elbowing to the front of every deal.
“Four to five years ago, US firms were not really interested in investing in European companies”, says Christopher Spray, a general partner at Boston’s Atlas Venture. The firm also has offices in the UK, the Netherlands, Germany and France. “And for the most part they still want to do it in syndication with a partner. But while there’s more money available for technology investing in Europe, there are not many technology-dedicated firms that have tried to replicate the US model in Europe.”
Deal Pricing Still Lower
For those US firms that are eyeing Europe, the reward can be summed up in lower pricing. Sources comparing a hypothetical US company with a similar UK company peg the transaction price to be some 50% to 70% less for the UK example. And for a comparable Continental European company, the discount would be even greater.
“We could see the same company in Europe at two to three times less for an early-stage investment”, says Vincent Worms, founder and general partner of San Francisco-based Partech International, which also has offices in Tokyo and Paris. “Especially if it’s a Silicon Valley, Internet-type investment; prices are very inflated here.” Much of the discount, Vincent Worms notes, is tied to the increased company/product risk faced by European companies. Not only do these companies have to succeed locally, but they also have to achieve a profitable migration to the US, he says. “For a US company to open a subsidiary in the UK or Europe is not that difficult, but it is the other way around”, Vincent Worms says.
“There’s one level of risk more for a European company, and that’s reflected in the transaction cost.” Other sources, however, name other risks that are reflected in lower pricing, such as a sense that these companies are further away from exit possibilities than an American counterpart (although this is changing with the accessibility of small-cap and midcap growth-oriented stock markets such as Euro.NM and Easdaq), and the fact that, especially for start-up and early-stage companies, there are still relatively few sources of capital.
For a firm like TVM, however, which takes advantage of government matching programmes to reduce even further the amount of TVM equity that goes into a deal, the risk likewise is reduced as its equity is leveraged. “The programs allow us to be a little ahead of the game”, John DiBello says, adding that European entrepreneurs are increasingly cognizant that their financial reward will come from an exit on a stock market, not from the equity investment from the venture firm. “So we have more ability to negotiate more effectively on the valuation side.”
The Impact of the Euro
One of the most significant changes in European financial history will be the January 1 conversion to a single currency. Although some venture capitalists have hyped the notion that the conversion to the euro will create a boom of technological opportunities, much like the technologies that are being built-up around the need for Y2K compliance, most sources agree the conversion itself isn’t a business niche. The cross-border transparencies the euro will create, however, will have a significant impact on local markets.
“First of all, all exchanges will move to value their stock in euros, so you almost will have a pan-European value of stocks”, John DiBello says.
“Second, we’ll be able to measure valuations without going through the conversion gyrations.” On top of that, however, is the ground-zero impact a single currency will have on European companies with cross-border sales. Currently, international trade inside Europe is somewhat fogged by currency conversion, sources say. Once consumers buy and sell goods in the same currency, however, there will be a bit of a fall-out for some manufacturers.
“The differential price on a car is 20% between Belgium and England, and that’s not going to work anymore”, Clive Sherling says. “Why would someone be willing to pay 20% more for the same car?” In addition, new businesses will emerge – it will be much easier to sell, say, financial goods across a continent united under a single currency – and others will disappear – exchange conversion companies, for example.
Venture capital investing, however, will not change because of the advent of the euro. “Deal structures are dictated by local country legal issues, not by currency issues”, John DiBello says.
Syndication Is for Strategy, Not Equity
When domestic venture capitalists look for deals in Europe, they have to know what they’re bringing to the table, sources say. Equity is plentiful all round these days; what’s still in demand is the strategic exposure to the US consumer and financial markets that a US private equity firm can bring.
For the US firm not willing to open an office in Munich, the only way to get a piece of a European deal is through being an equity partner, and that usually won’t happen at the start-up or early-stage level, when the company prefers a local partner. More transactions with US partners, therefore, are often for follow-on rounds when the company has reached a certain size.
