Fading light

When Nordic Venture Partners (NVP) invested in mobile address book business Zyb in 2006, it knew it was on to a good thing. The company was becoming the preferred back-up system in the industry and was adding social components to its offering. Over the next one and a half years, the company developed into the market leader and built a strong global user-base. NVP invested a total of DKK37m (€5m) over the period.

Earlier this year, NVP sold the business to Vodafone for DKK235m, netting NVP a very tidy 209% IRR.

It’s precisely this type of success story that the Nordic venture capital community needs right now. Local limited partners, which until recently had been investing strongly in local VC teams, have become much more reticent about committing to venture funds overall in the absence of the kinds risk-adjusted returns they were seeking.

“The Nordic VC market had been one of the most buoyant in Europe, supported by a stable local investor base,” says Ulrich Grabenwarter, head of equity fund investments at the European Investment Fund. “This had kept it apart from the rest of Europe, where funding was harder to come by. Now – with the exception of a few – local LPs aren’t investing as much in VC funds and so we’ve seen a widespread consolidation in the market as some firms have been unable to raise successor funds.”

Such exceptions include Sunstone Capital Partners, a spin-out from Danish Government-backed investment fund Vaekstfonden, which reached a €180m second closing on its second fund in the summer, with commitments almost entirely from local investors such as Tryg i Danmark, Nordea Liv & Pension and Industriens Pension. Creandum also managed to reach a final close recently on SEK750m (€80m) with Skandia Liv and AP6 as cornerstone investors.

Creandum managing general partner Staffan Helgesson puts the firm’s success at least partly down to the way it went about fundraising. “We took a slightly different approach to fundraising from many other VCs,” he says. “We identified a small number – 25 – that we believed had a strong chance of investing in our fund and we spoke to them. In the end, we got just below 10 of them to invest, mainly from the Nordic region. We want to increase our investor base over time, so that in the next fund we have more investors from other parts of Europe and for the fund after that bring in US investors.”

But there is no doubt that it’s a tough market, he says: “There is little interest in the sector among LPs as they have sought to gain access to the fantastic returns generated by buyout houses over recent times.”

Vicious circle

Even those LPs that are interested want to see more proof of success before they will commit. “At least half of the Nordic VC population is either contemplating a fundraising or is out on the road,” says Christian Motzfeldt, CEO of Vaekstfonden. “Many of them have approached existing investors, but they have been told that they need a better track record before they will receive commitments.”

NorthCap Partners is currently on the market and, says managing partner Thomas Weilby Knudsen, it is having to take a pragmatic approach. “Ideally, we’d have liked to double the €140m we have under management, but we’ve taken the view that this is unrealistic in the current environment,” he says. “We know several players that have put their fundraising on hold because conditions are so tough.” Instead, the firm is looking to raise around €100m and will be out on the road again sooner than planned.

The problem, of course, is that without further capital, many firms in the region are unable to exit successfully as their investee companies need more money for growth. “A lot of funds are hitting the ceiling of what they can invest in their portfolio,” says Knudsen. “They need more capital to reach liquidity.” And without the returns, they are unable to raise further capital from LPs, who are more inclined to invest in better capitalised and more experienced US and international VC funds. It’s a classic vicious circle.

Indeed, one of the biggest success stories to come out of the region in recent times was an investment made by international players including Index Ventures and Balderton Capital. Having raised just US$39m in venture capital since its first round in 2003, Swedish open source database company MySQL was sold at the tail-end of last year to Sun Microsystems for a cool US$1bn.

These are the kind of numbers that Nordic VCs can only dream about. “Swedish VCs are just as capable as international investors,” says Knudsen. “But their current fund sizes mean that they simply have to exit much sooner than US VCs. They don’t have the funds to make enough follow-on investments to build a company the size of MySQL. The market is still too immature in terms of fund size and track record. I doubt that I’d find any VC in the region that would turn down an exit at an earlier point in their portfolio companies’ development if it meant they were going to get a decent return.”

Early stage scarcity

In addition to stunting the growth of companies and preventing the kinds of home runs US VCs expect to find in their portfolios, the lack of capital has caused wide-ranging consolidation of funds, particularly in the early stage arena. “Early stage is not a very competitive area here,” says Helgesson. “There are now only four or five firms that invest in the space. Before, there were too many – there were between 25 and 30 active firms overall.”

Many of those that have managed to raise funds have found they have had to shift strategy. As with other parts of Europe, most VC funds in the Nordic region now invest much more in later stage opportunities than they used to. “There has been a general move in the region towards later stage investments and expansion capital,” says Grabenwarter. “Some of the funds that have been successful in fundraising have had to move to later stages in order for them to deploy capital.”

Yet it’s more than just a question of deploying capital. Many feel the only way they can generate attractive returns as well as build a good track record is through making later stage investments. Creandum is one example. “Our strategy is to invest roughly 50/50 in classical early stage opportunities and later stage or early expansion,” says Helgesson. “We feel this makes sense because it provides the upside potential from the early stage deals and portfolio diversification through the later stage investments. This approach appears to be appreciated by LPs.”

