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Private equity overview - Sweden 2000

Sweden's private equity market has undergone a period of strong growth over the past few years – the number of investors and the amount of funds raised have both grown significantly. The Swedish market continues to mature as demonstrated by more early-stage investment and more precise industry focus. EVCA details the trends of the last year in this overview.

Sweden has seen a tremendous growth in the private equity market during the past few years in terms of both the number of investors and funds raised. This growth has resulted in an increase in the number of members of the Swedish Venture Capital Association from 55 in 1998 to 150 in 2000.

The Swedish private equity market is maturing visibly, demonstrating more precise roles in terms of stage of investment and industry focus along with increased investment in earlier stages. Part of this process of maturation is demonstrated by increased syndication, which still, however, is very low from an international perspective. Ever-increasing globalisation, along with intensified risk-reduction is likely to further fuel this trend.

Corporate venturers continue to strengthen their role and are seen as a favoured co-investor by their financial counterparts. Most corporate venturers do not have closed-end funds, which have traditionally been, and still are, the most common form of fund.

The government also continues to play an important, but diminished role in private industry initiatives and still provides a substantial amount of risk loans as an alternative to equity. Government initiatives have traditionally been a source of funding for seed ventures - an area where private equity houses have tended to be relatively cautious.

Over time, the number of investments outside Scandinavia has increased. Market players have, to a large extent, chosen to liase with foreign players in order to increase their global presence and create a knowledge base for the international expansion of their Swedish portfolio companies.

Foreign investors are increasingly active in Sweden, in most cases through co-investments with Swedish investors. Observation reveals that foreign investors have recently focused on start-ups and IT-related companies. The emergence of innovative IT companies following the lead of technology successes like Ericsson and combined with a global investor focus on mobile communication is one of the main explanations for this. During 2000, foreign private equity houses continued to acquire Swedish players, possibly demonstrating a movement towards consolidation in the market.

Several new market entrants such as formalised private individuals and incubators are relatively small. The majority of the new players focus on early-stage and IT-related investments with mobile communication and life sciences as particular areas of interest. Some established players have also focused in on these areas.

Following activity in this direction at the end of 2000, it is believed that market consolidation will occur, especially among newer and smaller players. This may have been stimulated by an increase in the number of write-offs during the period in question.

Sources of capital

The total amount raised in 2000 amounted to SEK30,641m, of which the largest part (76.4 per cent) was independently raised funds; 13.9 per cent originated from realised capital gains and 9.8 per cent was raised by captives. This serves to illustrate Sweden's strong tradition of independently raised funds.

Of the SEK26,392m in new funds raised, pension funds contributed 35.1 per cent, followed by insurance companies with 11.7 per cent and banks with 10.9 per cent. Corporate investors only accounted for 7.9 per cent, which represented a decline from last year's 21 .6 per cent. This can be explained principally through heavy fund raising activity by large private equity players during 2000. Contributions from private individuals increased slightly from 3.3 per cent to 6.8 per cent. Fund of funds are not yet a strong tradition in Sweden and therefore were limited to a 7.4 per cent contribution to fundraising.

European countries other than Sweden accounted for the largest part of total funds raised and amounted to SEK12,145m, equivalent to 39.6 per cent, showing a decline from last year's 52 per cent. Domestic funding fell from 47.9 per cent to 34.9 per cent. The rise of non-European funding from 0.1 per cent to 25.4 per cent is, again, a result of fund raising activity by large private equity players.

The expected allocation of funds to buy-outs grew from 19.3 per cent to 74.7 per cent at the expense of venture capital investment, which fell from 80.5 per cent to 25.0 per cent. The expected allocation to early-stage investment has dropped from 28.7 per cent to 11 .6 per cent of total funds. On a more dramatic note, expected investments in the high-tech area have fallen from 57 per cent to 17.7 per cent.

Investment patterns

During 2000, 702 investments, of which 382 were initial investments, were made in 569 companies. This is a decrease from last year's 819 total number of investments.

As in most capital markets, Sweden suffered a heavy decline in investment activity during the later part of 2000. Internet-related and pre-revenue businesses had particular difficulty in securing capital.

The amount invested, on the other hand, almost doubled from SEK11,249m to SEK19,420m. This dramatic growth can be partly explained by a few major investments by large private equity players.

Independent investors represented the majority of investments, both in number (46.5 per cent) and amount of capital (84.8 per cent). The second most active group was captives with 23.2 per cent of investments by number and nine per cent by amount. The remainder is divided between semi-captives and the public sector. Compared with 1999, independent investors have strengthened their position, whereas semi-captive and the public sector investors have diminished theirs.

