Raising Venture Capital Finance in Europe

The private equity industry raised $248bn in funds worldwide in 2005, as shown by the annual PwC global private equity report.

The trend appears to be for mega funds, with funds for buyouts in the range of $15bn to $20bn raised by international private equity firms such as the Blackstone Group, Kohlberg Kravis Roberts (KKR) and Texas Pacific based in the United States, and Permira based in Europe.

A recent study by Deloitte showed that private equity has the firepower to acquire 43% of the FTSE 100 in the UK. In fact private equity firms have already acquired many leading companies in the UK such as Birds Eye (formerly part of Unilever), Debenhams, Travelex, Kwik-Fit, Saga, the AA, Le Meridien hotels (now part of the Starwood group), NCP and many more.

With the huge funds now available to private equity, and particularly if the large private equity firms pool their resources in so-called 'club' deals, the industry has the ability to make substantial future acquisitions.

THE CONTRIBUTION OF PRIVATE EQUITY

The creation of value for investors involves more than just funding and, at both the smaller and the larger ends of the investment spectrum, private equity firms can contribute to the growth of the companies that they back in many ways. Whether by using their experience to provide support to the management teams, or by providing guidance on strategic or operational issues, private equity firms will usually be a source of considerable help.

As shown in the BVCA's publication the economic impact of private equity in the UK, published in November 2005, four out of five companies sampled felt that their private equity backers had made a major contribution to their businesses over and above the provision of money.

Private equity can promote economic growth and create jobs. Studies by the BVCA show consistently that employment rises by up to 20% when private equity is involved. Around a fifth of UK private sector employees are now employed by companies that have received funding from private equity firms.

EUROPEAN VENTURE CAPITAL AND TECHNOLOGY INVESTING

Apart from the height of the dot-com / internet era in the year 2000, much of the recent growth in the private equity industry has been focused on management buyouts, with the bulk of the monies currently being raised for the industry designated for this area.

In 2005 over 80% of all funds raised in Europe were expected to be allocated to buyouts, compared with just 15% to investments at the venture capital stages. This contrasts with 65% for buyouts in 2004 and 32% for venture capital.

However, in terms of the numbers of investments actually made, as opposed to absolute amounts, 8,152 investments were made at the venture capital stages (75% of all investments by number) and 2,366 were made at the buyout stage (22%). This simply reflects the vast difference in deal size between venture and buyout investments.

Investments at the venture stages of investment (seed, start-up, other early-stage and expansion) can realise exceptional returns for the experienced venture capital investor.

All the criteria are currently in place for an upturn in the venture capital and technology industry, including increased spending on information technology as infrastructure requires renewing, improved earnings of the international technology-based corporations, a more active mergers and acquisitions market, an increase in the number of flotations on the European stock markets (especially on the London-based alternative investment market or AIM) and a less risk-averse, more entrepreneurial approach among Europeans looking to start up and grow their own businesses.

Many of today's leading technology companies have received venture capital backing at some point in their life cycles. In the United States these include Amgen, Apple Computers, Cisco, Compaq, Fairchild Semiconductors, Genentech, Google, Intel, Lotus Development, Netscape, Oracle and Yahoo!

In Europe we have perhaps fewer 'big name' success stories. Skype is a recent example. Skype, backed by Index Ventures, was sold to eBay for $2.6bn in 2005. The German solar cell company, Q-Cells AG, backed by Apax, went public in early 2006 and was reportedly the largest single capital gain made by a European venture capital firm since the dot-com boom.

Examples of other venture capital and, in the wider context, private-equity-backed companies in Europe in a variety of industries include: Actelion, Antler, Autonomy, Benjys, Ben Sherman, Cambridge Silicon Radio, Earls Court and Olympia, Filofax, First Leisure, Focus Wickes, Halfords, Kwik Fit, Legoland, Linguaphone, Ministry of Sound, New Look, Nexagent, Oxford Glycosciences, Pinewood – Shepperton Studios, Plastic Logic, the AA, Waterstone's and Yell.

THE ADVANTAGES OF PRIVATE EQUITY

Private equity is invested in exchange for a stake in your company and, as shareholders, the private equity firm's returns are dependent on the growth and profitability of your business.

Private equity is a medium to long-term investment providing a solid capital base for the future, to meet the growth and development plans of your business. Unlike a bank loan, there is no repayment expected during the term of investment and no interest costs. There are also no charges on your business assets or security required on your personal assets, such as your home, and no personal guarantees required from you or your fellow directors, any or all of which may be required by a bank lender.

A bank may in extreme circumstances even bankrupt you, if you have given personal guarantees. Debt which is secured in this way and which has a higher priority for repayment than that of general unsecured creditors is referred to as 'senior debt'.

The private equity process and subsequent period of investment provides a true business partnership with a venture capitalist who shares in the risks and rewards of the business along with the entrepreneur. A bank lender has a legal right to interest on a loan and repayment of the capital, irrespective of the success or failure of the business.

The private equity firm is rewarded by the company's success, generally achieving its principal return through realising a capital gain through an 'exit' which may include:

• Selling their shares back to the management
• Selling the shares to another investor (such as another private equity firm)
• A trade sale (the sale of company shares to another)
• The company achieving a stock market listing

The provider of debt (generally a bank) is rewarded by interest and capital repayment of the loan.

The private equity firm should also provide you with advice and expertise during the investment period by providing guidance on strategic or operational issues, introducing you to their network of contacts, which may include potential customers and suppliers, or helping to fill gaps in your management team.

The private equity firm will seek to increase a company's value to its owners, without taking day-to-day management control. Although the entrepreneur will have a smaller share of the total equity in the company, within a few years that share should be worth considerably more than the entire company was worth before the venture capital investment.

Edited extract from Raising Venture Capital Finance in Europe, by Keith Arundale. Hardback, pp334, published by Kogan Page, £45.