Privately Speaking: Sonali De Rycker of Accel Partners

European venture has disappointed investors for a decade. But many believe the prospects for this segment of the market have never been better – and funding is starting to concentrate around a few managers who seem to have the models to take advantage. Accel Partners’ European arm, which has just closed a $475m fund, is emerging as one of the best of its breed – and in Sonali De Rycker, it boasts a partner described in some quarters as ‘the best VC in Europe’. James Taylor went to meet her, to ask why LPs should believe that this time will be different...

In the 10 years to the end of 2011, European venture capital funds delivered to their LPs an average net IRR of -0.94 percent. In the five years to 2011, the return was slightly better: -0.14 percent. That’s according to the industry’s own trade body, the European Private Equity & Venture Capital Association. To put it bluntly: as an asset class, European VC has stunk the continent out for a decade.

So it’s understandable that some institutional investors have come to the conclusion that in these risk-averse times, they’d be better off hiding their cash under a pillow than backing a new venture fund.

But is it the right call? That’s a moot point. Those venture firms that have made it this far will tell you that there’s never been a better time to invest in European venture – and that the biggest problem is that investors will not trust them with enough cash to prove it. Total capital raised by European venture funds has been in steady decline for the last five years, according to data from PEI’s Research & Analytics division: almost $10 billion was raised in 2008, but the 2012 total was less than $1 billion.

One firm that has no shortage of firepower is Accel Partners, which in March closed its fourth European fund on $475 million. Founded in Silicon Valley in the early 1980s, Accel only opened a London office in 2000, and still only has four partners here. This group has been set up very deliberately to operate independently from the mothership: they raise their own funds and make all their own investment decisions. But they also sit within a genuinely global platform, with strong links into the best companies in Palo Alto – a nice USP in a world where the best entrepreneurs have global ambitions.

PEI went to ask partner Sonali De Rycker why Accel succeeded where others have failed – and what it means for the future of the asset class in Europe.

POST MORTEM

First things first. Why has European venture had such a bad run?

The first point to remember, says De Rycker, is that this is still a relatively young market. “In the US, venture as an asset class has been around for 50+ years. In Europe, it only started to materialise in the mid-1990s. So it’s a much, much younger business – and there’s no more cumulative business in the world than venture capital.”

It’s also true that a decade ago, European VC had the opposite problem to the one it has today: a surfeit of capital. As EVCA board member Hendrik Brandis, a partner at German VC Earlybird, explains: “This poor performance has its root cause in the hype of 1999/2000 – when there was an all-time high in venture fundraising, but a relatively low density in terms of investment opportunities. So there was an imbalance of capital supply and start-up demand, which led to inflated entry valuations and mediocre investments.”

De Rycker agrees. “There was way too much capital, and it took a while for that to be washed out. In the US, a lot of this was forgiven because people managed to sell companies and make a lot of money in the bubble. But in Europe, there weren’t that many exits to pay for the mistakes. So we got punished both ways.”

De Rycker has seen most of European VC’s triumphs and disasters of the last decade at close quarters. Born in India and educated in the US, by the mid-1990s she was working for Goldman Sachs in New York, pitching for mandates from high-growth tech companies in the post-Netscape world. Bitten by the venture bug, she first came to London in 1999 to do a summer placement during her MBA at Harvard (“I was very lucky; I didn’t make any massive mistakes in the bubble because I was at business school!”). When she graduated a year later, in the summer of 2000, she took a permanent role here with US group Atlas Venture. “Europe looked from the outside the way it is today – but I was 10 years too early!”

So what’s different today? Why are so many of those who invest in European venture – including De Rycker – more positive about this market than they’ve ever been?

METTLE TESTED

The first point is that the whole political and fiscal system seems much more conducive to enterprise than it has ever been. European governments have been introducing tax breaks and investment schemes to encourage early-stage investment gaps; while London, Berlin and to a lesser extent Stockholm have developed into vibrant technology and start-up hubs.

GPs will also tell you that the quality of entrepreneurs is noticeably better. As the industry matures, more and more are on their second or third business. “There are just many more serial entrepreneurs out there,” says Anne Glover, chief executive of Amadeus Capital. “The talent pool is better and richer and more experienced than it’s ever been.”

And generally speaking, those who have successfully built companies in the last few years have shown their mettle. “A tough economy is one of the best times to back brilliant businesses,” says Alex Macpherson, head of UK-based Octopus Ventures. “We’re seeing a number of companies coming through from 2008/9/10 that are innovative and different and have new routes to market.”

GPs are also better equipped these days, says De Rycker. “It’s the cumulative experience – the pattern recognition. Accel has been around for 30 years; there’s nothing we haven’t seen before as an institution. The best investors are patient; they don’t get too excited in an upturn and don’t get too dismayed in a downturn. That’s a crucial skill that only comes from the experience of having seen it all before.” There are also some promising new firms emerging, several of which – including the likes of Atomico, PROfounders and Notion Capital – are run by former entrepreneurs.

