Europe's Vc Boom: Well, That Didn't Last Long

Its New Economy has stalled, and the venture capitalists who financed it are plotting new moves

If you took your eye off Europe at the turn of the century, you missed the Old World's New Economy cash festival. For a brief 12 months, Europe had the pieces in place for a startup revolution. High-tech markets caught fire; engineers dropped out of their big-company jobs to turn entrepreneur; venture capitalists descended by the score from the skies via London and Frankfurt airports. At the popular First Tuesday networking parties, entrepreneurs shouted over the hubbub at financiers about their next big thing. In 1999 and 2000, eager investors committed more than $40 billion to VC funds in Europe in hopes of getting a piece of the New Economy. That was more than the total for the previous decade. Silicon Valley powerhouse Benchmark Capital announced a $750 million fund. Carlyle Group's Internet Partner Europe raised $700 million. Deutsche Bank targeted $1 billion for Net and phone investments. The European private-equity scene, previously dominated by management-buyout specialists, shifted focus to young, high-tech companies.

Now, the party's over, and the VCs who financed it are poring over the bills and plotting their next moves. How they adapt to a more sober reality is likely to shape Europe's high-tech scene for years to come. Before they make any new investments, the funds are looking for alternatives to initial public offerings to get their money out of the current ones. That includes squeezing startups hard to cut costs and become profitable. When it's clear a company is a lost cause, funds are bailing out.

The easy money is gone. Germany's Neuer Markt, France's Nouveau Marche, and other tech markets followed the Nasdaq dive that started last March. That shut off the VCs' preferred vehicle for turning a fast profit--taking companies public--and the unrealized value of still private companies in their portfolios has greatly eroded. Scores of dot-coms face death as VCs slash their lifelines. In mid-January, the British VC leader 3I said it would cut off further funding for BarrysWorld, a British online gaming site, in which it invested $2.9 million last year. The company will probably close for good. Earlier, Unilever's venture arm put Wowgo, a site for young girls, out of its misery after $9 million in investment and four months of operation.

SQUEEZED. Even jumbo startups with massive financing are feeling the squeeze. FirstMark Communications, a pan-European phone company that offers high-speed connections, received $1 billion in private financing last June, a European record. That was then. Seven months later, when big new expenses loomed and conditions augured ill for an IPO, FirstMark's prestigious cast of investors, including Kohlberg Kravis Roberts & Co., Groupe Arnault, and BNP Paribas, preferred to cut the burn rate. That forced the company to close its 190-person London operation and abandon its ambitions in Britain's phone market.

The early weeding out of Europe's high-tech startups has a potentially serious downside for its Net economy. In this rough climate, more of Europe's startups are retrenching and looking for linkups with industrial giants. This makes it less likely that European VCs will breed stand-alone giants like the U.S.'s Yahoo! and Amazon, much less Intel and Microsoft. Instead, VC funds eager to find an exit for their investments are turning for help to Europe's traditional corporate powers--from France Telecom to Germany's Bertelsmann to Sweden's Ericsson--by offering them stakes in the newly devalued properties. "We'll take payment in Nokia or Alcatel stock, gladly," says Will Cardwell of Eqviteq Partners in Helsinki, a venture firm that specializes in wireless startups.

Venture capitalists and entrepreneurs may be grateful for such industrial partners now, but during Europe's short-lived VC boom, they didn't give them the time of day. The traditional companies' slow pace was at odds with the ethos of the moment--lightning-fast progression from initial funding to IPO. And the young companies feared that a big shareholder with a strategic interest in their products might hinder them from selling to competitors.

They've apparently overcome their reticence. The big companies' growing importance in startup financing is evident throughout the region. In Paris, on Jan. 23, Webraska Mobile Technologies, a French company that sends maps and directions to mobile Web phones, announced a $49 million round of financing led by the London-based Apax Partners' Funds. Backing Apax was an assortment of industrial partners hungry for Webraska's technology, including technology giant Royal Philips Electronics and chipmaker Infineon Technologies. In December, Finnish software startup Digia, which also focuses on the mobile Net, raised $31 million, including investments from Intel, Sony, and Cisco Systems. Cisco, like other big companies scavenging in the down market, hopes to do loads of similar deals. "We could be helping to spawn 50 to 100 new businesses in Europe in the next year," says Robert Lloyd, Cisco's regional vice-president for small and midsize businesses.

Not that the conventional VC firms are bowing out of the picture. Their own investors were so eager to get on the high-tech bandwagon that over the past two years they showered them with cash--more than they could invest before the tech markets began collapsing last March. As a result, some VC firms are flush for the next upturn. Industry insiders estimate that of the $40 billion raised in Europe since 1998, barely half is invested. Waldemar Jantz, principal at Target Partners in Munich, says his company had just started investing the more than $100 million it raised when the downturn hit. That turned out to be fortuitous. "Now, our investors are excited that we didn't invest last June," he says.

CUTTING ORANGE. Europe's VCs will no doubt be misty-eyed with nostalgia if the IPO of France Telecom's wireless division, Orange, fares well. There are ominous signs, though. In mid-January, France Telecom's bankers sliced another 25% off their already reduced estimated issue price, valuing the 13% stake at $11 billion, barely half of what the company was hoping to raise a few months ago. Even if Orange does better than expected, however, it won't necessarily usher in a new day for unlisted companies. The only startups that stand a prayer of listing successfully in the current climate will be profitable ones in optical and wireless technologies and life sciences. Dot-com IPOs are still poison ivy. "I don't think you'll see a pure Internet IPO for the next six months," says Dominique Peninon, managing partner at Access Capital Partners in Paris.

The New Economy boom was so brief in Europe that many of the VCs are still scouting for their first big win. Jean-Bernard Tellio, who until early January headed Washington (D.C.)-based Carlyle Group's Internet Partners Fund, places much of the blame on the strict guidelines limiting many funds' investments to fully European companies. That makes little sense in a global economy or from an investment point of view, he says. European startups that lack a U.S. component are far harder to sell to a potential U.S. buyer. Tellio says that of the $700 million Carlyle raised, the firm only invested $125 million, and he suspects that other investment powerhouses have not fared much better. As for newcomers to the VC business, "a lot of the funds will disappear," he predicts. "But the investors will remain." They'll just be a bit poorer--and a whole lot hungrier.

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