PRINT THIS PAGE LPs slightly more optimistic about European early stage investing28/11/2007. Source: AltAssets. 
European limited partners are showing a bit more of an interest in the European venture capital market again, according to the EVCA study entitled The European Venture Capital Market: Scaling Beyond Current Boundaries, undertaken by the Private Equity Institute of London Business School and the Center for Entrepreneurial and Financial Studies (CEFS) of Technische Universität München. The European venture capital industry is still recovering from the effects of the dotcom crash which left the majority of LPs with little or no confidence in this segment. During the dotcom boom many GPs entered the market without the necessary investment skills and/or industry knowledge and experience.
While the surveyed LPs from Benelux, France, Germany, Switzerland and the UK - all active investors in European venture capital funds - stated that their view on European venture was still somewhere between 'neutral' and 'marginally negative', they said they felt encouraged by an increasing number of high quality investment opportunities and the improving exit environment.
According to data compiled by EVCA, Thomson Financial and PricewaterhouseCoopers, LP investments into European funds with a focus on early stage venture capital and/or expansion/development capital went up to €17.5bn in 2006 from €10.9bn in 2005.
While this could be the start of a positive development, venture experts warn that the enthusiasm comes too early and is exaggerated. Adjunct Professor Dr Martin Haemmig, a recognised researcher and lecturer at 15 high profile universities in the United States, Europe and Asia and a 3i venture advisory board member, said, 'If you look at venture capital, using the US NVCA definition - ignoring growth capital - European VC investment reached just about €4.1bn (according to both Ernst & Young/Dow Jones VentureOne; and Thomson Venture Economics). US VC investment levels were reported in the range of $25-26bn (€20-20.6bn). In other words, the 'real' European VC investment volume is about five times smaller than in the US, when using the exact same database search criteria on both sides of the Atlantic. The same ratio holds true for venture capital fundraising.'
Attracting LPs
Venture capital firms have told EVCA that it continues to be difficult for many of them to raise new funds, despite their track records and a significant number of promising deals in the pipeline.
'LPs shied away from high risk investments in Europe. The results do not show marked improvements from the EVCA 2006 survey, where 81 per cent and 36 per cent of LPs interviewed respectively suggested that weak performance and bad experience in the bubble were primary reasons for their hesitance to invest in this sector,' it says in the report.
EVCA also found that most LPs say that out of the over 300 venture capitalists in Europe fewer than 100 meet their criteria.
In addition to that, legal requirements in some European countries make it hard or impossible for certain types of LPs, such as pension funds or insurance companies, to invest in venture capital.
Professor Gerard George, Tanaka Business School, Imperial College London, and previously London Business School, commented, 'There are fewer large LPs in Europe than in the US, which makes it much more difficult for VCs to raise funds. Though the past investment returns have not been stellar, European VC is beginning to show favourable signs as an asset class. The optimism stems from reasonable entry valuations and a solid pipeline of growth opportunities.'
John Holloway, director, investments, at the European Investment Fund, a major investor in European venture capital funds, said, 'LPs still have a headache left over from the crash nearly eight years ago and European VC is still not back in people's thoughts. This should not really be a surprise because if you look at the returns achieved over the past ten years, they have not been stellar. However, we are finding it a bit easier year on year to find investors who are happy to invest alongside us in some of the best managers and some promising emerging managers.' The EIF's mandate is to provide the European SME sector with financing for growth. EIF is majority-owned by the European Investment Bank, with the European Commission also holding a significant stake in the fund.
Europe versus the US
Compared to the US, venture capital investing through venture capital funds is still a relatively young business in Europe, especially if you exclude the UK and look at Continental Europe only. In Europe, median deal sizes are still small. Professor Dr Haemmig explained, 'Between 2001 and 2006 the annual median investment size per company across the different round classes (seed, first, second later rounds) and across industry sectors is about two to five times smaller in Europe than in the US.' He added, 'The fact that European VC funds are much smaller than their American counterparts represents a challenge for the larger limited partners because less capital per fund can be invested. The top quartile VC firms in Europe should raise some larger funds to build bigger and globally more competitive companies. If each fund manages to hit some more home-runs, this could mark the necessary breakthrough. The exits cash multiples on M&A and IPO are as good as in the US over the last three to four years, however, the absolute exits amounts are much smaller.'
A number of factors have recently led LPs to take another look at European venture. These factors have included: some success stories in the European venture space (such as Skype), more visible track records of venture capital investment professionals, but also access issues and lower return expectations in the buy-out business, especially at the larger end, which makes LPs look elsewhere for higher returns.
Major venture capital firms recently said at a meeting with EVCA representatives that within a few years access is likely to become an issue for LPs interested in European venture funds. As Professor Dr Haemmig puts it, 'Many LPs may figure out too late that Europe will be one of the few major resorts left outside of the US for meaningful investments once the Chinese and Indian VC bubble starts to deflate. I would not be surprised if some more international US VCs find their way to Europe, to tap into strong technology and good cleantech deals with great valuations, either with own offices or through alliances, as witnessed in the last 12 months'.
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