In an earlier post, we reported some of the major findings from Library House’s Q2 2008 Quarterly Briefing. The most significant of these was a 33.6% drop in investment in the most recent quarter across Europe, from €1.43bn in Q1 2008, to just €949m in Q2 2008.

This raises the question: are VC-Firms spooked by the credit crunch and the resultant change in economic conditions, and as such holding off on making investments? Or are they being more selective in the types of companies or sectors that they invest in?

To further explore this we interviewed a few VCs to get their perspectives on the current investment landscape and whether this has changed compared to last year.

Some think that there has not been a visible effect of the credit crunch in the VC investment market. Balderton Capital co-founder George Coelho, who recently joined cleantech-focused Good Energies, thinks that nothing has changed, with VCs still being busy in both Europe and the US. With regards to the Cleantech sector, he stated that there also hasn’t been an effect so far, with lots of competition for deals. He also said that although the amount of investment for web companies may be affected, he is not worried about the impact of the credit crunch and economic downturn on the VC field overall.

However, other VC’s are less optimistic. Frederic Court, of Advent Venture Partners, believes that people are now being more cautious, with deals taking more time. He also believes that it could be harder for early stage companies, and companies which raised early round funding 2 years ago and are now seeking to raise funding in the near future.

Interestingly, Mr Court also thinks that the IPO market is closed at the moment, which is supported by Library House data. Many entrepreneurs are also moving to the view that a trade sale is the most likely exit option in the short term.

The increased caution of investors has been apparent from other VCs that we have spoken to. Nic Brisbourne, of DFJ Esprit, also believes that investors are being more cautious in certain sectors, particularly ventures associated with the financial sector. He said that VCs are aware of the general economic climate, and will focus on sectors that are likely to be unaffected by the economic downturn.

The underlying messages were positive, which is testimony to the robustness of the sector. All of the VCs that we spoke to believed that good companies will continue to receive investment, no matter what the economic climate. The view was that whilst there will probably be a slight decline in the VC investment market, as caution takes hold, this won’t be anything like the significant downturn that was witnessed in the financial sector.

All this suggests that VCs are not spooked, but are rather aware of the current economic climate, and are tending to be more selective in the sectors in which they operate, and the deals that they make. It will be interesting to see how this plays out in the coming months and whether Q3 2008 figures show signs of an upturn.

Library House recently compiled figures for Q2 2008 European venture capital investment. The quarter saw VC investment fall significantly across Europe, from €1.43 billion last quarter, to just €949 million this quarter, representing a drop of 33.6%. This is also much lower than the corresponding quarter last year, when €1.3 billion was invested.



The number of deals across Europe during the quarter was also down on previous quarters. There were 357 deals in Q2 2008, compared to 447 in Q1 2008, representing a drop of 20% on the previous quarter. This was also 13% less than Q2 2007, which had 410 deals.

However, it is not all doom and gloom. Most VC investors are up beat about the current venture market, but uncertain economic times have been delaying some investment decisions, especially for first rounds. Many of the investments in the quarter were directed towards follow on investment rounds, in more established companies where capital has already been committed. It seems a short spell of risk aversion and consolidation is taking place. Deal activity so far in Q3 2008 indicates a bounce back in the current quarter could well be on the cards.

Top 5 deals roundup

Top deal of the quarter was UK-based Apatech, one of the world leaders in synthetic bone graft technologies, receiving a 5th round funding of €29.4m on the 16th of June. The second biggest deal was a substantial first round of €28m to a pioneer in Internet retail, Nedtherlands-based Netretail Holding, in a syndicated deal involving 3TS Capital Partners and Intel Capital. Other deals making up the top 5 of the quarter include a second round €27.5m deal for biopharmaceutical firm Apogenix, a €25.9m 4th round funding for Israel-based Vascular Biogenics and a €25.4m 6th round for the well established UK-based Icera Semiconductor.

