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  • Portfolio News
  • 21 April 2010
  • 20 min read
  • Words: Northzone

In the Zone

(Real Deal Magazine, 21/04/2010) – The European venture capital industry has long struggled to shake off its reputation as the US’s ugly sister. Recent EVCA figures reveal that European venture has made average annual returns of just 0.7 per cent over the last five years. US firms, on the other hand, have returned 4.9 per cent over the same period, according to the NVCA.

Battling the disappointing figures as well as the chill winds of the financial crisis, Northzone was one of the few European venture houses to brave the fundraising trail last year, going on the road in the autumn. Last month the firm reached a first close of ?90m on its sixth fund, with a target size of ?150m.

“We’ve been raising a fund every three to four years since we started in 1996,” says Tellef Thorleifsson, Northzone co-founder and general partner. “We didn’t want to break the cycle because of a difficult market.”

The firm has now secured ?100m in commitments from a mixture of Nordic and European institutional investors, according to Thorleifsson, and expects to reach the target size during “Q2 or Q3 this year”.

It is no accident that the latest fund is smaller than its predecessor, which, at ?175m, was the largest technology fund to be raised in the region. “Quotas from institutional investors have been seriously reduced after the financial crisis, and that seeps through the whole value chain. Especially last year, volatility was so high, many investors stepped back,” says Thorleifsson.

Fundraising has been challenging across all asset classes, especially so in an area that has failed to measure up to mid-size and larger buyout funds. But while reaching two-thirds of target size in six months is still an achievement, Northzone’s fund has not been free from criticism. “They’re struggling to reach ?100m,” says one placement agent. “They have a good team with good experience, but in this market, LPs expect to see a record of cash-producing businesses and major exits that few GPs can boast.”

Yet Thorleifsson remains confident that VC fundraising in Europe will improve, although it will remain selective. He argues that depressed valuations mean large buyout funds require less capital, and, in theory, LPs have more available to deploy to the venture sector.

Lies, damn lies…
Thorleifsson also questions the statistics used to determine the asset class’s performance. The venture capital tag in Europe encompasses a motley crew of public-private investors, regional funds and government-sponsored firms; not the sort that institutional investors would typically back.

By the time average returns are calculated, the figures are “skewed”. In addition, he observes that European VCs tend to invest smaller amounts than their US counterparts, and a strong exit will earn them a higher multiple than would be typically seen in an American deal.

As an example, Nimsoft, an IT performance services provider, was recently sold to US management software group CA for $360m (?265m). “We achieved a decent multiple, with a holding period of three years. It’s a good exit by any standards,” says Thorleifsson.

Since its inception, Northzone has raised ?445m. Its latest fund will continue the strategy of investing in cleantech and consumer-related internet businesses. Thorleifsson says: “Cleantech has experienced a phenomenal growth rate, especially wind power, which has been expanding by 20 to 30 per cent year on year.” In the first quarter of 2010, the number of VC cleantech investments worldwide was a record 180, according to research by Deloitte and the Cleantech Group.

Within the sector, the firm stays away from capital-intensive projects, as much for the long holding periods as the lack of resources, and focuses on technologies that reduce the cost of electricity generation.

Examples of recent investments include Innotech Solar, which repairs damaged solar cells, and Chapdrive, a manufacturer of hydraulic transmissions that are designed to reduce weight and improve efficiency in wind turbines.

On the technology side, Northzone was an early investor in highly rated music-streaming service Spotify and has recently invested in Videoplaza, an ad-serving platform for online videos.

“Videoplaza blurs the distinction between watching TV and being on the internet, and commercialises it. It’s a billion-dollar market,” says Thorleifsson.

Northzone also has the notable advantage of its geographic remit. The firm focuses on investing in Scandinavia, the scene of some of Europe’s greatest success stories. Internet telephony company Skype was bought by eBay for $2.6bn in 2005, and MySQL, an opensource software developer, was acquired by Sun Microsystems for $1bn three years later.

The region’s size has played a part in its success, according to Thorleifsson, as small domestic markets have helped businesses to foster global ambitions from an early stage. Skype, for instance, had bases in Luxembourg, Tallinn and London from the very start.

Denmark-based Napatech, a manufacturer of network-optimisation hardware, has received some $6m from Northzone, and is similarly internationally minded. Henrik Brill Jensen, chief executive of the company, says that 80 per cent of its business comes from the US: “We were receiving positive feedback in Europe, but people were reluctant to build a system around a company they weren’t sure would be around in two years. In the US, it’s normal to work with a technology start-up.

Another Northzone company, Swedish online product review aggregator TestFreaks, is keen to look even further afield. “When it comes to the internet, the US is not an expanding market, and Europe is barely growing either,” says chief executive Kristopher Arwin. “The real growth is in Asia.”

In addition to a business base that is comfortable in international markets, David Carratt, managing director of Kennet Partners, notes that Finland and Sweden are home to telecoms behemoths Nokia and Ericsson, which made entrepreneurial engineers in the region unusually well equipped to benefit from the boom in wireless technologies in the 1990s.

Wireless may not be as cutting-edge as it once was, but Scandinavia still has “world-leading” technology companies, says Thorleifsson.

“In any index you care to look at – R&D spending, entrepreneurship, world competitiveness or economic activity – Nordic countries tend to come out quite well.”

While European venture capital still has a lot to prove, Nordic businesses have created some of its most compelling growth stories, and Thorleifsson believes the asset class can expect better times. “We have a strong pipeline because competition is limited. It’s important to have funds in a market like this.

If everyone wants to invest, that’s when you should get worried.”