Old World, New Economy

SAN FRANCISCO (02/08/2000) - It was a scene only a venture capitalist could love. In January more than a hundred Harvard MBA candidates jammed into a stuffy lecture room during a technology conference at the campus of the London Business School. They were there to ask a panel of European VCs the essential question: How do I convince you to give me millions of dollars for a business plan drawn on the back of a napkin?

For the European VCs this was like shooting fish in a barrel. There is so much entrepreneurial activity in Europe now that the people with the money are having a hard time catching up. The Internet is skyrocketing here, its growth spurred by a few notable local successes, by the emergence of Web stocks on European public markets and by the opinion in the U.S. that Europe is the next big thing on the Web.

But you still have to build those Web businesses. And that's where many VCs here are behind.

"In Europe there's been little idea of how to build a great Web site," says Adam Valkin, an associate with Arts Alliance Advisors, a London VC firm. "And a lot of venture capitalists here wouldn't know where to start in helping a company build one. That makes it easy for good VCs to differentiate themselves."

European venture capitalists are finally realizing that they need to get up to speed - and fast. Most pundits estimate that the European Web market trails the U.S. market by one to two years, which indicates that both public and private financing of Net companies will likely explode this year.

Gauging the size of the Internet VC market in Europe as it stands now is difficult. The European Venture Capital Association doesn't break out Web financing details from its high-tech totals, and it hasn't released figures since 1998. But the momentum is clearly there: High-tech VC investments rose 28 percent from 1997 to 1998, according to the European association.

The growing sophistication of the market is showing in ways familiar to VCs in the U.S. Already in Europe, for instance, the notion is emerging that there is "smart money" and "dumb money." While the two kinds of cash are different - smart money usually comes from a firm with partners who have operating experience and many international contacts; dumb money is cash and little else - smart money needs dumb money, and vice versa. The argument goes that the smart money will fund the very best companies and the dumb money will fund nearly everyone else, creating a market for the top-tier players.

"It's really market share vs. mindshare," says Christopher Spray, senior principal at Atlas Venture in London. "What we as a firm need to do is to have a great mindshare position so we get the best deals and rely on the rest of the firms to create a stable market."

Atlas is a good example of a firm bringing the U.S. investing style across the pond. The company has offices in Europe and in the U.S. - in Boston and Menlo Park, Calif. - and splits its investments evenly between the two markets. Its most recent fund, its fourth, totaled $400 million; it was expected to close its fifth, totaling $750 million, at the end of January.

But the numbers tell only half of the story. Walking into the Atlas offices in London feels a lot like a visit to one of the myriad VC offices on Sand Hill Road in Silicon Valley. There's the same modernist furniture, the copies of the Wall Street Journal and the Financial Times in the waiting area, and the endless stream of partners hustling from one meeting to another.

While the offices are decidedly Americanized, though, the European public market that the VCs here are counting on is not. But this too is changing. In February 1999, NetVision, a Belgian Internet security company, went public at about $12 a share and soared to around $70 before closing at about $48 a share on Belgium's Easdaq market. In October, Tiscali, an Italian Internet service provider, went public on that country's Nuovo Mercato for small, high-growth companies. It raised about $161 million and had an initial market capitalization of around $718 million.

Then there's Freeserve, the U.K.'s biggest Internet company. Freeserve, which provides free Internet access, was launched by British electronics retailer Dixons Group in September 1998. By November of that year, according to Dixons, Freeserve had signed up 475,000 subscribers. Eight months later came its IPO on Nasdaq and the London Stock Exchange. On its first day of trading Freeserve's market capitalization soared to $3.29 billion. That'll get the attention of any entrepreneur.

According to VCs in Europe, IPO fever has dramatically affected their deal flow. While some naysayers still complain that these Net companies have no profits and can't justify their lofty initial valuations - as critics used to, and to some extent still do, say about Web stocks in the U.S. - they're missing the larger point, which is that these success stories and the accompanying press coverage draw talent and capital into the market.

"The press coverage of the stock market has made a lot of business school graduates give up their careers at McKinsey," says Pierre Morin, a partner at Global Retail Partners in London. "Those who work in older European companies are looking at the markets and starting Web businesses."

The hot public market for Internet companies in Europe shows no sign of cooling. There are more IPOs in the pipeline (notably one for Lastminute.com, an e-commerce site that has ads on practically every double-decker bus in London), and the banks are anxious to take any company with an Internet business public, and soon. Says Barnaby Terry, a director with Elderstreet Venture Capitalists of London: "Everything we hear from Goldman Sachs and Morgan Stanley is that they want more companies quickly."

The only brake on this train is European buyers' institutional bias against Web stocks. Europeans are traditionally more conservative than their U.S. counterparts. "We're lacking a bit in savvy institutional investors. There's been a lot of skepticism in the market, but they are learning from examples like Freeserve," Atlas' Spray says. "But the U.S. bankers are saying their institutional investors who had successes with Yahoo and Amazon.com in the States are just now looking to Europe as a good opportunity."

The European Web finance craze isn't all good, however. The VCs observe that the mania has led to a lot of garbage pitches from entrepreneurs who say, "We want to start the music site of Denmark," for instance, or, "We want to start the pet e-commerce site of Germany." Many of the top-tier financiers have already moved on from the predictable business-to-consumer e-commerce copycat plays to more ambitious startups, some in the business-to-business market. In this way the market is learning from what has and what hasn't worked in the U.S.

"In the first quarter of 1999, the penetration level of the Internet got to the point where finding bankable Internet companies was no longer an issue, so the market became very noisy," Spray says. "We have to skim the cream off the top and look for deals that are more pan-European in scope."

But a truly pan-European company is not so easy to find. Ironically, the Web company that's made the most headway in markets that cross the continent's tricky cultural and physical borders is probably Yahoo Europe. For the VCs, there have not been many success stories of this kind. Most are putting their cash in things like travel sites, figuring that everyone everywhere needs a holiday.

Many European VCs say the biggest, but perhaps the least tangible, change in the business environment here is the culture. To be sure, the people who write the checks have benefited from what some would guardedly call the Americanization of the European businessperson.

"The entrepreneurial spirit has gained momentum in Europe," says Hendrik Brandis, partner at Earlybird Venture Capital, based in Germany. "There was a time here when it wasn't so highly regarded to be an entrepreneur." "In the States, being an entrepreneur is in the fabric of the culture," adds Dominique Laffy, a principal at Global Retail Partners. "In Europe it's never been rewarded. Here, if you failed you were dead."

As the Internet steams ahead in the Old World, however, it will likely be the VCs who don't try who will fall by the wayside.

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