Pricing is also much more attractive than it was a decade ago, claims Brandis. “The demand side is much better now. We’re already seeing the emergence of significant European start-ups – companies with billion euro valuations – with much higher density than we used to. But at the same time the supply side has collapsed – which means you can now invest at a fraction of the valuation in much higher-quality companies.”

European companies tend to be more capital-efficient, adds Glover. “In Europe it costs less to hire people and they stay longer; there’s much more talent stickiness. So you can achieve a lot more with less in Europe – which means that to get a really good return you don’t have to sell at exorbitant prices.”

Another potentially big advantage for Europe is the huge amount of cash sitting on the balance sheets of big US tech companies’ overseas subsidiaries – which in most cases, can’t be repatriated without punitive tax implications. “The only thing it can be used for is growth,” says Glover. “That means there’s a wall of cash available to invest in and buy companies.”

These benefits are starting to be felt, says Dushy Sivanithy, a principal at fund of funds manager Pantheon. “Returns are starting to get more interesting; after a long wait, strong exits are starting to come. And we see a number of sizeable companies in the portfolios that are going to be exited in the next couple of years.”

Unfortunately, he admits, there’s still a fundamental disconnect. “The underlying story is stronger than it’s ever been. And yet the fundraising problem has never been more difficult.”

UNFAIR ADVANTAGES

Unless you’re Accel, it seems. The team reached a first and final close on Accel London IV within just eight weeks; the fund was “significantly oversubscribed” and experienced “unprecedented demand”, the firm said (interestingly, two-thirds of the capital came from US LPs).

In other words: in two months, Accel raised more than half as much money as the entire asset class put together during the whole of last year in Europe.

So why is it inspiring so much confidence? “The thesis behind venture in Europe should not be about being a European venture firm; it should be about accessing great European talent and making it a global success story,” De Rycker argues. “The ability to provide access to the best entrepreneurs in the Valley, who have created market-defining category-leading businesses, is absolutely unique. And right now, in this region, [Accel is] the only firm that can do that. It’s just a very unfair competitive advantage.”

This was precisely what persuaded De Rycker to leave Atlas and join Accel in 2008. “When I found myself losing out on some investments because I couldn’t deliver the depth and breadth of such a distinctive network, I figured that if I couldn’t beat them, I should join them.” (Incidentally, one of the ones that got away was QlikTech, which became one of most lucrative European VC deals ever – see box, below).

Accel clearly believes in local (“The venture business is all about relationships and judgement, and it’s hard to have that sitting on a videoconference many time zones away.”). But thanks to their links to the US, and to the firm’s other outposts in India and China, De Rycker and co. can plausibly claim to have something pretty unusual in venture: a global footprint.

That has several advantages. First of all, it gives Accel a “global radar screen” to work out what the next big thing will be. It increases its sphere of expertise (“We have 400 companies in the portfolio; that’s a lot of pattern recognition and experience we can call upon.”). And it means Accel can make some heavy-hitting introductions – with Facebook being the obvious example. Accel was an early backer of the social networking site, and reportedly reaped a $2 billion return when it went public (not bad for a $12.7 million investment). These days, the close ties it retains are hugely significant in a world where Facebook is so important to so many online business models.

De Rycker recalls the example of gaming company Playfish, whose founder Kristian Segerstrale was persuaded by Accel partner Kevin Comolli to take some early stage seed funding from the firm (it was later bought by Electronic Arts for $400 million). “One of the reasons Kristian went with Accel – other than to get Kevin off his back – was because he was able to deliver Facebook at highest level. If an entrepreneur’s entire business is based on Facebook, and you can actually have Facebook’s top management leaving voicemails telling them that this is the firm they should work with … Think how explosive that is.”

The Accel offices also share a common investment philosophy, based around a Louis Pasteur phrase: “Chance favours the prepared mind”. Or to put it another way: do your homework. “Being lucky is necessary but not sufficient. So our approach is very thesis-orientated. We go very deep into a sector and work out what the blueprint is for success. So when we meet a company, we don’t start learning when we sit down opposite them; we’ve already done our homework. That helps us to win the hearts and minds of entrepreneurs.”

When she wins a deal and joins the company’s board, De Rycker says much of her focus tends to be on people. “We like to be the people behind the people; we’re not trying to tell an executive what he should be doing in terms of daily operations. I sometimes think of myself as a glorified headhunter… We can be a magnet for great executives, and so we have that unfair advantage of having access to a very deep talent pool.”

One of her investments at Atlas was Moo.com, an online printing business – whose chief executive Richard Moross remembers her fondly. “She was a fantastic board member – very engaged, very strategic, always all over the numbers and never afraid to speak her mind. She seemed to really understand how the business operated and what kind of talent it needed; and she really got the personalities of my team and how to get the best out of us.”

When PEI was talking to people in the market about De Rycker ahead of our interview, our favourite quote was: “Absolutely terrifying, but probably the best VC in Europe right now.” In person, she seems perfectly charming – but is it a different story for entrepreneurs?