Top 5 exits roundup

Biggest exit was the €150m sale of Germany-based cancer drug developer U3 Pharma, to the Japan-based Pharma Daiichi Sankyo. Second was the €101.1m buy-out of another Pharma focusing on cancer treatments, UK-based PIramed acquired by Roche. Third was the €38.7m acquisition of Tech Track featured Sarian Systems, a UK manufacturer of mission critical IP routers, acquired by Digi International, and fourth was the €31.5m sale of mobile data backup solutions company ZYB to Vodafone. The fifth biggest exit was JacobsRimell, which was sold to Amdocs for €28.6m.

In the 12 months from Q2 2007 through Q1 2008, the most active venture capital investor in Europe was Germany’s High-Tech Gründerfonds Management. The German group was the most active investor both in terms of total deal activity as well as first-time investments (see Figures 1 and 2). High-Tech Gründerfonds manages €272 million from a combination of public and private-sector sources, including KfW Bankengruppe, Germany’s federal bank, as well as corporates BASF, Siemens, Deutsche Telekom, Daimler, Bosch and Zeiss.

High-Tech Gründerfonds operates using set deal terms, investing up to €500k in exchange for 15% of a company. The group offers the possibility of one additional follow-on round, though the large majority of its investments are new: 37 out of 43 deals it completed during the period were new.

KfW Bankengruppe itself, which runs a variety of investment and co-investment schemes, was the third-most active new investor during the year ending Q108, as well as one of the 10 most active overall. BayBG Bayerische Beteiligungsgesellschaft, a German state bank which runs similar investment initiatives to KfW Bankengruppe, also made both top lists.

KfW, BayBG and High-Tech Gründerfonds rank among the most active investors by all measures, but three more German investors figure in the top 10 most active European VCs by number of new investments. In the year ending Q108, Germany accounted for 6 of the 10 most active VCs by new investments, up from 3 out of 10 in the preceding year.

One of those VCs is the European Founders Fund, the investment vehicle of the Samwer brothers, founders of auction site Alando.de (acquired by eBay) and mobile content provider Jamba! (now part of New Corp’s Fox Interactive Media). In the year ending Q107 year the fund made 6 new investments; this past year it invested in 14 new companies.

Holtzbrinck Ventures, the corporate venture capital arm of German publisher Georg von Holtzbrinck, also went from 6 new investments a year ago to 14 new investments in the past year. Holtzbrinck Ventures and European Founders Fund collaborated on five of those deals: Adscale and AdiCash, two online advertising plays; deutsche startups, a news website covering tech businesses; MeinAuto, a website for automobile sales; and Internations, a social network for expatriates.

Wellington Venture Partners also cracked the top 10 list in terms of new investments, continuing its aggressive investment strategy. Over the past two years the firm has been amongst the top 25 investors by number of total deals and top 15 investors by number of new deals. 12 of its 14 deals during the year ending Q108 were new investments.

The string of new deals by German VC firms over the past year comes as some perennially active European VCs are scaling down their new investment activity. Just 28% of Sofinnova Ventures’ deals in the year ending Q108 were new investments, compared with 61% during the year preceding that. 3i also dramatically decreased its new investments, in keeping with the firm’s announcement earlier this year that it would wind down its involvement in early-stage venturing. 3i made just 6 new investments in the past year, compared with 19 the year prior - though 3i’s continued follow-on investment still places it among the top 10 most active VCs by total number of deals.

In March of this year, venerable Silicon Valley VC firm Kleiner Perkins Caufield & Byers announced it had ‘earmarked’ $100m (€64.2m) for worldwide investment in companies being created on Apple’s iPhone/iPod touch platform. The iFund is a partnership between KPCB and Apple, which will provide the firm with ‘market insight and support’.

KPCB is one among several VC firms tying up with platform providers, including the UK’s Eden Ventures and Salesforce.com with their Million Pound Challenge for companies developing on Salesforce.com’s Force.com platform; and Accel Partners, The Founders Fund and Facebook with their fbFund for Facebook application developers.