That might not be so bad, considering historic returns have been higher the further along a company lies on the maturation scale. According to the 1998 investment survey published by the European Venture Capital Association, later-stage/development investments over a 10-year period posted 7.9% net annual returns as of December 31, 1996; comparatively, early-stage investments posted returns of 6.5%. Three-year returns were 15.8% and 16.4%, respectively.
At the more evolved stages, however, there is less syndication than in prior years, due mostly to the large amounts of equity that have been raised locally in European countries and to increased competition, although competition is not as intense as in the US. “The UK used to be the bastion of the syndication market, and there’s less going on”, says Doug Brown, president and chief executive of Advent International in Boston. “We don’t need to syndicate; deal possession is nine-tenths of the law, and you’re not going to give that up. When you’re Gordon Bonnyman [of Charterhouse Development Capital], and you’re sitting on a billion-plus of new money and haven’t done deals in the last year, you’re not going to bring in someone else’s money.” In 1993, just 39% of European private equity deals were done without syndication; last year, that percentage jumped to 72.9%, according to the association. Of the syndications that did transpire, 16.8% included transnational partners in 1993, but just 8% did in 1997.
On the early-stage side, however, there may be more opportunities, although the early-stage experience has not been a very good one. “It’s a very difficult area to manage”, John DiBello says. “We started in 1984 in Germany with about 20 other firms. We’re the only firm left from that vintage, although there are some new ones now.”
Finding and Closing Deals
When it comes to finding companies to back, the best question to answer, sources say, is, “Is this business competing on an international basis, not just in the local marketplace?” “What we try to do is set the same standards as for deals in the US”, Christopher Spray says. “We’re looking for best of breed’ technology on a worldwide basis, and we use partners in different offices to confirm that a technological approach is better than what we see elsewhere.” Admitting that it’s not easy to build a transatlantic business is a first step toward a success story, and resisting the urge to step outside of one’s own area of expertise is a second.
TVM, which has built its European reputation in Germany, for the most part stays within those linguistic borders when it searches for outstanding technology and stellar management teams. “We do not lead deals outside the German-speaking world”, John DiBello says. “We’ll do deals in the UK, France and the Netherlands, but we won’t lead them. Unless you have people there, you’re not going to understand the deal.” In addition, US venture capitalists need to find internationally minded entrepreneurs in order to have a successful deal. “You have to have people on the ground”, Clive Sherling says. “In Europe, more people don’t speak English, and there are the culture, tax and legal systems to deal with.” However, he adds, in certain industries, such as high-tech, entrepreneurs in general already tend to be more internationally oriented. “The technology is universal, and what US venture capitalists suggest they offer is access to the US market”, he says.
As Atlas Venture pondered investing in Spot Fire, a bioinfomatics company founded in Sweden, the fact that the founder had stayed in the US during his postgraduate work and was “US-centric” was a plus, Christopher Spray says. Now the research and development group is still based in Sweden, but the senior management team, including a chief operating officer and vice president of sales recruited from Britain, is in Boston. What Spot Fire needed, and was able to realise because of the global mindset of its founder, was an initial sales push into the US market following local success. “It’s typical for a company to address the smallish home market first, go to the US and then go back and fill out Europe”, Christopher Spray says. “But it takes an international mentality to do that.” At the same time, many entrepreneurs are very unsophisticated by US standards and approach venture capital firms with little besides an understanding that the US venture firm can provide a strategic alliance. “They can be a little naive”, Vincent Worms says. “They’ll come to us for funding without the necessary infrastructures to get it.” When scouting for European deals, S.R. One Ltd. in Wayne, Pa., hits some directly, but often relies on another sourcing technique. “We also take positions as a limited in some funds, and we’ve done that purposely in Europe for coverage – it’s a great approach”, says Brenda Gavin, a vice president.
“These aren’t huge positions, because being a limited is not our business, but in addition to co-investing on deals, we get some referrals.” S.R. One has invested in funds run by Sofinnova in France, Abingworth Management in England and Isratech in Israel for the purpose of sourcing deals.