“She’s like a predatory animal; she’ll lie in wait very quietly and then pounce,” laughs Moross. “She has a very sharp intellect that she’ll switch on at exactly the right time to ask a challenging question or expose something that might be wrong. Her entire approach is to challenge you; to interrogate the logic behind how things work. But it’s not about her winning, it’s about you and the business winning. She is very direct, but she does it with charm. I can see why people might think she’s scary, but I think she’s wonderful.”

MORE THAN ENOUGH

There’s been a lot of gloom around European venture in recent years. And for the industry as a whole, the lack of funding is clearly a problem.

However, De Rycker rebuts the idea – by no means uncommon in the market – that there’s a shortage of capital for the very best companies. “For good entrepreneurs, there’s more than enough capital. Great companies here always have multiple term sheets.”

And she remains confident that great businesses can be built out of Europe in the coming years. “Innovation is global; the tools are global. Companies can get started in people’s bedrooms in Lithuania; it doesn’t matter – you don’t need capital to get to a product. And now you don’t even need capital to sell a product; you can just put your product on the App Store or Amazon or eBay and start selling. The market has evolved in such a way that good entrepreneurs who have a good product can get to critical mass without a lot of capital. That has just intensified the growth of some of these businesses.”

Since European entrepreneurs are normally quite used to dealing with different languages and currencies and jurisdictions, they’re often actually better at internationalisation than their US counterparts, she says.

Whether Accel can capitalise on this and deliver the sort of returns that US venture investors have enjoyed remains to be seen. But the European venture market seems better positioned than it’s ever been. And judging by its fundraising success, investors clearly believe Accel has the right proposition to cash in. n

 

 

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CASE STUDY: EUROPE’S BEST EVER VC DEAL?

As a template for how European VC deals ought to work, it’s hard to see past QlikTech

When Accel invested in QlikTech in 2004 (alongside Jerusalem Venture Partners), it was an obscure business analytics company in a technology park in provincial Sweden. Six years later, its flotation on NASDAQ generated a €408 million return on Accel’s €17 million investment – equivalent to 23.6x. Apparently, some of Accel’s investors reckon this is the biggest return to a single VC firm in the history of European venture.

It was also a perfect illustration of Accel’s ‘prepared mind’ philosophy, according to De Rycker, in that it aligned with one of its core investment themes: the consumerisation of software. “This was about taking very complicated business analytics and making them very user-friendly, so that a business person could use them immediately without needing to get IT involved.”

The original deal was extremely competitive; Accel was by no means the only firm convinced of QlikTech’s potential. But its US links – along with the sector experience of partner Bruce Golden, who ked the deal and continues to chair the company’s board – were crucial. “They chose Accel because Bruce was a domain expert – and because they figured that if they really wanted to be a global success story, they needed help to get into the US.”

 

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BOX-OUT: CAPITAL NEW POOLS

European VCs’ search for innovative funding sources – largely by dint of necessity – has some interesting lessons for larger firms


If you’re suffering from a lack of capital, as European VC has been lately, it’s generally a good incentive to seek out innovative new sources of money. That’s particularly true in capital-intensive industries like semiconductors, cleantech and (to a lesser extent) life sciences.

Happily, a new source of funding has emerged. “Corporates are very interested in innovation in those sectors: they have direct investing arms, but they also see the benefit of participating as an LP in funds as well,” says Anne Glover of Amadeus. Their potential financial upside comes not just from the fund investment, but the whole relationship – particularly the window on innovation it provides.

As such, corporates are becoming increasingly important players in venture – responsible for much of the fresh capital that has come into the asset class lately. However, there is a flipside for GPs: this new breed of LP typically wants much tighter, more focused mandates.  “We’ve been raising capital successfully every year for the last three years – but in targeted pools,” says Glover.

In fact, she admits Amadeus probably won’t try to raise a big generalist fund next time round.  “What we had to do was discard the old model – that there’s a mega fundraise every four years and if you don’t achieve that the world falls apart. And it’s playing out very well, because the smaller funds are looking incredibly good.”

Another model that would seem foreign to most buyout firms is that of Octopus Ventures, which invests most of its money through Venture Capital Trusts (UK-listed vehicles with a favourable tax status in which retail investors can invest directly).

“Our VCTs are evergreen funds and we look to raise money every year,” says Octopus’s Alex Macpherson. “This gives us a consistent flow of funds that enables us to invest in a range of businesses.” As Octopus makes exits , it distributes the proceeds via a tax free dividend. “That’s highly attractive, especially to higher-rate tax-payers,” he adds.

The more novel bit of the model is the Octopus Venture Partners network, an advisory group of entrepreneurs and businesspeople. As well as helping with deal sourcing, due diligence and post-investment support, they are also given the option to co-invest alongside the GP on a deal-by deal basis. “The acid question for us is always: ‘would our Venture Partner invest?’” says Macpherson. “If he/she says no, it’s quite simple; we drop it and move on.”

To Glover, no structure should be out of bounds. “It’s really whatever works. Our function is not to preserve the venture capital model.”