Buy-outs attracted the most capital at 75.5 per cent, followed by expansion at 14.5 per cent and start-ups at 8.7 per cent. Seed companies received only 1 .2 per cent of invested capital. In terms of number of investments, start-ups took the lead with 49.7 per cent, followed by expansion at 29.0 per cent, seed at 15.2 per cent and buyouts at 5.2 per cent. Of the 702 investments, 465 were high-tech.

No syndication took place in 59.0 per cent of investments by number, which corresponded to 69.6 per cent of the capital invested. Figures for national syndication are 28.5 per cent and 9.9 per cent respectively. Only 12.5 per cent of investments were internationally syndicated and accounted for 20.5 per cent of the capital.

A trend towards internationalisation is shown in the geographic pattern of investments. However, 88.8 per cent of the investments were still made in Sweden, followed by eight per cent in Europe and 3.2 per cent in other countries. The corresponding figures for 1999 are 93 per cent, 6.7 per cent and 0.3 per cent.

Other manufacturing attracted the most capital during the year at 26.0 per cent, followed by chemicals and materials at 21.6 per cent, industrial products and services at 18.6 per cent, communications at 10.2 per cent, computer related at 7.3 per cent and medical/health related at seven per cent.

Investments by number show a different picture with computer related at 25.9 per cent, communications at 21.4 per cent, medical/health related at 12.5 per cent, industrial products and services at eight per cent, other services at 5.1 per cent and biotechnology at 4.8 per cent. These investment patterns have not changed dramatically since last year.

Legal & fiscal environment

Companies in general

· Taxation of profits follows the classical system. Profits are taxed both in the companies and on the individual level with only a small relief granted for dividends paid by small companies. Corporate income tax is 28 per cent. Individuals pay 30 per cent tax on dividends and capital gains.

· Domestic dividends paid to companies are exempt from tax, except for dividends from portfolio companies. This participation exemption can be extended to foreign dividends.

· Capital gains are taxed as company income, i.e. Sweden today does not have participation exemption on capital gains. Losses are thus deductible.

· The maximum depreciation allowance on machinery and equipment is 30 per cent on the aggregate value at the beginning of the year.

· Dividends paid to foreign owners are not subject to withholding tax.

· A lower income tax applies to foreign experts employed in Sweden during a maximum three years.

Private equity houses

· A profit periodisation reserve is allowed of up to 25 per cent to be dissolved at the latest after six years.

· Private equity houses that are granted investment company status have a favourable tax regime. Firms specialising in one or a few industrial sectors are not granted such status and thus risk triple taxation of dividends from portfolio companies.

· The present tax rules lead funds and investors to domicile their funds or companies in other European countries or offshore. This is mainly due to the lack of rules for participation exemption for capital gains.

Entrepreneurs

· Entrepreneurs owning their companies get half the capital gain received, up to SEK7m when selling shares, taxed as income rather than capital gains. These unfavourable tax rules apply also to dividends from such companies. These rules do not apply if an outside investor holds 30 per cent or more of the shares in the company.

· Stock option programmes are common. Options, also to employees, can be taxed as capital gain at 30 per cent or as income, depending on the conditions of the stock option programme. If taxed as income, companies also have to pay social security taxes of 33 per cent.

Proposed changes

· A parliamentary committee has proposed that capital gains in companies will be exempted from company tax from 2002. This will enable VC firms to reinvest capital gains without paying tax on the profit. Losses will then consequently not be deductible.

· Also proposed are CFC - (Controlled Foreign Companies) rules that will tax interest and royalties paid to companies domiciled in countries with company tax lower then 20 per cent, if the companies have an interest in each other.

Exiting

In terms of capital divested at cost, the trade sale strengthened its leading position, increasing from an amount of SEK1,148m (55.8 per cent of the total divested) in 1999 to approximately SEK2,081m (62.2 per cent of the total divested) in 2000. Divestment through public offering remained steady at 21 per cent, of which 2.8 per cent was through IPOs.

The number of divestments shows a slightly different picture with trade sales representing 35.9 per cent of the divestments made, public offerings 27 per cent and write-offs 19.7 per cent.

During 2000, some 30 companies had IPOs on the main stock markets in Sweden and the number of exits slowed during the second half of the year. The low number of IPOs and trade sales was mainly due to low valuations led by a weak stock market.

This extract is taken with kind permission from the EVCA Yearbook 2001

The European Venture Capital Association's mission is to promote globally and to facilitate the development of the European private equity and venture capital industry through active lobbying and development initiatives. It seeks to help create an entrepreneurial environment in Europe and promote European private equity and venture capital to institutional investors worldwide. For more information, please visit www.evca.com
         
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