Making the Index

July 24, 2007

Geneva venture firm Index Ventures has made some big early-stage bets. Luckily for the firm, and European VC, they’re paying off handsomely.

A major force in the rise of European venture capital, the IT-heavy firm has its own contrarian style. Index is neither a U.S. firm nor a family firm, though often mistaken for both. It not only weathered the post-bubble wasteland that hammered VC firms on both sides of the Atlantic, but thrived. And while there’s much talk of returns falling short lately, Index has been racking up exits and raising more money. Indeed, Index is enjoying the ride as European VC matures, exits open and serial entrepreneurs proliferate in Europe.

Index’s most spectacular exit was peer-to-peer Internet telephony startup Skype Technologies SA, for which it co-led an $18.8 million Series B round of funding three years ahead of a 2005 sale to eBay Inc. worth up to $4.1 billion in stock — a deal that reportedly yielded a 100-fold return for one co-investor.

“Skype really has been that stonking great exit that Europe needed,” says Charles Cotton, executive director of London research firm Library House Ltd. and a co-founder of Virata Corp., one of Index’s early successes. “Every venture capital firm globally stood up and paid attention to Skype.”

Skype, however, came after Index Ventures spent years building a record, exit by exit.

The firm traces its roots to 1996, when three Stanford alums closed on a $16 million pilot fund. Stanford undergrad Neil Rimer, a Canadian who grew up in Europe and holds a Harvard Business School M.B.A., had worked at Montgomery Securities Inc. on semiconductor offerings and in the VC group. His brother David, another Stanford undergrad, left money manager Capital Group Cos. The third member of the trio, Giuseppe Zocco, whose M.B.A. is from Stanford, came from McKinsey & Co. In 1992, Neil and father Gerald had sold the elder’s Geneva bond-trading business, Index Securities; they kept the name, but turned to VC. Neil rounded out the early team, recruiting Bernard Dallé to join in 1997 from McKinsey and Francesco de Rubertis in 1998 from postdoctoral work at Massachusetts Institute of Technology, to head biotech investing.

Index sought to replicate an early-stage Silicon Valley style of VC in Europe at a time when private equity-influenced, risk-averse investing dominated. Europe, in fact, was five years behind the U.S. in the VC wave, says Jan Svejnar, a University of Michigan economics professor. In 1996, 124 U.S. funds closed on $12 billion according to Dow Jones & Co.’s VentureOne data. In Europe, there were only a handful of big players like 3i Group plc and Sofinnova SA. West Coast firms Benchmark Capital and Accel Parters would set up London shops only in 2000 and 2001.

Eventually, two more Rimer brothers joined Index. Richard (yes, Stanford again) appeared after founding a direct-service pharmacy startup and a McKinsey stint. He focused on biotech before leaving in 2006 to start a buyout fund-of-funds. Danny, a onetime managing director at Hambrecht & Quist charged with starting its Internet analyst group, established the firm’s London office in 2002, after his then-employer Barksdale Group wound down. Danny (a Harvard alum) ranks No. 25 on the Forbes rich list, having had a significant hand in many VC successes, including Skype and Tellme Networks Inc., which raised $265 million from several investors before its $800 million sale to Microsoft Corp. in March.

Index’s style emphasized not only early-stage investing but also close partnering with entrepreneurs. “We’re not looking for a lot of downside protection in these things,” says Neil.

Among early hits from Index’s pilot fund were Germany’s SCM Microsystems Inc. and U.K.-based Virata, which went public in 1997 and 1999, respectively. The exits justified Index’s Fund I, which closed in 1999 with $180 million under management. Neil acknowledges it’s probably the worst vintage in VC history, but maintains Index’s fund is returning a profit. Successes include Danish biotech Genmab A/S, in which Index led a $40 million Series B ahead of the firm’s 2000 initial public offering in which it raised €209 million, and online gambling exchange Betfair, which reportedly drew a £1.5 billion-plus valuation via a 23% stake sale to Softbank Corp. last year.

Exits and good timing likely fueled the next funds, says Cotton, an Index adviser and investor. Indeed, Index sailed through the post-bubble shakeout. When the bubble burst, Michigan’s Svejnar says, the U.S. was hard hit but had already generated big gains. It was tougher in Europe, which was just beginning to see returns. Many firms that launched between 1997 and 2001 faded, merged or waited out the storm. “The funds that made it had to have a pretty good track record and some niche,” Svejnar says.

Index’s Fund II pulled in $300 million in 2001, when little money was around, and Fund III picked up €300 million ($413 million) in 2003. Out of Fund II came Skype, as well as Kvault Software Ltd., which absorbed $30 million in funding before a $225 million sale to Veritas Software Corp. in 2004. According to the California Public Employees’ Retirement System, Fund II’s return to date as of Dec. 31, 2006 was 32.8%.

Of course, the firm took a few blows. Online music subscription service Listen.com raised more than $100 million before offering investors the chance to liquidate their shares a year ahead of a sale to ­RealNetworks Inc. for $36 million in stock. Smarterwork.com, a London-based online job site that raised $13 million from Index and Wellington Partners Venture Capital, has since shut down; Index liquidated its stake.

But generally, Index has thrived. “I think they’ve done a huge number of deals that a lot of VCs would also have liked to have done,” says Simon Walker, the head of law firm Taylor Wessing’s U.K. venture group. “They’ve been able to demonstrate that European VC can post good returns and that’s been good for European VC generally.”

Peter Wilson, a HarbourVest Partners LLC managing director and Index’s largest investor across three funds, classifies the firm as a “top 5” global VC firm and chalks its success up to: a focus on companies aiming to transform global, not local, markets; understanding what corporate acquirers will want; and savvy negotiation tactics when it comes time to exit. And exit it has, as markets have come into their own in Europe. “U.S. companies, and companies all over the world, are showing they’re more than happy to buy businesses in Europe,” Neil says.

The latest big exit stemmed from London-based online radio startup Last.fm, in which Index invested just $5 million as the only institutional investor, a year ahead of its $280 million sale to CBS Corp. in May. The investment came from Fund III, which also includes BioXell SpA and Trolltech, which went public in Europe last year, and Addex Pharmaceuticals Inc., which debuted this year. As of Dec. 31, 2006, the fund had delivered an IRR of 50.3%, according to Calpers data.

Index has clearly been helped by a general maturation in European markets, particularly for IPOs. In January, McKinsey reported that in 2006 U.S. exchanges captured one-third of their 2001 IPOs, while European exchanges saw 30% more over the same period. According to VentureOne, Europe’s 87 venture-backed IPOs in 2006 raised €1.75 billion, while 56 U.S. companies generated $3.7 billion.

Neil contends that easing listings requirements, investors’ access to nearly any market and the emergence of market makers have produced a more robust environment for IPOs in Europe.

And despite a recent report that suggests VCs may be largely investing locally, Index has focused on companies targeting global markets that just happen to be started in Europe. Index recently ventured to Russia, where the VC market is still in its infancy. “Our thesis is that if we’re able to do that … we’ll be able to raise money regardless of where people are looking to invest geographically,” Neil says. “They’ll always go after returns.”

The firm capped its latest fund earlier this year with €350 million ($482 million), when most European firms are targeting €200 million to €250 million, Taylor Wessing’s Walker says.

Index continues to nurture a strong network and enjoys a reciprocal deal-sharing relationship with firms in the Valley, HarbourVest’s Wilson says. In May, Index and Sequoia Capital co-led a $45 million Series A round for Joost Operations SA, the latest venture from Niklas Zennström and Janus Friis, the team behind Skype, which included other backers. Joost recently installed former Cisco Systems Inc. dealmaker Mike Volpi as CEO, whom Index had earlier brought to Skype’s board. Wi-Fi sharing service Fon Wireless Ltd., the latest startup of Martin Varsavsky, whose previous hits include Spain’s No. 2 Internet company Ya.com and its No. 2 public telecom Jazz Telecom SA, has Index and Zennström as backers and Volpi on its board.

Serial entrepreneurs like Zennström, Friis and Varsavsky set an example for European startups, says Saul Klein, who has worked with Index as an entrepreneur, executive, co-investor and now venture partner. Klein recently helped engineer a $5 million round for Openads, which joins fellow open-source startups like Zend Technologies Ltd. in the portfolio and MySQL AB, said to be considering an initial public offering.

It’s all part of the firm’s characteristic pattern: sniffing out potential, taking risk, building a company.

In the Skype case, Danny had long had his eye on Zennström and Friis, the pair behind music file-sharing service Kazaa Inc. They’d started Skype with a $2 million A round from Luxembourg’s Mangrove Capital and U.S. firms Draper Richards LP and Bessemer Venture Partners, but they needed more. Danny e-mailed them for a meeting, then agreed to put up money for the B round, joined by Menlo Park, Calif.-based Draper Fisher Jurvetson. Index also helped build the company, recruiting staff right down to Zennstrom’s assistant.

Why do the deal? Kazaa, Neil says, demonstrated that Zennström and Friis knew P2P technology and how to build scalable, user-friendly systems requiring little infrastructure. “The reality is that when we made the investment, nobody else wanted to do it.”

Which is why they call it venture investing, in Europe or the U.S.

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