The credit crunch and resultant economic downturn has been with us for over year, and unfortunately shows no sign of changing in the near future. In previous EVI articles, we have looked at whether this has changed the behavior of VCs with regards to Exit strategy, and their general investment strategy.  In a continuation of this theme, this week, we look at whether their investment strategy has changed with regards to early stage companies.

We used our Library House database to compile data on the number of first round deals, which is a reasonable proxy for investment in early stage companies, and compared this to the total number of deals in each quarter.  To provide a representative view of investment before and after the credit crunch, we included data from Q1 2007 until Q2 2008. This is shown in Figure 1.

Interestingly, the number of first round deals in Europe remained fairly constant throughout 2007, apart from a 17% dip between Q1 and Q2, which was swiftly followed by a 24% rebound in Q3, and a stabilization in Q4 2007. However, the number of 1st round deals dropped significantly in 2008, with a 22% drop between Q4 2007 and Q1 2008, and a further 10% drop between Q1 and Q2. Given that the credit-crunch became firmly established in Q3 2007, this suggests that there has been an effect on investor behavior, but with a lag of around a quarter.  This could be because many deals for Q3 and Q4 2007 were already signed-off or in the process of being signed-off before/during the initial stages of the credit-crunch, and as such, the actual change in investor behavior in Q3 and Q4 2007 was only reflected in subsequent quarters.

In terms of the total number of deals, apart from a dip in Q2 2007, the numbers were relatively constant between Q1 2007 and Q1 2008 (a 7% drop) when compared to the number of first round deals, which dropped by 18% in this period.  However, between Q1 and Q2 2008, there was a 15.5% drop in the total number of deals, mimicking the drop seen in first round deals, but with a delay of one quarter.

This has several implications; firstly, that perhaps in a response to the credit crunch, VCs appeared to be turning away from first round deals, presumably because such deals are perceived as being riskier than later stage deals. This is supported by the observation that VCs were making similar numbers of deals in Q4 2007 and Q1 2008, but with a focus away from first round deals, with the proportion of first round deals dropping from 63.4% of all deals in Q4 2007 to only 49.7% in Q1 2008. Secondly, VCs eventually reduced their total deal activity beyond that of only first round deals, perhaps because by Q2 2008, the secondary impact of the credit crunch such as the slowing down of the global economy was becoming patently clear, and showing no signs of going away.

What this suggests is that the Q3 2008 figures will be vital in determining whether this is merely a blip on the radar, or a more longer-term downturn. However, what is clear is that even if this is a more permanent downturn, historical evidence suggests that the VC industry will bounce back as it has done on previous occasions of this nature. Better times will return, and, at least based on the current evidence, VCs are appearing to be cautious until this time.

The final step in a venture capitalist’s involvement in a portfolio company is the exit of the company that the VC firm has put its time and money into. This is the point at which VCs can recoup their investment, hopefully many times over.  Companies can exit in several ways, but a trade sale to another company, or an initial public offering are generally considered to be the most profitable.

Following the recent release of Library House’s Quarterly Briefing for Q2/2008, we explored the exits in this quarter, with regards to how many companies exited, and for how much, as well as examining the companies that made the most prominent exits in closer detail.

There were 63 exits by trade sale or IPO in Q2/2008, trade sales making up 60 of the exits, and IPOs only representing 3 exits. See Figure 1. Considering that there were 31 IPOs in the same quarter in 2007, this just serves as a reminder to the current IPO drought.

Of the companies that exited by IPO, French healthcare and life sciences company Ipsogen had the highest exit by value, issuing shares on the Alternet Paris Exchange in June 2008, resulting in a total market capitalisation of €31.9m. Ipsogen specialises in cancer diagnostics, developing and marketing diagnostic tests that profile the wide variety of cancerous tumours, helping oncologists to decide on the right treatment for the particular cancer. Ipsogen took six years from its first round to exit, having raised €11.36m in four rounds of funding, roughly providing a 2.8 times estimated return on investment. It is important to note this is on the lower scale for IPOs, and given that the company listed on the Alternet Exchange, the fact that the primary purpose of the IPO was to raise new investment cannot be ruled out.

