Return of an old favourite
European venture-capitalists are walking with a spring in their step for the first time in years. The industry has finally shaken off the vestiges of the dot com debacle to reach new investment heights, and cautious optimism pervades 2007's growth prospects.
There are reasons to celebrate. According to figures from Ernst & Young and VentureOne, a research firm owned by Dow Jones, venture capitalists poured €4.1bn into European companies last year. This was the highest annual amount since 2002, and slightly more than the €3.9bn raised in 2005. The major beneficiaries were technology companies, which enjoyed a 5% overall increase over 2005's investment
European investors, like their US counterparts, have become more selective. Although the money flowing to companies rose, the number of deals dropped by 27% to 867 from 1,189 in 2005. This has translated into the median deal size jumping to €2.2m, the highest yearly median since at least 1999, when VentureOne began compiling European data.
Another marked change has been the increased allocation to seed and first-round financings. These early-stage deals accounted for 40% of financing rounds in 2006, and 44% in the fourth quarter, up from just 32% in 2005. The seed and first-round deals also received a total cash injection of €1.26bn, which is the most capital directed to these early-stage deals in five years.
The revival in Europe's venture capital fortunes reflects the global trend which is expected to top the $32bn (€24.3bn) mark in 2006. Overall, IT won back a place in investors' hearts, ranking as the hottest sector. IT captured about 56% of global investment in the first three quarters of 2006, while healthcare companies grabbed 29.5% of the pot.
Although the industry was slowly recovering from the ravages of the TMT crash, the turning point came in 2005 when trade buyers as well as public markets welcomed venture backed companies. The European initial public offering market was particularly buoyant, overtaking its US counterparts, although the sums raised were smaller.
VentureOne reported that the region boasted a record 60 IPOs, raising €2.03bn in 2005. This was not only more IPOs than the US for the first time since 2001 but also the most European IPOs in a single year since 2000.
The pace gathered momentum in 2006. The first three quarters of last year witnessed 56 European venture-backed IPOs, raising around $1.2bn compared with 37 US IPOs worth around $2.47bn. Overall, about one third of firms made their debut on the stock market while two thirds exited via an M&A route.
A new era has dawned particularly for consumer internet, thanksmainly to headline-grabbing deals such as the €2.6bn sale of Skype Technology, the Luxembourg-based internet telephony company, to eBay and Google's $1.65bn acquisition of YouTube, a video sharing website. Investors gained a new confidence
as the purchases were all made by existing internet or media companies endowed with substantial
revenues and cash reserves. Google, for example, is sitting on a $9.8bn cash pile.
Patrick Sheehan, venture capital committee chairman of the European Venture Capital Association also believes 2006 was the best year the industry has had since the crash. "There have been a number of factors contributing to this," he says. "One is the European IPO market has become competitive with North America. Europe is also benefiting from globalisation as venture capitalists are looking outside their home markets for opportunities. The success of Skype is a reflection of this. Moreover, as so much money is going into buyouts, private equity investors are looking at smaller companies for diversification."
Despite the impressive figures, the activity is nowhere near the boom times of the late 1990s when the market routinely saw over 200 IPOs per year, with annual proceeds often exceeding $10bn. Data from Thomson Financial reveals that venture-backed IPOs currently represent 1.6% of all debut offerings, a drop in the ocean compared with 11.7% in 1999 and 8.5% in 1992.
However, industry participants have no desire to turn back the clock. The industry that has emerged from the 2000 crash is not just leaner, but older and wiser. As Gil Forer, global director of Ernst & Young's venture capital unit, says: "In 2006, we put the bubble behind us and moved to a new cycle of growth. The industry has matured and venture capitalists conduct much more rigorous due diligence before investing. Investors are looking for solutions to painful problems and for products or services that have substantial markets that can create the next market leaders."
According to Gregoire Revenu, co-founder and managing director of Bryan, Garnier & Co's corporate finance activities: "What we are seeing today is the best venture-backed companies from the early 2000 period either coming to the market or being sold. Venture capitalists had cleaned out their portfolios and the companies left were of the highest quality which enabled them to survive a difficult period. At the same time, these firms strongly benefited from equity markets that were overflowing with liquidity. "
Equally important for the industry is the feasibility and potential of the internet. It is no longer a pipedream. Analysts do not have to be creative in their projections because these firms have actual and not virtual customers. For example, according to a report from comScore Networks, a web measurement firm, in January 2007, Skype had 24.1m unique users, while YouTube boasted 100m video downloads a day, and 133.5m unique viewers. MySpace, on the other hand had 94.8m unique viewers, and these are mainly young people, a group that the traditional media has found difficult to reach.
Broadband penetration is also growing, particularly in Europe, and there are enough seasoned internet veterans who know how to navigate their way through the opportunities.
For example, Janus Friis and Niklas Zennström, who founded Skype, are hoping to work their magic in television. They are ploughing the proceeds from the sale into a global broadband television service which promises viewers, content owners and advertisers "the best of the internet with the best of TV".
Given the long lead times and intensive research and development spend, life sciences have been a harder sell. However, the market has improved in the past year, prompting Abingworth, a 33-year-old venture capital firm, to raise $300m for its eighth and Europe's largest heathcare fund.
It aims to invest invest between €11.3m and €30m in biotechnology and medical companies both in Europe and the US.
Stephen Bunting, managing director of Abingworth, says: "It is predicted that up to $80bn a year of drugs will be off patent by the end of 2009 which means that companies are becoming more visionary and looking at more products, technologies and opportunities. We are also seeing more acquisitions of smaller companies such as PowderMed, which was one of our investments being sold to Pfizer."
The healthcare venture capital industry has also seen the £230m sale of antibody manufacturer Domantis as well as the reverse merger of UK-based biotechnology firm Solexa into Nasdaq-listed Lynx Therapeutics. The company was sold to Illumina for $600m in 2006.