Part 3: The Incredible Shrinking VC Market
At the beginning of 2000, venture capital skyrocketed in Sweden and all over the Western world, then dropped in the first years of the new decade. Most VC markets then stabilized although they keep on struggling. The Swedish VC market has continued to shrink, also in the last five years when exciting new startups have been booming. To be fair, since the financial crisis in 2008 there is a downward venture capital trend (both fundraising and investments) in Europe, according to the European Private Equity and Venture Capital Association (EVCA).
It’s useful today to make a distinction between “formal” and “informal” capital. The formal capital is investment companies, public funds and the private equity and venture capital funds backed by institutional investors and pension funds (Limited Partners). This formal capital has typically provided the bulk of the capital.
The informal capital is angels, superangels, family offices, crowdfunding, incubators, accelerators and corporate ventures. The trend is that this informal capital is growing, while the formal capital is shrinking.
From the entrepreneurs’ perspective, there is also a difference between the formal capital and the informal capital. While formal capital can provide bigger funding, it is also more complex since by default it requires more rigorous structures involving preference shares, investment committees, lengthy due diligence processes and detailed agreements. The informal capital usually acts faster, since the decision makers usually are private individuals investing their own money based on gut feeling.
The “formal” venture capital investments in Sweden have decreased with an average of 20% per year since 2008, according to data from the Swedish Venture Capital Association. SVCA tracks private equity, VC funds, the government’s investments and direct investments from corporate venture capital firms and family offices with a fund for direct investments. Comparing the first half-year of 2012 with the first half-year of 2013, the decrease was even larger, a drop of 25%. This is more than the European average in the same period. In absolute amounts, Swedish venture capital investment in 2008 was 4.7 billion SEK ($670 million). In 2012 the amount had shrunk to just 1.9 billion SEK ($270 million). It was even smaller in 2013, down to 1.7 billion SEK, almost 10% from 2012 according to the SVCA. In the middle of a formidable startup boom.
SVCA does not track the “informal” capital from angels, superangels, individuals or family offices without a fund structure. This capital is substantial today, growing and replacing some of the capital from VC funds. There is no reliable data about the size of these investments, but the Swedish venture market is probably much bigger than the official number. Furthermore, the share of public and foreign capital is also increasing, making the profile of the pool of capital quite different today compared with ten years ago. The amount invested per company seems to be decreasing too. The number of investments is quite stable, but the invested amount per company is smaller – another European trend. One explanation is that startups simply don’t need as much money today to start, as software and distribution is cheaper today. However, to succeed in later stages still requires massive capital.
To summarise, the new face of Swedish venture capital is a mix of a few remaining VC funds and smaller boutiques, very few active limited partners, some government programmes and funds, rising angels, incubators, foreign capital, corporate VC and crowdfunding – and in this mix is the share of traditional VC capital backed by limited partners is significantly smaller than it used to be.
Why? There are two reasons. The first is obvious. Like in the rest of the world, venture capital has produced poor returns to investors. During the last ten years, most of the institutional investors have moved to later stages and buyout funds when allocating capital in alternative asset classes. But in their hunt for returns, several of these Private Equity firms acted so aggressively in the sensitive school and healthcare sectors that the resulting bad reputation made “riskkapital” (the Swedish general word for both venture capital and buyout) a politically impossible term to use, and much less politically possible support.
The other reason is about cash. Besides QlikTech, there has not been a major exit here in the last five to six years. According to research from Creandum, four Nordic companies (REC, Skype, QlikTech and MySQL) represented 7.5% of all billion-dollar exits globally in the period from 2005 to 2012, but most of these were long ago. New cash injections from major exits into the Nordic venture system would be a catalyst. There are least ten future un-exited companies with billion-dollar potential: Klarna, Avito, Rovio, Just Eat, Mojang, Spotify, Soundcloud, King.com and Zendesk. Rovio is rumoured to IPO in 2014. Supercell was successfully sold in 2013. King filed for an US IPO on 18 February.
At the beginning of 2000, there was a record of over 140 venture capital firms listed as members of the Swedish Venture Capital Association. That number is now reduced to three major players – Northzone, Creandum and state-owned Industrifonden. You might also add SEB Ventures, connected to the bank. In addition there are smaller boutiques, but not anywhere near the number of active funds around the turn of the millennium. New “formal/informal” VCs are entering the market like former QlikTech chairman Måns Hultman’s investment company Zobito in Malmö and Rovio founder Kaj Hed’s investment arm Moor in Stockholm. That’s good news. The money in these funds is essentially based on QlikTech’s Nasdaq-exit in 2010 and Angry Birds’ cash flow. There will probably be more VC funds launching in 2014.
