Has Venture Capital in Europe finally arrived?

This is the question I hear the most having moved from Toronto to London 18 months ago to start Columbia Lake Partners. CLP provides growth loans to venture-backed companies in Europe, mostly those that have raised a Series A or Series B equity round. This gives us a good vantage point from which to observe a few of the trends in Europe.

On 21 March, CLP will sponsor a discussion on this topic at the London School of Economics (LSE). It’s an event you won’t want to miss - registration details here.

The evening will feature successful investors from Europe and the United States, including:

·      Byron Deeter, Bessemer Venture Partners  

·      Saul Klein, LocalGlobe and formerly of Index Ventures

·      Magnus Goodlad, Rothschild Family Offices (a limited partner who provides the capital for venture funds).

Felda Hardymon of Bessemer Venture Partners will moderate the discussion starting with a presentation by Professor Ulf Axelson of the LSE. Professor Axelson will present his paper citing new evidence on the success drivers of venture capital deals, contrasting results in Europe and the U.S. He will discuss the myth that Europe underperforms with respect to IPOs and has a stigma of failure. He will also address the differences in performance, which are explained in part by the United States benefiting from a deeper pool of serial entrepreneurs and more experienced VCs.

At CLP we have found that the tide is turning on these latter points. Evidence points to successful role model companies, increased talent to scale new companies and a new generation of European venture funds with significant capital to help fund startups to scale. With these ingredients in place we believe European technology companies are in a strong position to succeed in the years to come.

Europe is building large, role model companies.

The success of companies such as France’s Criteo, Denmark’s Zendesk or Zoopla and Monitise in the UK, which together employ over 4,000 people and are growing quickly, demonstrate that European companies do not have to sell before reaching scale. These success stories also show potential founders that it is possible to build a large company in these countries.

As a Canadian I know the importance of growing strong, native companies. In the 1970s our country had too many “branch plants” – American companies with offices in Canada but decision making from south of the border. These companies were good for employment but lacked the impact of native leaders like Magna, Barrick Gold or Newbridge Networks.

These leaders created employment both in-house and for a network of suppliers and service providers. The companies, in turn, were equipped to help other manufacturing, mining and technology companies thrive. Newbridge, founded by Welsh-Canadian Sir Terry Matthews, was a particular success that produced multiple spin-off software and hardware companies and venture capital funds.

Europe is building the critical management roles needed to scale companies.

As a company rapidly scales it has to quickly hire – and develop – a team that can successfully grow the business. Silicon Valley has long had a deep bench of talent. If you need a VP of Sales with experience growing ARR from $5 to $50 million you can find that person.

The good news for Europe is that these roles are getting easier to fill. Our portfolio companies Clavis Insight, Falcon Social and Showpad have all grown quickly with talent from Ireland, Denmark and Belgium respectively.

As role model companies grow through their stages of development, some staff will leave for smaller companies and take the lessons of successful growth with them. With that knowledge the next iteration of a company has a smoother path to success.

Take Berlin’s Rocket Internet for example. In eight years Rocket has grown to 30,000 employees across its network of companies. With that speed of growth, Rocket gave a large group of managers great responsibility early in their careers. A number of those managers have moved on with Berlin’s start up scene benefiting from their experience.

Funding is available and increasingly coming from a new generation of VCs.

Another sign of the current success – and signpost of future success - is the creation of a new breed of venture capital funds in Europe. The partners in these new funds are a combination of investors from US-style venture firms and company founders.

As the venture landscape in Europe matures, funds are beginning to specialize. This specialization from the likes of Point Nine (SaaS), Notion Capital (enterprise software) and Felix (the creative class) will lead to a better understanding of the challenges faced by the companies they fund and, in return, better outcomes.

And there are large funds. Six of the largest (Index, Accel, Atomico, Balderton, Index, Lakestar and Northzone) have raised a combined $2.5B since 2013. These larger firms have the firepower to help fund companies to scale. This capital removes a key barrier European companies had faced in the past.

