Fredrik Cassel, Class 12
As venture investors, we require our entrepreneurs to know their market. In fact, one of our first actions is to ask them detailed questions such as, how large is your market? How fast is it growing? Can you grow without taking someone else’s business or do you need to kick another supplier out the door to win a new deal? How many companies of your kind does the market support?
It is rather surprising, then, that few venture investors can answer those questions for their own operations. In this sense, we steam ahead as if the market was endlessly large. Although that might have been close to true at certain points in history, during the last decade most fund managers have experienced something very different—a contracting market.
The business-school recipe for contracting markets is to look for new segments or opportunity pockets. Venture funds, perhaps because they do not recognize the problem as related to market size, seem to instead change their assembly line or sourcing strategy. Many move from early stage investing to later stage and supposedly lower-risk companies. While this could have its merits in the short term, it does not grow the market and is not likely to address the core need to expand the venture market for U.S. companies.
Raising separate funds for investing in China or India has grown popular for funds large enough and self-confident enough to attract good fund managers in new geographies. This choice produces promising additional returns for their investors, but since these are separate funds, they do not impact the performance of the local venture asset class and therefore also do not address the contracting U.S. market.
For certain firms, the market is distinct: at Creandum we invest in the best tech companies from the northern European region, in both early and growth stages. The available market is thus made up of returns to investors from companies originated in this region, as they are sold or publicly listed. We have done the homework we ask our entrepreneurs to do. Knowing our market is a great competitive advantage, both when investing and when attracting investors to our funds. In this article, I share what we have learned and consider one means of expanding the U.S. venture market.
The location of value created for venture funds has shifted over the last decade. Value is no longer completely U.S.- or Silicon Valley-centric: only one third of the really successful exits in past years have U.S. roots. Two thirds of significant successful exits have been Asian or European companies, and within Europe, numbers indicate that the Nordic countries represent some 25% of large, “home-run” exits.1
Our research identified three significant descriptors of the Nordic market. First, our market is growing slowly, but it is growing. It is comforting to see better returns to venture investors during the last cycle than during the preceding one around the millennium bubble—despite the lack of proper IPO opportunities and the abysmal business climate during 2002–2004.
Second, our market is limited: at most, large enough to support 5 pan-Nordic firms raising €125M funds every 3-4 years. The Nordics have gone through the same shake-out of venture fund managers as the United States; however, in the Nordics capital overhang never was that large and venture capital performance was not based on the 10x fund multiples sometimes seen in the United States in the 1990s. It has therefore been an easier task to properly manage expectations here, and with the number of active fund managers now approaching what should be the right level (according to our market sizing analysis), our confidence is high in both our own performance and that of the Nordic venture asset class.
Finally, and most significant to this discussion, our market is heavily dependent on companies being sold to U.S. acquires. The market data we gathered show that companies sold to the United States are, on average, priced at 75% higher revenue multiple, merit 30% higher exit value with 25% less headcount, and are sold 13 months earlier than those sold outside the United States.2
This is where it gets interesting. The data and our case-study interviews show that a U.S. investor’s primary value added to non-U.S. companies is the stamp of approval their brand name gives. A U.S. brand among the investors changes the game plan radically for the most critical task of U.S. market entry—recruiting.
Past successes and failures highlight several critical lessons from attempts to enter the U.S. market. First, the traditional strategy is to hire a headhunter to find a CEO for the U.S. operations and then train that CEO at the non-U.S. headquarters. This strategy has almost always failed—data show a very high risk of overpaying for an underqualified resource. Instead, one of the founders or a long-time CEO should be located in the United States with the task to break open the market and build an organization to replace him—this strategy has in general proven much more fruitful.
Second, another successful strategy is found with companies who have built their business and reputation large enough outside the United States to pinpoint—through their own organization—key recruits in the U.S. market. However, this approach is not realistically achievable for small organizations and has primarily been successful for internationally experienced management teams, who have inroads to qualified potential recruits on the right level.
A third successful, complementing building-block is backing from a U.S.-based investor. Here, instead of relying on headhunters or a network built from abroad or locally from the ground up, the company can attract A-list applicants right from the start. Quality recruits’ desire to work for a young company from a remote corner of the world can be radically affected by the backing from a brand-name U.S. investor. Almost all testimonies told the same story: with a U.S. brand, the company can access a much better pool of talent more quickly, without having to build its own reputation first.
Unfortunately, the appetite for U.S. investors to invest in non-U.S.-based companies has been limited, and required imminent plans for the company to relocate management. For instance, only one in seven companies from the Nordics that sold for more than €50M to U.S. acquirers has had U.S. venture capitalists as owners.3 This is a number we believe should be much higher, to the benefit of both U.S. and Nordic venture investors.
From the angle of expanding the U.S. venture capital market, the fit is excellent. Companies with proven business outside the United States looking to enter the U.S. market offer an ideal means for U.S. venture funds to grow their market without adding significant risk to their portfolio. A U.S. brand adds value both from the start and in terms of increased return on investment—the potential is evidently huge at the same time that the downside is limited. The business is proven in other geographies, can be valued based on fundamentals such as past performance and traction outside the United States, and significant upside remains from the influence of the new investor.
We foresee an increasing number of cross-Atlantic transactions along these lines and are working hard to make that happen. We have everything to gain from improving the statistics of U.S. venture capitalists participating in Nordic companies and so, we believe, have our U.S.-based colleagues.
Fredrik is a General Partner at Creandum of Stockholm, Sweden, where he serves on the Boards of Cint, Spotify, and Videoplaza, among others. Fredrik joined Creandum after heading the Internet search division of two publicly listed north European online publishers, Scandinavia Online and the Yellow-pages/ Internet search firm Eniro, which acquired Scandinavia Online. Fredrik holds a Master of Science in engineering physics, specializing in materials physics and semiconductor physics. He studied at the Royal Institute of Technology in Stockholm, Sweden and at the EPF in Lausanne, Switzerland. He speaks five languages.
1 Creandum, Nordic Technology Exits (Stockholm, Sweden: Author), 2010; Dharmash Mistry, “Building Global Companies,” as presented at the Nordic Venture Network Annual Meeting, May 2009; VentureSource data service, Creandum, Venture Capital Investments in Nordic Companies 2000–2006 (Stockholm, Sweden: Daniel Blomquist, Carl Sunesson), 2007.
2 Creandum, Nordic Technology Exits.
3 Creandum, Nordic Technology Exits.