Why venture capital is going high tech in Europe
10/01/1999
A key factor in the race to increasing export markets in recent years has been the emergence of advanced technologies, often from innovative new companies, which rapidly escalate the growth of new industry. Until recently, however, there have been very few high-tech start-ups in Europe. In the US, by contrast, the emphasis on technology has played a significant role in fueling the economic engine, as evidenced by the $11.4 billion invested by the US venture capital (VC) industry in the first half of this year alone.
Now the European tortoise is showing signs of catching up. As a unified Europe takes shape, it is becoming a stronger trading entity, poised to challenge its American rival for international business. The European VC industry has begun to recognize the significance to the economy of investing in new businesses and new technology. Traditionally, our capital markets tended to shy away from start-ups and young companies.
The roots of this reluctance lie in the conservatism that has always been a pillar of European society. After the ravages of World War II, limited credit lines were the only accepted method of doing business. Money was basically lent only to those who already had it (in most circles, this is still true today). As a result, all innovation was channeled through large corporations, and the best and brightest graduates aspired to work for those industry giants. Anyone with the "radical" notion of going it alone either moved offshore or lived with the stigma of being labeled a misfit. The prospects of limited financial resources and the fear of failure in an extremely hierarchical society proved too much for most entrepreneurial individuals.
Today, however, not only is the European financial community starting to recognize the importance of venture capital, but so are governments, universities and society at large. How has this come about?
For a start, Europe has reached a level of comfortable affluence. Many individuals are in a position of inheriting sizable sums, and the idea of gaining only 3-4% annual interest is not appealing. Thus, venture capital funds are swelling with cash in many countries. The problem is not the availability of capital, but rather where to spend it! In 1998, the VC market in Europe was about $US14.4 billion, up nearly 50% from the previous year, with the UK accounting for almost half of that figure.
The fear of failure, one of the biggest handicaps to entrepreneurial advancement everywhere, but even more so in Europe, is also diminishing. Many new graduates are faced with limited prospects in the normal corporate environment. Yet, they are expecting more than their parents, and have seen many success stories in the US. Growing confidence that it is possible to make it on one's own, coupled with the limitations of innovating and advancing in large corporations, has given many individuals the courage to take the plunge.
In parallel, cash-strapped governments are now more closely scrutinizing European research and educational institutions, among the best in the world. These institutions must now capitalize on their research in order to justify their existence, and some are collaborating with VCs to do just that. Therefore, it is no surprise that many new funds are establishing themselves in close proximity to areas such as Cambridge, Berlin, Leuven, or Grenoble in order to establish a steady stream of ideas and talent.
The prospects of Pan European trading in young dy namic companies, through such venues as the EASDAQ or the Nouveau Marche, has also captivated the imagination of investors and entrepreneurs alike. Individual investors can now personally participate in trading of stock in tomorrow's rising stars, adding more visibility to the entrepreneurs responsible for the company's share price.
Europe's chronically high unemployment rate is another reason for governments to take a closer look at the maze of red tape normally associated with establishing a company. It is clear that among other metrics, venture-backed companies create jobs much faster than established corporations. From 1994-1998, the number of people employed by this sector increased by 24%/year against a national growth rate of 1.3% in the UK.
This is not to say that sourcing European venture capital is as easy as presenting your business plan. As a semiconductor assembly and test foundry now located in Belgium, CS2 required significant start-up capital to develop the necessary manufacturing infrastructure and technology. Since first funding 15 months ago, the company has tripled the initial capital investment, employs more than 100 people, has developed leading-edge packaging technology, and is plotting a path toward an IPO.
As seed funding escalates, one concern is that the size of a project relative to the targeted fund needs to be in sync. If the project is insignificant in the overall portfolio, the company may not get the attention it needs from investors when it becomes vital. Conversely, if the start-up team convinces the VCs to invest beyond their normal limits, so much sensitivity may be created that, at the first sign of trouble, the company may become micro-managed, an unwelcome prospect for any entrepreneur.
Despite the recent explosion in the number of European VC funds, the investment community is still quite small and fairly tight-fisted toward green-field operations and first-time funding. In this situation, a management buy-out or an experienced partner can prove an asset. However, once someone on your team has a track record, money is quite easy to come by, particularly in today's environment.
That is not to say that the environment is as good as it could be. Membership of the European Private Equity and Venture Capital Association has grown from 43 members in 1983 to over 410 today, but more than half of all investments still relate to expansion finance as opposed to start-up capital. And although the amount invested in technology sectors has increased dramatically in recent years, it still accounts for less than 25% of the total amount invested.
But still, the trend is beginning to look positive for European high-tech start-ups. With a cumulative net return/year to the investment community of close to 20%, Europe should witness significant and continuing growth in technology-based start-ups.
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Steve Lerner is the CEO of Custom Silicon Configuration Services (CS2), Hermesstraat 2a, B-1930 Zaventem, Belgium; e-mail [email protected].