More resilient, more confident

In March 2004, those with a sceptical view of the French venture market's prospects were forced to acknowledge that the seemingly impossible had happened: two Internet-based companies were sold to industrial buyers in deals that delivered excellent reported returns to their venture capital backers.

The €475 million sale of Paris-based price comparison service Kelkoo to US search engine Yahoo more than vindicated Banexi Ventures and Innovacom's decision to lead a €4 million first-round financing of the business in December 1999 – and delivered a reported fivefold return on their original investment.

The transaction hinted at the intriguing prospect not only that strategic buyers once again provide a possible exit route for venture capital firms, but also that Internet-related portfolio companies need not necessarily be viewed as walking wounded – and that valuation of these companies can reasonably be more positive than in the past.

The theme was reproduced when Carlyle Europe Venture Partners and Credit Lyonnais Private Equity sold online business travel service Egencia to IAC/InterActiveCorp, the parent company of Expedia, in a deal that resulted in an IRR of ‘over 30 percent’ according to a statement issued by Carlyle. The two private equity houses had invested in the firm in 2000 and 2001 and then coled its last financing round in 2003.

“There are profitable, well established companies based on a pure Internet model, and they will prove that we were not wrong in all cases when we backed these firms,” says Jean-Bernard Schmidt, managing partner and chairman of Sofinnova Partners, an investor in the IT and life sciences sectors.

Indeed, these two sales were not the first sign of renewed interest in the technology sector. On 30 January 2004 Iliad, the parent of Internet service provider Free, took the Paris stock market by storm when its IPO, which raised €94.5 million, was 28 times oversubscribed – bringing back (mixed for many) memories of the late 1990s technology boom.

Such success stories means confidence may begin to seep back into the venture fundraising market too. In 2003 the only two major fund closings by French venture firms were by Innovacom, which closed its Fund V 20 percent ahead of target on €120 million, and Iris Capital, formerly known as Part'Com, whose €100 million closing of Iris Capital Fund II coincided with its spinout from French bank CDC Ixis.

“We are seeing signs that venture funds are coming back to the market,” says George Pinkham, senior partner in law firm SJ Berwin's Paris office and head of the office's fund formation group. “I have no doubt that a number will come back in late 2004 and 2005, but it is very difficult to tell how they will fare.” Another professional in the market says the key is the target amount firms set out to raise: as long as they remain pragmatic, and do not have a false impression of the speed of recovery, they will be fine, he says.

Schmidt at Sofinnova says there is no better time to be investing than now. “The crytical view some investors have of European venture capital is misplaced,” he insists. “Europe may be seen to have come through the downturn reasonably well compared with the US and now is an favourable time to be investing. Institutions will certainly come back when they see the IPO market opening up, though in a way that's already too late. To invest effectively you need to commit steady amounts every year.”

Although the French authorities are sometimes perceived as heavy handed when it comes to regulating the financial sector, they have won plaudits for their recent efforts in making the environment more conducive for investment in young companies. The Government has provided arguably the most decisive response of any European country to a specific recommendation arising from the EU's Lisbon Summit in 2000: namely that R&D spending in the EU should rise from less than two percent of total GDP to three percent by 2010.

Institutions will certainly come back when they see the IPO market opening up, though in a way that's already too late. To invest effectively you need to commit steady amounts every year

Jean-Bernard Schmidt

In a clear signal that it is keen to see French entrepreneurs flourish, the French government has passed legislation allowing companies less than eight years old and with at least 25 percent of their operating expenses accounted for by R&D to get a full exemption from social charges (such as healthcare and retirement costs), income tax for the first three years of profitability and capital gains tax for investors in those companies.

There is also the possibility that France may eventually provide another lead by being the first European country to force life insurance companies to invest more in private equity. Senator Philippe Adnot, a champion of young and innovative companies, won approval in the Senate for an amendment to the 2004 Finance Bill that would have seen life insurance companies obliged to invest 1.5 percent of total assets in unlisted companies this year, rising to five percent in 2007. The amendment was blocked by the National Assembly, but is likely to be tabled again ahead of the 2005 Finance Bill, and commentators are predicting that it will become statute.

Resorting to force is controversial, and reflects the difficulty French venture funds have in attracting support from domestic investors. With banks seeking to reduce their exposure in the wake of concerns about Basle II and pension fund appetite for private equity remaining limited, there are few sources of capital to rely on – which explains why international investors tend to easily outnumber domestic investors in French funds.

Aside from attracting new investors, it is even proving tough holding onto existing ones. George Pinkham of SJ Berwin says there is increasing litigation being initiated by investors in venture funds wanting to escape their commitments. In addition, he says: “There is a lot more negotiation regarding the inclusion of clauses providing for what happens if things go wrong.” One example is the nofault divorce clause: not a talking point at all in France a year ago, but hotly debated now.

All this sits rather uneasily with the view that the French venture market is fighting its way successfully out of the downturn and represents an attractive opportunity. The fact is, many investors have had their fingers badly burnt and will take a lot of winning over. But at least it can be said with some confidence that the lucrative exits seen in recent months will help to ensure French venture once more gets a fair hearing. And these firms are now more resilient, more confident: there is value to deliver in their portfolios.