It’s also a strategy employed by InnovationsKapital. “We are an early stage fund,” says the firm’s managing investment director Staffan Ingeborn. “But we have to balance the risk and make money sooner and so we do later stage investments as well.” One of these is its recent investment, alongside CapMan, in IT consultancy group Crayon. Founded in 2002, the company now has net sales of nearly €50m. “We looked at the business around 18 months ago,” says Ingeborn. “But we felt they had a very enthusiastic business plan. In fact, they ended up exceeding their plan and their revenue growth is now running at about 100% a year. It now has a very strong market position in Norway and Sweden and there is scope to extend into new geographies.”

Ingeborn admits that his firm is far from alone in seeking to invest in more established companies. “Everyone is now looking at later stage investments,” he says. “They are looking for businesses with traction. It has been difficult for many firms to show good results with early stage investments and so they and their LPs have become more risk-averse.”


Yet a focus on later stage companies has not been the only reason for the not-so-stellar performance of many of the region’s VC firms. Some observers point to the fact that they have been too parochial and not ambitious enough in their vision for portfolio companies. “One of the main problems in Scandinavia has been that, while firms have generally been good at identifying good technology, their focus has been on building regional players,” says Grabenwarter. “This hasn’t been enough to generate the kinds of returns LPs expect from VC.”

But there are signs that this is changing. “There is now a realisation among many of the players that they have to create international companies,” says Grabenwarter. “They are adding a new spin to their investment themes.”

For NorthCap, this means getting US buyers interested. “We invest strongly in software and the main exit market is therefore US companies,” says Knudsen. “Over the last few years, we have developed a strategy of structuring businesses for the US market and making sure our companies have a strong visibility in the US.” As an example of the strategy in practice he points to last year’s sale of Copenhagen-based web analytics business Instadia by NorthCap predecessor fund IVS, to the US software company Omniture.

Helgesson agrees that thinking beyond the region is essential to success. “We strongly believe that you have to bring businesses onto the international stage at an early point in their development,” he says. “That is how you create the big winners. Yet there are still some investors that think this is too risky a strategy and are willing to build regional companies and accept lower returns.” Creandum’s recent investment in online video advertising start-up VideoPlaza demonstrates his thinking. “With VideoPlaza, our aim is to take the company to the major European markets and first the UK,” says Helgesson. “It would do OK in the Nordic region, but the UK is where the really big European market is. It is such a big factor in the European media market, we can’t ignore it.”

And when NVP sold Zyb to Vodafone, the firm was keen to stress the importance of expansion outside the region. In addition to its Copenhagen headquarters, the company had offices in Cambridge and London and it had concentrated on building a user-base globally. “This demonstrates the potential of creating big successes in the Nordic region if the will to think big is present,” NVP managing partner Henrik Albertson was quoted as saying. The firm’s investment in Sanako earlier this year also demonstrates the firm’s ambitions outside the region. The €5m round in the language learning technology business will be used to help Sanako expand into key markets including Brazil, Russia, India and China.

Even government-backed organisations are starting to understand the importance of thinking beyond home territory. Sitra, Finland’s Innovation Fund, changed its venture capital investment approach in 2005. “Instead of investing in early stage companies primarily in Finland, we are focusing our investments into selected programme areas,” explains Pauli Marttila, director, Sitra Ventures. “These investments may also expand to later stage and into international deals.”

Public to private

Other countries are overhauling their seed investment programmes, with some essentially privatising them. In Denmark, the state has reorganised its funding for early stage businesses by co-investing with private sector limited partners in seed funds.

Established in 2004, Seed Capital Denmark is the country’s largest seed investor and has attracted DKK530m in funding, alongside capital from state-backed organisations, from private sector investors such as Carlsberg, Nordea Liv & Pension and Danske Bank.

There are now plans to set up a similar scheme in Norway through which the government provides loans to seed funds. Early stage VC Alliance Venture has already raised a fund, Alliance Venture Polaris, with help from the state as well as commitments from LPs such as Borgen Investment Group and Kistefos.

It’s a move welcomed by some observers. “The approach of privatising seed funds is a good one – it brings them closer to market reasoning and it means deals will be shaped closer to market dynamics,” says EIF’s Grabenwarter. “It will also mean that commercial money will no longer be crowded out.” Although there are potential problems, he says: “The issue with these seed funds is that they need a certain critical mass to be successful. In Denmark, we saw a consolidation of seed funds. It brought together funds that were just about viable with some that were not, resulting in funds with critical size. I hope we will see a similar process in Norway.”

More commercial use of government funds may go some way to helping foster a more healthy venture capital investment environment, but ultimately, Nordic funds are going to have to start showing excellent performance if they are to survive. “The main challenge for the region’s VCs is the need to demonstrate that they can generate risk-commensurate returns,” says Grabenwarter. “Only then will they be taken seriously. Soon, they will be facing a fundraising environment where it won’t just be US versus European venture; it will be US and Asia versus Europe.”

And how can they do that? “Fund managers will need to be either more defensive by investing in later stages or to have sufficiently large funds to adequately diversify,” Grabenwarter adds. “At the same time they’ll need the courage to concentrate resources on value drivers and defend their stakes right through to exit rather than seeing them diluted in over-syndicated deals.”