Achieving Liquidity
One significant change in the European deal arena that bodes well for investment by US firms has been the acceptance and growth of public markets. There are now some 33 local stock markets, many of which, including Le Nouveau Marche and Neuer Markt, may end the year higher than when they started.
In particular, the viability of some of the new stock markets, such as Easdaq and Euro.NM, that are focused on small- to mid-size high-growth companies has been a boon to venture capital firms, especially those that specialise in early-stage high-tech transactions.
“When we started out in 1990, very few, if any, tech companies had gone public”, Christopher Spray says. “There were very few investment bankers who understood these companies, and our only route was to take them public on Nasdaq.” There has been, however, a sea change in the perception of these companies as European investors move toward a greater comfort level with equity. Investment banks, including Morgan Stanley, BT Alex. Brown and BancAmerica Robertson Stephens, are building their presence in Europe as part of their conquests to become global players, sources say.
“Now we appoint the banks first and the exchange for the float second”, Christopher Spray says, adding that listing in the US, in Europe, or both, are strategic options now available to his European portfolio companies. “Just several years ago, we couldn’t even go public in Europe and get a competitive valuation.” Some of these stock markets have also loosened their requirements on the number of years a listed company is in operation and is profitable in order to accommodate those industries, such as high-tech and biotech, that might not fit the plain vanilla manufacturing mold.
In addition, there is some movement within these stock markets. Four of the most successful small-cap and midcap growth markets – Le Nouveau Marche in France, Neuer Markt in Germany, Euro.NM in Belgium and NMAX in the Netherlands – are becoming competitive with Easdaq by combining their trading systems into a single point of access for market information and trading across the entire network.
“Whether Easdaq becomes stronger or the alliance becomes stronger, it’s all good news to us”, John DiBello says. “We had no liquidity options before.”
Some Industries Translate Well …
In general, some European investments will “translate” better for US Venture capitalists, specifically those in sectors that have applicability overseas, including telecom services, software and medical technologies. Investing in these kinds of companies can have immediate benefits to a domestic VC’s other portfolio companies; by having access to German pharmaceutical companies, for example, John DiBello says the firm’s US portfolio companies have help with clinical trials. “These are done under FDA standards, but [they are done] in Germany, where it can be a little easier”, he says.
In life sciences, the market has matured in the last two to three years – in 1996, private equity firms invested ecu 423.9 million through 595 biotechnology and medical/health-related investments, while last year the dollar value jumped to ecu 665.8 million through 660 investments – and sources report the quality of deal and infrastructure is comparable to the US “Financing for life sciences is now more friendly in Europe than in the US”, Christopher Spray says. “Local governments have been pushing public policy initiatives to stimulate growth in biotechnology.” At the same time, venture capitalists have opportunities to work with academic institutions and pharmaceutical companies to spin-out opportunities, he says.
On the IT front, there still is a higher level of activity in the US than in Europe, and while there are two large concentrations of IT activity in the US, the key technology centers are numerous, but smaller and more geographically diverse.
… While Some Deal Structures Don’t
And finally, the US venture capital industry needs to understand the structure of non-US deals.
When Advent invested in InfoGenie, a Dutch software firm, with a West Coast venture capital firm Doug Brown declined to name, the alliance turned out to be less than desirable. “They didn’t understand any of the tax and legal ramifications of investing in a Dutch company”, Doug Brown says. “There are things you can’t do. In some countries, convertible preferred stock is not just [uncommon], it’s not even legal.” Aside from deal structures, US firms often battle with non-US entrepreneurs or business owners over controls and covenants in a way that is unusual for Europeans. “A West Coast venture capitalist is going to make certain assumptions about what the company has to come to him for approval, things like budget, capital expenditures and acquisitions”, Doug Brown says. “When you get to Europe and start talking, especially to family-controlled companies, they get that long list of covenants and controls, and it can really scare them off. Protecting your interest is sometimes a bit more delicate.”
If you do not receive this within five minutes, please try and sign in again. If the problem persists, please
email: