Robert Smyth in Budapest -
When US IT giant Cisco Systems decided to invest in budding high-tech firms in Central and Eastern Europe late last year, it turned to regional venture capital veterans 3TS Capital Partners to point the way. Pekka Maki, managing partner of 3TS, told bne that three or four more investments are expected this year, to add to the first investment made in November, in which 3TS participated in a €2m investment into Romanian email server specialist GECAD-Axigen in return for an 11.8% stake.
For this investment, 3TS and Cisco created the co-branded 3TS-Cisco Growth Fund III, which started with €30m in capital and could grow to €50-60m. This is the third fund under 3TS' management, bringing the VC firm's total funds under management to over €200m. 3TS also manages the €66m TCEE Fund and the €130m 3TS Central European Fund II. While Maki rates the investment outlook in CEE as very good, he wishes that for everyone's sake local entrepreneurs would be that bit more daring and start thinking outside the box.
Skills in CEE are characterized by a basis of solid math and physics education, enhanced by a "fair bit of creativity." This may lead to CEE programmers producing clever solutions when programming, but Maki feels that few come up with groundbreaking products. "There aren't many people here who can create something that changes the way the world does business. While they're creative on the level of creating architecture or programming, there's less talent in thinking what the software could be used for," he says, citing the example of free IP voice service Skype, which despite being programmed by Estonians, was the brainchild of two Swedes. "The concept is seldom local. I hope they will come up with better concepts in future."
Case in point is 3TS' investment in remote connectivity firm LogMeIn.com. The software for this firm, which allows users to access their home computers from the office, was originally a locally created administration and diagnostics tool for carrying out the remote access and servicing of computers, but it took American entrepreneurs, especially noted CEE investment specialist Mike Simon, to think up the idea to offer a hosted remote access service on an ASP (Application Service Provider) basis. The firm now claims more than 40m users worldwide.
Hands-on, not day-to-day
Since 2001, when 3TS opted to stop investing in risky seed capital prospects and concentrate on more mature rapidly growing companies, returns have been around three times, according to Maki. For the latest fund, Cisco is acting as the anchor investor, with 3TS contributing just 1% of the fund value but acting as the fund advisory company, meaning it makes the decisions on where the money will be invested. 3TS' formula since 2001 is simple: it searches for growth capital in the sectors that grow the fastest and companies that can grow faster than the competition in those sectors. It then brings in expertise and enough capital for companies to pursue further growth.
The sectors 3TS looks at comprise technology and telecommunications, media and marketing, environment and energy, and services including healthcare services and business services. The target companies are also in the growth sectors that are most likely to benefit from the catch-up process to the West or the pre-EU accession run-up in the case of the next wave of entrants.
3TS also looks to provide financing to companies that are expanding into the CEE region from outside and has invested in two Austrian firms: PXP software and renewable energy specialist Cycleenergy. 3TS' typical period of involvement is three to five years, while management participates in profits "above a certain rate."
"We're hands-on board members but not day-to-day managers," says Maki.
3TS also makes private equity investments, though is not in the business of making complete buyouts but rather supporting other investors.
A feature of the investment climate in CEE is that venture capital firms do sometimes have to battle against the perception that they demand too much in return for their cash. "Some people don't understand that money is expensive. Some companies see us as banks, but we can open doors that banks never can. We offer much more than money, but also a guarantee for success and introduce the company to people who can help them."
People have a fixed idea that they want to own 60% of company that's worth €1m, but think less about owning 20% of €20m, he explains. "No matter how much money is put in, people want to hold on to a large stake. Some of the wealthiest people on the planet have a couple of percent of the big companies. CEE business people are too obsessed with percentages and you have to ask where the level of ambition is."
Most people seem to be happy if their company is worth a couple of million and are not prepared to put the work into building their companies into something bigger, he asserts. Thus, it's an issue for venture capitalists that people aren't dreaming of becoming worldwide success stories. "After Bjorn Borg became Wimbledon Champion, he was followed by lots of great Swedish tennis players. Hopefully LogMeIn will spread the same kind of message in CEE tech circuits," he says.
However, the more the region evolves, the more entrepreneurs understand the role played by venture capital and get on with building companies. "We are seeing better ideas and there are more serial entrepreneurs emerging," says Maki. "Some are already onto their third businesses, so we're not only dealing with first companies set up by a couple of friends from university. Many entrepreneurs have been around the block and now much more people understand the role of venture capital."
3TS has made 25 investments across CEE, half of which are currently active. "There aren't major differences between countries, but rather between companies," remarks Maki. "Differences are evened out across the region and 3TS tends to work with internationally or pan-regionally oriented, although the larger markets of Poland and Romania can support domestically focused companies."
However, some countries are better at foreign languages, particularly in Romania where business can be done in most major European languages.
Of the next wave of potential EU entrants, look out for first 3TS deals in Croatia, Serbia, Turkey and Ukraine, hints Maki.
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