The global top tier venture capital firms like Sequoia Capital, Index Ventures, Greylock, Accel, Kleiner Perkins, DST and Benchmark are all watching Stockholm and scouting for opportunities, but so far none has set up shop here and only made a few investments in more mature companies. When asked about his view on early stage investments beyond their own Bay Area neighbourhood, Sequoia partner Pat Grady said it’s unlikely that they would make an investment in the Nordics in a company with revenue below $20 million. That’s about the general principle among top global VCs. However, Sequoia participated in a quite early stage investment of $18 million in Swedish Trucaller, announced in 2014.
There is an urgent need for a highly functioning local venture capital market with an effective stack of players. Local capital can finance startups’ early and expansion stages A rounds, preparing companies for the later growth stage where international top VCs can step in with larger B and C rounds, syndicating with local VCs. Data shows that Nordic companies are still primarily financed by Nordic VC, while foreign appetite is increasing. The foreign share of VC investments is up from around 10% in 2010 to 30% in 2012, according to data from investment bank GP Bullhound.
“We definitely see a trend. More US venture capital and growth equity investors are looking at the Nordic region. They first come to Stockholm, then go to Berlin and back to the USA. We have shown that we can provide value in the region, we have track record from successful companies and we have the ability to do it again,” says Per Roman, head of GP Bullhound’s Stockholm office.
The Swedish VC market can be viewed as an S-curve. On the left-hand side at the bottom of the curve we have the seed investments in the range of $10,000 to $500,000. Stockholm has a rather good eco-system for early stage and seed rounds, with networks of business angels (both from financial industry and successful entrepreneurs with lucky exits), public funds for smaller investments and loans, and the new crowdfunding platforms, most notably FundedbyMe. However, the seed financing “market” is not anywhere as transparent as in Silicon Valley with a critical mass of business angels and platforms like AngelList to match demand and supply. Aspiring entrepreneurs in Sweden must be well connected (which is not usually the case at the beginning of your career) or rely on the good old FFF – friends, family and fools. Or get help from agencies like STING with a network of some 40 business angels.
For much later stages along the S-curve, with the need for larger pools of capital for international growth, companies like iZettle, Rebtel and Wrapp that make the cut can access the international capital market and top tier VCs.
The bottleneck is the middle of the S-curve. Expansion capital in the range $1 million to $10 million is scarce. It’s the Swedish “valley of death”. There are far too few VCs that can act locally to bridge the divide from seed to international growth, with the muscle to finance promising startups in the middle stage.
We simply need more VC players to make a working and efficient market. If you do have a great startup with proof of concept and fast growth, but the VC funds happen to be fully invested at the moment or busy raising their own capital or at end of a fund cycle or already have a similar company in the portfolio, or have gone fishing, you won’t get funding anyway.
Although the “big three” are all competent, well connected and have backed decent companies, there is probably room for at least a league of “big five or six” local VCs to match current demand and opportunities.
Institutional investors like pension funds and insurance companies are slowly re-appearing as limited partners in venture capital funds, as alternative investments in early stage is gaining acceptance as an asset class again. There seems to be ready capital at hand. But according to Karl Swartling, CEO of 6 AP-fonden (The Sixth AP Fund), one of the Swedish pension funds that used to be one of the most active venture investors, the problem is a lack of VC funds to put money into.
“Swedish pension funds are often accused of unwillingness to invest in venture capital and blamed for the shortage. But we have capital to invest here, and would like to invest. The problem is that there are not enough VC teams in Sweden, with the ability to produce competitive returns. You cannot only look at the supply, but also the demand side,” he says.
But, does the new generation of Swedish entrepreneurs want Swedish capital? How do Swedish entrepreneurs view the local VC market? Many entrepreneurs testify to the challenges of raising capital in Sweden. There are too few investors to turn to, and there’s also the matter of size.
Alexander Yngling, a Norwegian living in Stockholm and self-proclaimed “Scandinavian”, is the founder of mobile restaurant payment app Waitress. “We would love to have Nordic investors, but we can’t find the kind of money here that you need to win globally.” It seems it is not only a matter of the pool of capital, but also the investment culture. “Swedish investors tend to be more risk averse. They look more at the pre-money side of the transaction and how much they will get now, trying to justify the price and protecting the downside, rather than looking at the post-money valuation and what they will get in five years,” Alexander continues.
So, what’s next in VC? Part 4 coming soon.