Martin Gagen is spearheading the expansion of one of Europe's largest venture capital firms, 3i, into the US. From a standing start a year ago, 3i has invested $200m in US IT startups and has already expanded beyond its beach-head in Palo Alto, Silicon Valley, to Boston's booming IT corridor. It plans to build a multi-billion dollar business in the US, tapping deals with the country's most-promising entrepreneurs by offering them the opportunity to take their businesses global via 3i's global presence, which spans 40 countries. A former executive director of 3i's UK business, where he masterminded technology investments for four years until 1999, Gagen tells Stephen Phillips about the differences between the US and European VC markets, US funding trends that will cross the Atlantic and the current funding outlook for ambitious e-business startups.
Why is it important for venture capital firms to have a global footing?
Most of the lucrative markets are, by definition, international. Meanwhile, technology is emerging everywhere. Good VCs enable companies to scale, and you cannot do this on a national or regional basis anymore. However, it's only recently that many [US] VCs have woken up to this. The US still represents the best eco-system for VC investing. It's got everything - outstanding academic institutions, a big pool of entrepreneurs, lots of VC money and, finally, a very liquid public market in Nasdaq. This makes it possible to accelerate the growth of a company very quickly. When you look overseas you see that some of these conditions exist, but not all. What this has led to [in the US] is a very introspective nature among the VC community. They have not needed to look outside, and, frankly, could make more money focusing on the US market. However, alongside 3i, new VC entrants like the investment banks and corporates, such as Dell Ventures, operate on a far more international basis than long-standing VCs.
What differences are there in the way VCs operate in the US versus the UK and Europe?
US VCs tends to look at everything with a view to creating capital value. Their test is: "Does this increase the valuation of the business?". So they spend a lot of time fundraising, making strategic introductions and alliances and contact-building. They are quite useful on issues that, in the short term, add capital value. For example, you will see a US VC pushing for an IPO and filtering funds towards that goal, while anything that doesn't add to the timetable of going public has less priority.
Generally, in Europe, [VCs] are more concerned with the effectiveness of management and that the technology is sound, plus they will take a longer-term view of return on investment.
What does 3i look for from entrepreneurs/start-ups?
The market opportunity has to be big. Also, there has to be a profitable end-game - it's appropriate for there to be a growth period, when a company is cash absorbing and unprofitable, but at some point it needs to reach a profit that will drive its ultimate value. The key, though, is top quality management. If you have this, they answer the questions about the business rather than the VC.
How does the route of many Internet company valuations affect the funding outlook/prospects of start-ups?
It was bound to happen. Valuations had got out of hand. Many of the companies had interesting products, but not sound businesses. What you're seeing now is an appropriate change in attitude. It's no longer possible to flip a company to the IPO market. Some of the last few years' deals reached IPO very quickly so VCs didn't have to take responsibility for some of the things they do now. So they are reverting to business fundamentals, taking responsibility for scaling the company, which means recruiting more extensively than before. They are also allocating more funds to follow-on investments in existing investments. I know at least three major [US] VCs that have allocated half their available funds to current portfolios. That's a huge redirection of capital, which is making it hard for new entrepreneurs. Another development is down-rounds. This is where a succeeding round is less than the previous one, unlike the usual progression in valuations. Lastly, companies are having their funding stopped because VCs are unable to give them the money they need.
What developments and trends under way in US VC funding do you pick to turn up in the UK?
In Europe I see a mimicking of some of the US disciplines, [particularly] the focus on scaling companies aggressively. The US has a degree of ambition that many people in Europe don't share. The other trend is that Europe has gone through a huge expansion. There's something like 1,000 VC firms who've raised vast amounts of money and over the next few months they will see the same correction that the US market has just gone through. You'll see [continued] failures in the incubator movement, for instance.
What are the differences between the entrepreneurs and start-ups you are seeing in the US versus those approaching 3i in the UK/Europe?
US entrepreneurs are trained to present. You get slick presentations but, unfortunately, there's no correlation between talent and presentation. So you have to get behind the slickness. As a terrible generalisation, European companies are far worse at putting their case across. You'll get a proposal that on the face of it doesn't look good but once you dig looks better. The other main difference is that US entrepreneurs are far more ambitious for their personal wealth. If you make $50m as an individual in the US, that just about makes you credible and you want to go and make some more. If that happens in Europe, people say, "That's it, I'm done."
What lessons can firms in the new economy learn from the old economy?
The main lesson is you don't build a great company on technology alone. What dot-coms can learn is that you need people who are good at logistics, sales, production, and finance - all the things people assumed you didn't need in the internet age.
CV: Martin Gagen
Education: Politics degree from Hull University
1978-1982: Accountant with Arthur Andersen, specialising in multinationals and growth companies
1983: Raised VC for software startup, joined 3i, working in Leeds and London
1988: Brokered large international deals for investment firm, Investcorp
1989: Returned to 3i, spearheading East Midlands then Yorkshire operations, becoming a director in 1990
1995: Appointed Executive Director of 3i's, UK, heading IT investments and leveraged buyout businesses
1999: Appointed president and CEO, 3i, US
www.napster.com : Music download site
www.bloomberg.com : Financial and technology news service
www.ventureone.com : Venture capital market researcher
www.nasa.gov : US space exploration agency
www.nationalgeographic.com : National Geographic magazine
This was first published in January 2001