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Venture capital and private equity in Austria

The Austrian venture capital industry is comparatively young - activity only began in 1995 - and is therefore often overlooked by investors, both institutional and VCs alike. Nikolaus Spieckermann of Invest Equity Group provides an overview of the industry and discusses some possible trends.

Venture capital and private equity in Austria

Introduction

Austria is a young venture capital market where activity started only after Austria's EU-accession in 1995. The industry has since been very dynamic, even defying the tech-slowdown in 2001. However, Austria is still below the radar-screen of many investors, institutionals and VCs alike. This article therefore intends to give an overview of the local VC industry, the economic and legal investment environment in Austria, and an outlook on possible trends. Throughout, the term VC refers to venture capital and private equity alike, unless otherwise specified. All VC industry data are EVCA figures.

The private equity and venture capital industry

Development of the industry

For a long time, Austrian firms have relied on debt as the principal source of finance. Similar to Germany, Austria is dominated by mittelstand firms with strong links to local banks, sometimes employing quasi-equity instruments (silent partnerships, profit certificates, etc). Scarcity of pure equity finance became apparent when foreign business angels and funds started doing deals in Austria before EU-accession in 1995.
Subsequently, policies designed to kick-start a domestic VC industry were implemented and successfully triggered the emergence of local players. In particular, guarantee schemes by state-owned development banks had a strong impact. From almost no players and a negligible investment volume in the early nineties, the Austrian venture capital and private equity industry grew rapidly and has proven to be very dynamic. Today, the Austrian Venture Capital and Private Equity Association (AVCO) counts 22 members, who invested a total of E54m in the first half of 2001*.

Main players

At present, the Austrian VC industry is characterised by many small funds, often domestic in outlook for both target companies and investors alike. Only a third of the players are independent or sponsored funds, targeting outside investors - the remainder either fully captive or subsidiaries of international firms. Most firms manage total volumes below E50m.

Many players now in the market emerged between 1997 and 1999. Several others followed in 2000, often targeting internet deals and some employing an incubator approach. The subsequent downturn in the industry and accompanying problems in portfolio firms suggest that consolidation is likely in the medium term.

Investment patterns

Of E454m invested in venture capital and private equity in Austria during 2000, only E144m were managed domestically. The discrepancy makes Austria the largest importer of equity investment in the EU, underlining the fundamental attractiveness of the market as an investment destination, but highlighting the limits of the domestic VC industry. Comparison with structurally similar economies such as Germany show a low relative share of equity investment in Austria, suggesting substantial growth potential for the Austrian VC industry in the medium term.

Due to limited volumes, most domestic funds target seed to expansion stage venture opportunities and small to medium buyouts - deals difficult to source and manage from abroad. Large buyouts and public-to-privates are mostly managed by pan-European houses: CVC's attempted buyout of Lenzing AG - blocked by EU competition authorities - in 2001, the acquisition of AMS by Schroder Ventures in 2000, or the delisting of KTM by BC Partners in 1999 are recent examples. This pattern is reflected in a remarkably low share of later stage deals led by domestic players: of E163m invested by Austrian funds in 2000 - including some E19m outside Austria - less than nine percent went into buyout and replacement situations. The balance was invested in early to expansion stage venture rounds.

However, although many domestic players nominally target early to expansion stages, this segment is still underserved: Capital restrictions of domestic VCs limit their ability to fund successful firms through to a profitable exit, a situation likely to be exacerbated in the present exit environment with longer holding periods. Moreover, few groups can demonstrate the international experience and network of syndication partners necessary to bring in additional resources when needed. Moreover, many early stage opportunities are technology related and few teams have the required technical skills in-house to source, evaluate and close such transactions, or to add value in company development.

Sources of capital

A total of E235m were raised for venture capital and private equity investment in 2000 of which almost half was contributed by banks into their captive vehicles. Government agencies and insurance companies were second and third largest investors in the asset class, followed by private individuals. The latter reflect the going public of several vehicles in 2000, including an incubator and a fund-of-funds, all centring around a single management company. The following correction of public markets in 2001 led to reservations of domestic investors towards the asset class in general.

Pension funds have started investing in private equity in 2000. Their contributions are likely to increase following recent regulation freeing institutional investors from the limits of day-to-day valuation requirements. However, it will take time until recently established Austrian pension funds are fully funded, develop sophisticated private equity programmes and contribute the necessary resources to them. Many are therefore likely to choose a fund-of-funds strategy to begin with.

Exiting

EVCA figures on divestments for both 2000 and the first half of 2001 are not conclusive. Numbers are small and a large proportion of repayments of subsidised mezzanine loans to public development banks distorts the picture. The general exit environment in Austria is characterised by a comparatively weak public market. The IPO potential of the Vienna stock-exchange is limited for the immediate future, in particular for dynamic growth companies. However, proximity to alternative markets such as Zurich and Frankfurt and easy access to NASDAQ Europe (formerly EASDAQ) can, to a degree, compensate for this weakness.

Trade sale potential in contrast is very good, in particular since Austria has traditionally very close links to Germany, from where many firms have been acquisitive in Austria in the recent past. The imminent accession of three of Austria's neighbours to the EU is likely to renew interest in Austria as a springboard for these markets.