Of the top five trade sales of European companies last quarter, deal sizes varied from €27.8m for the sale of UK IT company Jacobs Rimell to Amdocs, to €146.6m for the sale of German pharmaceutical company U3 Pharma to Japanese company Daiichi Sankyo.

Like Ipsogen, who had the largest IPO by value, U3 Pharma is also in the healthcare and life sciences sector. U3 Pharma is involved in targeted cancer drug development using antibodies, which is further upstream from Ipsogen, which is primarily focused on cancer diagnostics. U3 Pharma also took seven years to exit, having been founded in July 2001 and sold in May 2008, and raised €37m in three rounds of funding, resulting in nearly a four times return on investment.

The second highest trade sale by value was that of PIramed, also a Healthcare and Life Sciences company. PIramed, based in the UK, is also involved in developing novel cancer drugs, but this time using small molecule inhibitors of proteins involved in maintaining normal cellular function, which can go awry in cancer patients. PIramed exited in around six and a half years, and was sold to Roche in April for €110.5m. The company’s funders included JPMorgan Partners, Merlin Biosciences and Genentech.

It is interesting to note that three of the top five exits by value (IPO or trade sale) were Healthcare and Life Sciences companies focused on the treatment of cancer (Ipsogen, U3 Pharma and PIramed). It is likely that there will be continuing opportunities for these types of companies (and indeed all drug development companies) to exit in the future as there will always be a market for cancer/disease treatment irrespective of the economic climate.

Based on this evidence, the Healthcare and Life Sciences sector appears to be quite robust, and could be amongst the best placed sectors to weather economic downturn. It will be interesting to see whether the most lucrative exits by value in the next quarter are also similarly biased towards Healthcare and Life Sciences companies.

The path for a company that receives venture funding is well established. After incorporation, it receives a few rounds of VC funding to help it grow rapidly, then once it has reached a certain size, or market conditions are favourable, the company either exits by an IPO or a trade sale. In either of those cases, the VC firms that invested in the fledgling company before it became a major player, hopefully receive a substantial return on their investment. Of course, this is a simplistic view, with a myriad of other factors influencing a company’s development, but the end game is always the same for the VC – it get its investment back (and hopefully a lot more) when the company exits.

But just how much investment does it take for a company to IPO or have a trade sale? Are there differences in the amount invested for either of these outcomes? And are there any differences for companies that are in particular sectors?

To explore this further, we used our Library House database of venture-funded companies to calculate the average external investment received per company before it exits via a trade sale, or an IPO. We also looked at how some individual sectors differed, including Life Sciences, Cleantech and Mediatech.

Overall companies that exited by IPO received about 54% more investment than for those that exited via a trade sale. In some cases this could simply be because companies that exit via IPO successfully are generally larger than those exiting via a trade sale, hence requiring more investment to fuel their growth to reach this stage. Furthermore, companies exiting via trade sale can be purchased at an early stage of their development, to acquire their technology or personnel, rather than for the actual company per-se. This is particularly true of the software sector, where this approach has been pioneered by companies such as Google and Oracle.


Life Sciences and Mediatech companies follow the trend in requiring more investment if they exit via an IPO than by a trade sale, with Life Sciences companies requiring 31.5% more investment to exit via IPO, and Mediatech companies, 38% more investment. In Cleantech however, companies that exited via trade sale have received 39% more investment than those that exited via an IPO. This could be because incumbents are more cautious about buying earlier stage companies in this fledgling sector, instead waiting until the technology has been commercially proven. Another partial explanation is that some Cleantech companies seek early IPOs on AIM, as a means to generate capital to further technology commercialisation, rather than seeking continued rounds of venture funding.

Whilst trade sales are becoming an ever more common exit route, it remains that large IPOs are extremely important for a sector, increasing the number of players and helping drive innovation, competition and growth. This has positive impacts for both the sector, and the economy in general suggesting that holding a steady course to IPO should be encouraged. Without IPOs, companies such as Google, Apple and Yahoo! would never have become the powerhouses that they are today.

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.