Investor interest in new platforms is understandable. As KPCB Partner John Doerr writes on the fund’s website, ‘A revolutionary new platform is a rare and prized opportunity for entrepreneurs, and that’s exactly what Apple has created with the iPhone and iPod touch… we think several new significant companies will emerge as this new platform evolves’.

In introducing AppFactory, their independent initiative to fund Facebook app developers, Bay Partners – another well-established Silicon Valley VC firm – make a similar point: ‘Facebook, in essence, became the social Operating System. Historically, the creation of an operating system, or platform, has led to a new economy which includes a marketplace of applications’.

It is also clearly in the interest of platform providers themselves to encourage development on their platform. This is the reason why Microsoft, Sun, Qualcomm, Nokia, Oracle and others run extensive partner programmes. Furthermore, platform providers often put their own money down to encourage early adoption of their platforms.

For example, Google Gadget Ventures is making $5,000 (€3,200) grants to Google Gadget developers worldwide, with the chance for winners to receive further seed investment of $100k (€64k) from Google. In Autumn 2007 Amazon.com ran the Amazon Web Services Start-Up Challenge to encourage development on top of its utility computing platform, which offers startups on-demand computing, storage and other facilities. The winner of the challenge received $50k (€32k) in cash, $50k in Amazon Web Services credits and an investment offer from Amazon.

For platform providers, spending cash on grants and seed investments to yield greater platform adoption is understandable. What is more difficult to understand is why VCs would put their own money on the line in these exercises. To generate returns VCs seek out the highest-potential startups – so why restrict prospects to just a narrow slice of the startup universe?

fbFund works much like Google Gadget Ventures, providing grants of $25k (€16k) to $250k (€160k) to Facebook application developers; however, the $10m (€6.4m) investment pool comes not from Facebook but from Accel Partners and The Founders Fund. The grants are open to companies globally so long as they have not already received VC funding; in return for the grants, Accel and Founders Fund receive right of first refusal for VC investment in the winning companies.

Eden Ventures’ challenge is set up as a competition rather than a fund; entries from UK and Irish entrepreneurs must be submitted by 7 July 2008 and the winner will have the chance to negotiate with Eden Ventures for an investment up to £1m (€1.3m) in exchange for at least a 20% equity stake.

Apple, Facebook and Salesforce.com are assisting KPCB, Accel & Founders Fund and Eden Ventures, respectively, with their investment screening processes. This suggests one reason for the creation of such vehicles on the part of VCs. The strategic insight offered by the platform provider coupled with “official endorsement” during the early stages of an emerging platform may be enough to counteract the downside of tying up funds for such a narrow purpose.

Furthermore, in the case of fbFund, Accel Partners and The Founders Fund are investors in Facebook itself - so they stand to benefit should the fbFund encourage overall adoption of Facebook’s developer platform, regardless of whether or not individual grantees succeed.

Two questions linger, though. The first is whether there are enough quality businesses being built atop these new platforms to warrant so much investment interest. fbFund, for instance, rejected all applicants from its first round of submissions in January 2008.

The second question is whether platform-specific funds are necessary or even advantageous for making investments into the most compelling startups developing on those platforms. Take the case of Camrivox, a Cambridge-based startup developing on Salesforce.com’s Force.com platform. The company’s products allow businesses to integrate their telephone equipment with Salesforce.com, so that when a call from a customer or sales prospect comes in their record will be automatically displayed on screen. Before Eden Ventures and Salesforce.com were taking submissions for their £1 million challenge, Camrivox had already raised £2.5m (€3.5m) in VC funding from CREATE Partners, Cambridge Capital Group, NESTA Ventures, IQ Capital Partners and others.