Building companies is not easy anywhere. In Europe, the presence of role model companies, a growing talent pool and new generation of VCs with significant capital all help to improve the odds of success.

Legal documentation

The past several posts have detailed the main points of a venture debt term sheet. I hope you have found them helpful.

A term sheet outlines the basic business terms of a deal. I think of a term sheet as a more detailed version of how you would describe a deal to a colleague in a hallway conversation.

Once those are agreed to the lender’s legal counsel will draft the full set of legal documents.

Warrants

The returns for a venture loan come from two sources – cash (in the form of interest and fees) and equity (in the form of warrants). Warrants give the lender an option to purchase shares of the company at some future date for a specified price. Warrants are sometimes called an “equity kicker” because they can boost the return of a loan beyond the coupon and fees.

Observer status

Best practice for a lender would be to sit as a board observer. There is no substitute for being in the room to see and hear how management presents the business, how the board/investors respond and how the group thinks about the issues at hand.

There is also no substitute, when a company is young, for managing with a small, focused board. Sometimes having fewer people in the room can lead to more frank, and efficient, discussions.

Financial covenants

A financial covenant is a company performance threshold placed into a loan agreement by the lender. A loan funding a leveraged buyout, for example, may require the borrower to generate cash flow of at least $10 million. The lender will ask for this knowing that of the $10 million cash flow, a portion will be used to pay taxes, to pay interest, to pay down principal and a portion will pay for capital expenditures needed to maintain and grow the business. Anything left over provides a buffer to protect from a downturn.

Interest rate

The interest rate is the headline number in any venture loan. If the return from warrants is modest or zero the majority of a lender’s return will come from the interest rate. For that reason it is a main point of negotiation.

In a standard deal the rate is shown as a fixed annual percentage, paid monthly. If the annual rate is 12% the monthly rate will be 1%.

Last payment due on the first day

The standard 36 month amortizing venture loan will ask for the first principal payment at the end of Month 1 and the final principal payment at the end of Month 36.

Some loans will ask for the last principal payment (and possibly even the first principal payment) at the time of funding. This is a holdover from the days of venture leasing and is similar to the last month security deposit required by landlords.

Tranches

There are times when the lender, or the company, prefer to fund in tranches rather than all at once. The structure of a tranched loan will differ based on whether a tranche is drawable at the lender’s option or at the borrower’s option.

This structure is typically preferred when the requested loan size is large relative to a company’s current profile. 

Availability

Availability. Most lenders will prefer for all of the loan to be drawn at the Closing Date. Exceptions are tranched loans or delayed draws.

Companies often find the easiest time to raise venture debt is when they are closing an equity round (in particular, an equity round with a new outside lead investor). Some venture lenders will only fund at the same time as a new equity round.

For the lender the new equity is valuable for a few reasons:

Costs

Costs. The borrower will be responsible to pay its costs plus the legal and out of pocket costs for the lender.

The borrower is typically responsible to pay its and the lender’s legal costs plus any out of pocket costs incurred by the lender. The lender’s expenses could include due diligence trips, consultants (some lenders will bring in an accounting firm to study the financials or audit collateral such as receivables).

We don’t like spending more than necessary to close a transaction.

Closing date

The next several posts will cover general terms of a venture debt term sheet. Please feel free to ask questions in the comments section below.

Closing Date. The date the legal documents are finalized, conditions precedent have been satisfied. The loan can be funded at this time.

When a company and lender sign a term sheet they should both be focused on closing the transaction.

Venture debt terms

Despite billions of dollars of venture debt deals funding every year there is surprisingly little information available about these loans. I hope that these posts can help fill the gap.

One of the first, and natural, questions a CEO/CFO will ask is “what are your terms.” This is different than “send me a term sheet, I’m ready to negotiate a deal.” I always take it more as an indication that the initial call/meeting has gone well and the CEO/CFO feel comfortable enough to get an early check of how a deal might be structured.

Let's cover general terms. Each company has its own needs and each financing is unique, but most venture loans have most of these general characteristics.