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MONEY

Offshore Drilling

Why foreign-based VCs are taking a closer look at U.S. firms.
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Having been involved with nine start-ups over the past nine years, Krishna Yarlagadda is no stranger to the Sand Hill Road shuffle. The 37-year-old entrepreneur knows most of Silicon Valley's major venture capital players. And because he already has a winning track record--in 1999, he sold ZSP, a chip-design firm, to LSI Logic for $11 million--many are also familiar with him. But last year, when Yarlagadda began seeking backing for his latest baby, an intellectual-property licensing outfit called Hellosoft, he looked beyond Silicon Valley--way beyond. In fact, of the four venture firms that invested $12 million in Hellosoft last fall, only one was local. The others are a mini United Nations of sorts, with roots in Europe, Asia, and India.

Sure, money raised overseas is just as green as that raised here. But Yarlagadda had other motives in going offshore. For example, hooking up with Acer Technology Ventures, the venture arm of the Taiwanese computer giant, has helped Hellosoft land several large customers in China and Taiwan, where the majority of wireless products--Hellosoft's primary market--are made. Its relationship with Sofinnova Ventures, a French venture capital firm, has been equally helpful in lining up European clients. And JumpStartUp, a venture firm in Bangalore, India, provides critical support where the bulk of Hellosoft's 125 employees are based. "Leveraging money from different parts of the world helps our business," Yarlagadda says. "Each of these VCs brings different things to the party."

U.S. venture capital, with its deep roots and even deeper pockets, remains by far the largest source of funding for American entrepreneurs. But in an increasingly global marketplace, more U.S. companies are beginning to turn to foreign venture capitalists. And, motivated in large part by the falling dollar, more foreign financiers are looking to invest in American companies. According to the accounting firm PricewaterhouseCoopers and 3i, a London-based venture capital firm, only about one-third of the $41.5 billion invested in privately held American companies in the first six months of 2003 (the latest period for which data is available) was raised in the United States. That's a big change from the same period a year earlier, when more than 75% of the money invested in U.S. companies was local. "European VCs are looking for big deals wherever they can find them," notes Keith Arundale, who heads PricewaterhouseCoopers' European venture capital practice.

Of course, American entrepreneurs who think they can get around the extensive due diligence and tough terms demanded by local VCs by heading off to India or some other country are in for a real awakening. Americans may have written the playbook on venture capital, but overseas players have mastered the rules quickly. The terms they offer are pretty much the same as their U.S. counterparts'--including sizeable equity stakes, preferred stock, and seats on the board, says Steinar J. Engelsen, a partner in Teknoinvest, a 20-year-old Norwegian venture fund that focuses on health care and telecom firms. What's more, finding a foreign backer often takes longer and is a much more cumbersome process than lining up an American venture firm. Even with a BlackBerry, there's no easy way around the time differences--nine hours between California and most European cities, 12 to 14 hours between the East Coast and Asia--which can be enough to make a CEO downright dizzy. And just try scheduling board meetings when your investors are scattered across the globe.

But for any U.S. entrepreneur who hopes to sell his widget outside the United States--and who doesn't?--securing overseas venture backing can be like having a personal concierge to help navigate the world's markets. That's exactly what prompted Mark Platshon, chief executive of Capnia, a pharmaceutical start-up based in Los Gatos, Calif., to turn to Teknoinvest. The four-year-old company raised $12 million in second-round funding in April. The round was led by the Norwegians, who contributed $3 million and received a seat on the company's board. "I'm happy to have their money, but I'm even happier to have their experience," says Platshon. "We know the U.S. market. But we don't know much about Europe."

"We are going to be an international company, so it was important that we add international investors."

One thing that Platshon does know about Europe is that it's often easier and less expensive to get a drug approved there. Capnia's plan is to begin clinical trials of its product, a prescription nasal spray that provides relief from migraines, later this year in both the U.S. and Europe. His Norwegian VC's expertise in navigating the European regulatory process will be worth as much as the greenbacks, which Platshon figures he could have gotten from any number of sources. Indeed, if the European trials prove successful, Capnia expects to be able to begin selling the drug--and start generating some much-needed cash--well before it gets the nod from the U.S. Food and Drug Administration. What's more, acceptance in Europe can only help the drug gain momentum globally. According to Platshon, 28 million Americans, and 240 million people worldwide, suffer from migraines.

Still, Platshon doesn't recommend that a company start out looking for overseas funding. Three years ago, when Capnia was seeking its first round, the company stayed close to home. But over time, it was those early investors, led by Asset Management, based in Palo Alto, Calif., who put Platshon in touch with the Norwegians, as well as with Novel Bioventures, a Hong Kong venture firm that Platshon hopes will be equally helpful when it comes time to start selling the product in Asia.

Microbia, a five-year-old pharmaceutical company in Cambridge, Mass., waited until it was even further along to tap into overseas funding. The company had relied on established American firms, including Venrock, Polaris, and the venture arm of Fidelity Investments, for its first three rounds of funding. And CEO Peter Hecht recommends that young companies follow a similar path. "You want someone who's around to solve problems and help you build relationships," Hecht says. "And it's hard for someone to be around when they're a long plane ride away."

But when seeking financing earlier this year, Microbia, which has three different drugs in development, felt that it was time to bring some foreign investors to the table. In April, the company closed a fourth, $40 million round of financing. Of its five latest investors, three were from overseas, including Bio-One Capital, an arm of Singapore's Economic Development Board. The others were from Europe. "We're going to be an international company, so it was important that we add international investors," Hecht says.

In some cases, the foreign investors are looking for more than just a financial windfall. One of the reasons Bio-One was interested in Microbia, Hecht says, is that the Singaporean government wants the company to base its Asian operations there. While Hecht stresses that the investment came with no strings attached, it's clear that some foreign investors are hoping to parlay their investments into jobs or some other form of economic payback for their countries. Yarlagadda, for one, says that's one of the primary reasons that JumpStartUp invested in Hellosoft: The company has about 100 employees in India and is likely to continue expanding its operations there.

In the end, Yarlagadda says, the most important thing for any entrepreneur to consider when shopping for a financial partner, particularly one that's based overseas, is staying power. Just as with any investors, if they're going to cut and run at the first hint of trouble, it's probably not worth it. "A lot of these overseas firms don't have a huge track record," he says. "So even if they have the heart, they may not have the capital. If tomorrow you realize that you need another $30 million, many of these younger venture capital firms won't be able to hack that."

Last updated: Jul 1, 2004




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