Throughout the current Web 2.0 boom, Microsoft and Yahoo! – joined by Google, TimeWarner’s AOL and News Corp - have driven the Internet M&A market and provided exits for numerous VCs and entrepreneurs. This weekend, however, Microsoft withdrew its largest-ever acquisition bid - for Yahoo! itself.

The saga may not yet be finished, since Microsoft could renew its bid after Yahoo!’s share price deteriorates and after disgruntled investors pressure the company’s management (Yahoo!’s top two institutional shareholders are already publicly fuming about the botched deal). Whether the Microsoft/Yahoo! merger is realised or not, one thing is clear: the discussion has sidelined two major acquirers of Internet startups.

Microsoft has been an extremely active acquirer on both sides of the Atlantic, purchasing European Internet startups such as Israel’s Kidaro, Norwegian enterprise search company FAST, The UK’s Multimap, and French mobile search company MotionBridge. Yahoo! has played an insignificant role in European Internet M&A to date, but is a key player in the US.

A platform business at heart

There is now press and analyst speculation that the nearly $50 billion (€32.2 billion) which Microsoft was prepared to pay for Yahoo! will go instead towards other acquisitions. The most commonly cited target is AOL, which TimeWarner appears willing to offload and which would provide the nearest approximation of the scale in the online advertising business that a merger with Yahoo! would have achieved. Yet smaller businesses have also seen their names thrown into the discussion: PaidContent suggests that online services like Facebook, Twitter or Digg are now possible acquisition targets for Microsoft.

These latter options are unlikely, because at its heart Microsoft is a platform business, not a content business. Like other technology platform businesses, from Oracle to Qualcomm, Microsoft’s business model is to ensure the dominance of its own software by making that software an essential part of other developers’ business models. This holds true not only for Microsoft’s Windows and Xbox platforms, but also for the company’s online advertising network, which is only as successful as the money publishers make using it.

Microsoft has clear ambitions to challenge Google as an online advertising network, and though Yahoo! would also have given Microsoft the US’s most popular web portal - Yahoo! web properties are more visited than Google’s in that country - the main driver for the proposed acquisition was for Microsoft to quickly build substantial scale in the online advertising business. Microsoft’s largest acquisition to date, the $6 billion (€3.9 billion) purchase of online advertising firm aQuantive in May 2007, provided Microsoft with a foothold but left the company with nowhere near the market share of Google, Yahoo! or AOL in either search or display advertising.

Furthermore, Microsoft has already tried smaller acquisitions in the space. Besides aQuantive, Microsoft acquired a slate of advertising companies over the past two years, including Israel’s YaData; the US’s AdECN, Massive and DeepMetrix; and France’s ScreenTonic. Yet what Microsoft needs now is scale, and Yahoo! and AOL are the only two players who can provide it.

Yahoo! preoccupied

As for Yahoo!, the potential merger has imperiled the company’s status as a major Internet acquirer. Firstly, Yahoo!’s engineering culture, reinvigorated 3 years ago through a series of critical acquisitions including del.icio.us and Flickr, has been crucial to the success of its more recent acquisitions. That culture is now at risk; as Om Malik points out, morale is undoubtedly low at Yahoo!, which will make retention of key employees a problem. Despite holding $2.61 billion (€1.68 billion) in the bank, Yahoo! will face inevitable challenges and potentially lawsuits from investors over the handling of the Microsoft offer, making immediate acquisitions difficult.

The silver lining is that neither a combined Microsoft/Yahoo!, a combined Microsoft/AOL or an independent Yahoo! are truly a match for Google’s online advertising business, particularly in search advertising. Any of those combinations would still necessitate the roll-up of additional online advertising networks, such as Germany’s Adconion Media Group, as well as the acquisition of innovative providers of advertising technology, such as Israel’s Kontera Technologies or Luxembourg’s wunderLOOP. Though neither Microsoft nor Yahoo! are likely to pursue smaller acquisitions in the short term, given time either could re-emerge as a buyer for European Internet startups.