Figures hint at venture comeback(2)

The venture capital industry seems to be profiting from the record levels of capital flowing into the private equity industry, even though its returns continue to lag behind the buyout funds. Jo Nash reports.

The latest figures from trade body EVCA, the European Private Equity and Venture Capital Association, show that the much-maligned European venture segment may finally be mounting a comeback.

Since the difficulties venture firms endured in Europe after the dotcom bubble in the early part of the decade, some investors have shied away from the sector. But EVCA’s figures suggest they may be coming back. Of the record €112 billion raised across the board in 2006, the vast majority – €84 billion – was allocated to buyouts. However, venture investment rose a massive 60 percent from 2005 to €17 billion, helped by successful fundraising efforts like that of Benchmark Europe – now Balderton Capital – which closed a €515 million fund last year.

Venture deal volume was also up, with €18.8 billion of venture deals compared to €12.7 billion in 2005. In all there were more than 8000 venture deals in the sector last year – almost 75 percent of the total number of private equity transactions.

Javier Loizaga, chairman of EVCA and chief executive of Spanish mid-market firm Mercapital, said he was optimistic about the smaller end of the market. “The marked growth of mid-market buyouts and of the seed and expansion segments of venture clearly demonstrate that private equity in Europe continues to focus strongly on building young companies and developing mid-market businesses.”

So what lies behind this increased activity? All the signs suggest that investors are increasing their allocations to the asset class, buoyed by the strong returns of recent years. This is noticeably true of pension funds in particular, who invested more money both directly and indirectly. Pension funds accounted for 27 percent of all capital raised, while funds of funds – which mostly consisted of pension fund money – accounted for a further 18 percent.

The problem for venture is that it cannot offer the same historical returns as the buyout space. The top quarter venture funds have now recorded an internal rate of return of 17.4 percent since inception, according to EVCA, compared to 31.0 percent for buyout funds.

However, the signs are encouraging for European venture. Several firms enjoyed some lucrative exits in 2006, and this trend has carried over to this year too: Index Ventures recently sold its stake in Last.fm, a UK radio and social networking site, to US television channel CBS for a reported $280 million. The sale is thought to have generated a $56 million profit for Index and a $38 million profit for each of Last.fm’s three founders.