VC investment slows in Q2 2005 but funds pool increases

In the second quarter of 2005, venture capital investment into European companies slowed, with €735.6 million invested in 203 financing rounds according to the European VC Report released by Dow Jones VentureOne and Ernst & Young. Although later stage investment grew considerably, the totals represent a 20.1% decrease over the amount invested in the first quarter of 2005.

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As occurred in the U.S., investors in Europe were directing a greater percentage of their capital investment into later stage financings. There was €371.6 million directed toward later rounds in Europe — 50% of the total capital invested in the second quarter, compared to 43% of the total investment in the same quarter of 2004.

Investors also continued to invest more sizeable sums into fewer deals, as median deal sizes have increased — a trend that was also apparent last quarter. The overall median deal size was €2 million in the second quarter, up from €1.6 million last year.

“With 14 venture-backed IPOs occurring in the second quarter, it was the most active quarter for public market exits since 2001,” noted Stephen Harmston, director of international research for VentureOne. “Investors are focusing a limited number of investments on those companies with the most potential for a profitable exit.”

IT sector declines but semiconductors remains a bright spot
By industry sector, €361.1 million was invested into 114 information-technology (IT) companies — a 22% decrease in investment and 33% decline in deals from this quarter a year ago. Although when measured across the first half of the year, the decline was not as steep as last year’s first half.

However one segment — the semiconductor industry — posted slight increases with one more deal and a more than three-fold increase in investment bringing the total to €81.7 million. When measured relative to 1H 2005, the picture was even better, with €193 million going into semiconductor sector compared to only €71 million in 1H 2004. The largest IT deal in the second quarter was for Level 5 Networks of Cambridge, U.K., which received €24.7 million.

The electronics segment also drew a considerable amount of activity with 20 deals and €51.7 million invested, the largest quarterly amount of capital invested in this segment since 2002.

France leads the pack
By country, France was the only major country in Europe to hold steady with investment levels from 2004 with €159.6 million invested in 53 deals in the second quarter. The number of deals in France resulted in the French market being tied in first position with the U.K. in terms of deal flow.

With 18 deals, Germany had only half the number of a year ago, and a decrease of 32% in investment, or €97.6 million for the quarter.

In the United Kingdom, deal flow and investment both fell by more than one-third to 53 deals and €206.5 million invested. The other European countries most active in venture capital include Sweden, which had 20 deals and €62 million invested in the second quarter; Denmark, which had 17 deals and €64.9 million invested; and Ireland, which posted seven deals and €27.4 million of investment.

VC funds raising climbs 60% in Q2 2005
The European venture capital pool (the amount going in as committed capital into the VC funds, as opposed VC fund being invested in high growth companies) fund raising grew in the second quarter of 2005, raising a total of €729.9 million through 11 venture capital funds, according to VentureOne. Meanwhile, in the U.S., 24 venture-capital funds closed in the second quarter – raising a total of €6.07 billion. This was the most raised by U.S. firms in a single quarter since the frothy bubble era of the fourth quarter in 2001.

The total amount of funds raised by European venture capital funds in the second quarter is a 60% increase over the amount raised in the same quarter in 2004. This is the second quarter in which venture capital fund raising has surpassed the totals of last year. At the half-year point, €1.60 billion has been raised by European funds, which is more than was raised in all of 2004 (€1.40 billion) and also more than then whole of 2003.

“European venture-capital activity, which often lags U.S. activity by several quarters, is catching up to the strong fund-raising trend that began in the U.S. last year,” said Steve Harmston, the London-based director of international research for VentureOne.

French back in action, again
Like the increased activity in the VC investment in growth companies, the new fund raising was also very active. Mr. Harmston added that France had a particularly strong second quarter in terms of venture capital fund raising in Europe. Two of the quarter’s largest venture capital funds were based there: Banexi Ventures IV fund – for €130 million – and Iris Capital Fund II – for €176.6 million.

Interestingly, of the 11 venture-capital funds completed in Europe this quarter, only one was based in the United Kingdom – which normally is the most active country for venture capital investing in Europe.

US heading for a slam dunk year
In the U.S., fund raising represented just two more fund closings in the second quarter than in the same period last year, but the amount of capital increased 164% from the $2.30 billion in capital committed a year ago.

Of note in the second quarter: three of the U.S. funds raised were $500 million or larger – including Menlo Ventures’ X Fund, which closed at $1.20 billion. At the half-year mark, U.S. venture capital firms have raised $9.43 billion, indicating that the year is on track to potentially surpass the $17.82 billion raised in 2004.

“After two years of slow down, 2004 proved to be a significant year for fund raising, and it appears that the growth is continuing apace in 2005,” said John Gabbert, vice president of worldwide research at VentureOne. “While the second quarter of this year saw the closing of some larger funds, a significant amount of interest still remains for smaller funds as well. More than 40% of the funds raised in the first half of the year have been for funds that are smaller than $100 million.”

The Chilli perspective: 2005 is a bumper year
It looks like 2005 will be a slow year for VC investments, as companies and VCs digest the relatively low exit market valuation plus the extra compliance costs and burden posed by the Sarbanes-Oxley regulations, which indirectly affects European based companies as well. We expect to see more late stage deals and larger size deals, as some VCs position themselves for lucrative exits and produce above average returns at the end of the year.

Meanwhile, in terms of new funds going into the VC pool, 2005 is going to be a bumper year for fresh capital injection in the VC fund pool, which is good news for European high growth technology companies seeking larger amounts of VC funding in later rounds – which incidentally will also be good for company valuations. Larger amounts will pressurise small and niche VC funds to start investing in more early stage Chilli S3, R1 rounds as the pool of late stage R3, R4, pre-IPO, pre-exit, companies begins to thin out. Having said that we expect the vast majority of the new funds to go into leveraged buyouts, as has been the case, for the past few years. See related story: UK technology VC investments fall by 17% in 2004.

It also worth noting that France is beginning to stir up again, after a few years is the doldrums. The recent funding of DibCom, a fabless mobile TV and DVB-H chipset company, at € 24.5m, is the largest venture backed financing for a French headquartered company so far this year.

Having said that, European policy makers, fund managers and entrepreneurs must persevere in building larger and more competitive early stage deal flows and funds, as other regions are fast catching up. It is already expected that the total private equity funds raised and invested in India will exceed $2 billion this year, according to the India Venture Capital Association. This is double the amount raised in the year 2000, and the pace will accelerate as more international LPs hedge their bets and funnel ever larger amounts into that region.

© Chilli Publishing Ltd 2005

05SEP2005