Investment environment

Role of the public

The state has been, and in some areas still is, an important factor in economic and financial matters in Austria. Accession to the European Union in 1995 however opened large parts of the economy to international competition, diminishing state influence in many sectors. Ongoing privatisation programmes by successive governments - of different ideological camps - have further reduced the state quota. Today the figure is under 50 percent, below that of other EU countries such as Sweden, Denmark, or France.

In structural terms, public support to the private sector still plays an important role, also for VC investors. Credit guarantee schemes by state-owned development banks (FGG - Finanzierungsgarantie Gesellschaft, Bürges Förderungsbank etc.) allow for significant leverage potential for equity investors, often up to 50 percent or more of the initial investment. Furthermore, FGG and Bürges offer downside protection to venture capital investors, either on a deal-by-deal or a fund basis. Finally, government agencies play a role in seed finance and pre-competitive research funding, especially relevant for early stage technology opportunities.

Mittelstandsfinanzierungs AG (MFAG)

With few exceptions, most Austrian VC funds have chosen the domestic vehicle MFAG (Mittelstandsfinanzierungs Aktiengesellschaft) over the international GP-LP model. The MFAG benefits from tax exemption at source for both domestic and foreign investors - this, in combination with familiarity of domestic investors with Austrian corporate law, has contributed to the MFAG's ubiquity.

The MFAG is a joint-stock company under Austrian law, with investors in the fund becoming its shareholders. Accordingly, investors are represented on the MFAG's supervisory board and choose its directors. The fund itself is managed by a separate management company. The management company employs the management team and manages the fund according to a management contract, subject to approval by the MFAG's supervisory board. Ownership of the management company is usually in the hands of a sponsor in the case of captive funds or the partners of the firm in the case of semi-captive or independent funds.

Investment activity of the MFAG is subject to restrictions: at least 75 percent of the fund's volume have to be invested in Austria and target firms shall not exceed E220m per annum turnover at the time of investment.

Institutional investors

Few institutional investors in Austria have a dedicated private equity or venture capital programme. One reason has been the lacking legal framework encouraging pension funds - currently themselves just being fully funded - to invest in the asset class. Last autumn, the Austrian government passed a bill, part of a larger framework to reform capital markets, enabling pension funds and insurance companies to allocate up to five percent of their assets to private equity. Previous regulation had required day-to-day valuation of investments for pension funds and insurance companies, thereby complicating allocation of funds to illiquid asset classes.

Market trends and recent transactions

Venture capital

The past year was dominated by negative reports about and from the venture capital industry, both in terms of new investments and existing portfolios. The situation in Austria was not as gloomy as elsewhere in Europe: Indeed, the first half of 2001 was marked by an increase in technology investments, up 160 percent on the E11m in the first half of 2000. Not included here is the lion's share of a E27m round for biotech firm Intercell in April, led by Munich-based TVM and thus reflected in the German statistics. The subsequent E30m second round of promising cancer vaccine company Igeneon in August 2001 (led by DVCG and 3i) was one of the larger biotech deals in Europe throughout the year and will have an impact on the figures for the rest of 2001. Several smaller deals and follow-on investments were closed during the same period. On the other hand, the largest write-off in Austrian VC history also happened last year when Vienna-based CEE telecom operator Kiwwi Telecom, after having closed a E40m round in April, collapsed in November.

Looking ahead, the prospects for the immediate future are similar to the general picture in Europe: valuations have come down and, accordingly, expectations of entrepreneurs are more realistic, while the quality of deal-flow has improved, albeit at the expense of the number of projects on the market. In Austria, recent changes in R&D policy are likely to further encourage activity in early stage sectors in the short to medium term, in particular university spin-offs and other research-based ventures.

Buy-out

Buy-out activity in Austria almost fully ceased in the first half of 2001 and only slowly picked up in the second half of the year. Most players nurtured their existing portfolios, and the headline-grabber of the year - CVC's acquisition of Lenzing AG - failed regulatory approval by EU competition authorities. A new buyer has to be sought, whether it will be a private equity house is yet unclear. A novelty in Austria was the successful bid of a domestic fund in the latest privatisation tender in December 2001.

Going forward, 2002 is likely to see increased buyout activity compared to last year - whether the levels of 1998-2000 will be reached is doubtful. Particularly positive is a changing attitude of entrepreneurs towards partners, financial and strategic alike. Several factors contribute to this shift, with generational moves, successful role models and increased competition on a European level among the most prominent. Remaining sensitivities towards outside equity finance and the still prevailing importance of credit as a source of finance are therefore increasingly coming under threat, creating opportunities for strong private equity financiers.

Overall, the prospects for the Austrian venture capital and private equity market are encouraging. Due to the potential of the industry as a whole to catch up to European levels, exciting possibilities exist for those established in the market, able and willing to make use of the opportunities at hand.

* Note: ‘Funds under management' figures are not conclusive as few captive funds disclose volumes or indeed invest from their sponsor's balance sheet.

Copyright © 2002 Invest Equity Group   

Nikolaus Spieckermann is an investment analyst with INVEST EQUITY Group (www.investequity.at), an Austrian VC firm sponsored by Investkredit Bank AG, operating since 1998 and currently managing three funds. He can be reached at +43 (1) 532 0551-383 or n.spieckermann@investequity.at.