Venture Capital Update

october 20061

european venture capital: a new opportunity? When eBay decided to purchase Skype Technologies SA for $2.6 billion last year, investors around the world took note. EBay’s interest in a Luxembourg-based provider of voice-over-IP services demonstrated that European startups can generate bold returns for globally minded investment partners.

Before Skype and a handful of other successful deals, sending venture capital to Europe had long been considered unattractive. The venture market was nascent by U.S. standards and casualties were common, especially when the Internet bubble burst in 2000. Long-term venture capital returns in Europe have historically lagged U.S. returns. At 22.7 percent, the 10-year pooled IRR for all U.S. venture capital firms is considerably higher than Europe’s 5.8 percent return for the same period.1 A weak IPO market, limited availability of trade buyers, stringent labor laws, a perceived cultural aversion to risk, and a stigma attached to business failure created an impression that there were no attractive venture opportunities in Europe.

Today, that is beginning to change. While the media fixates on India, China, and Israel, Europe is quietly turning a corner. Globalization and changes in attitudes towards entrepreneurship and risk have paved the way for innovation and growth in Europe. At the same time, a group of respected

Venture Capital Update

Written by: Natalie Braun, Managing Director, SVB Capital and Mike Clovis, Associate, SVB CapitalOctober 2006

U.S. vs. European HistoricalVenture Capital Returnsas of 3/31/06

Source: Thomas Financial/Venture Economics

European Venture-Backed IPOs

Source: VentureOne

venture capital update

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European VC players has emerged, and the European venture capital ecosystem has begun to develop, including the appearance of serial entrepreneurs. As institutional investors search for attractive opportunities worldwide, they should not overlook Europe.

Clear path to liquidityEurope’s elevated profile on the global venture capital scene is partly the result of vastly improved exit opportunities, thanks to lower barriers to entry for IPOs and increased merger and acquisition activity. Initial offerings on European venture-backed companies in 2005 totaled €2.1 billion, up from €0.7 billion in 2004, an increase of 300 percent.2 This compares with U.S. venture-backed IPOs totaling $2.2 billion in 2005, a 55 percent decrease from $5.0 billion in 2004.3 The top European IPOs of 2005 included the following:

° Q-Cells, a German maker of solar cells, raised €313.0 million and now boasts a market value of €2.5 billion4

° TradeDoubler, a Swedish consumer/business services company that raised €138.0 million, and has a market cap of €4.3 billion5

° Interhyp, a German consumer business services company that raised €103.0 million, and has a market cap of €462.4 million6

So far, Europe is on track to exceed the total number of IPOs for 2005. In the first half of 2006 alone, there have been 40 European venture-backed IPOs versus 69 for all of 2005.7

M&A on the riseMergers and acquisitions for European venture- backed companies have kept pace as well. In 2005, there were 163 European M&A transactions, compared to 195 transactions in 2004. While the number of deals decreased, the median transaction price increased from €17.8 million in 2004 to €22.5 million in 2005. The trend continues in 2006, with 67 M&A transactions during the first half of the year. Of the companies that were acquired and merged during the second quarter of 2006, the median amount paid approached €20.0 million. This is highest median amount since the second quarter of 2005, when it was €27.0 million.8 In addition to the eBay/Skype transaction, recent notable deals have included the following: ° Bredband, a Swedish communications company bought by Norway-based Telenor for €650.o million.

Investment in European Venture-Backed Companies

2005 VC Investment (Euros Invested by Country)

Source: VentureOne

Source: VentureOne

° GWI, a German medical company bought by Belgium-based Agfa-Gevaert for €257.0 million.

° Softbank, a Japanese internet group, bought a 23 percent stake in Betfair, a U.K. online betting exchange, from some of the company’s existing investors for £355.0 million, valuing the total company at £1.54 billion.

As a result of the improved exit opportunities, some of the best-performing venture investments are now coming from the European Union. A study of 2,600 venture deals around the globe from the past three years found that, among those that returned more than five times their initial investment, 43 percent took place in Europe, and more than half of all deals that returned 10x or more were European.9

Success breeds successThe convergence of several factors explains the change in Europe’s venture investment climate. Globalization means that it no longer matters where opportunities are located as long as there is access to a supply of talent, innovative technologies, business models, and capital.

Although Europe does not have a strong history of entrepreneurship, the tide is shifting towards an entrepreneurial mind-set as a young and ambitious new generation discovers considerable rewards in the pursuit of big ideas, inspired by spectacular exits such as Skype. Europe is also beginning to enjoy some of the fruits of the outsourcing boom. Central and Eastern Europe are emerging as another source of low-cost talent for third-party R&D and manufacturing for companies around the world. At the same time, the availability of seasoned and internationally savvy mid-level managerial talent is increasing, as more business professionals are willing to risk comfortable jobs with established companies to join startups.

With this growing pool of talent, Europe finds itself with strong capabilities in several areas, including wireless software and hardware, as well as renewable energy technologies. At the same

time, Europe is taking a cue from the U.S., where universities and research centers have learned to monetize the tremendous advancements taking place within their walls. European universities and research centers — long-standing hubs for world-class innovation — are gaining experience in transferring their innovative technologies to the private sector.

Growing entrepreneurial cultureThe VC market in Europe is maturing as a generation of more aggressive venture capitalists that emerged in the late 1990s begins to establish a track record of success. In turn, startups are benefiting from their experience, learning what business models work best, and how to support and develop companies. At the same time, the emergence of serial entrepreneurs who have experience launching multiple companies in Europe — combined with the return of entrepreneurs from the U.S. — makes for an increasingly strong entrepreneurial culture. Add to this the presence of U.S. VCs, like Accel Partners and Benchmark Capital, which have been on the ground for several years, plus others that are collaborating with European firms, and the foundation of expertise is growing by the day.

European startups are also enjoying growing access to the capital they need, as evidenced by the increase in seed and early venture investments by local and U.S. funds. In 2005, over 1,000 European companies received $4.6 billion; 34 percent of these were seed and early stage deals. The trend is continuing in 2006.

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Commitments to European Venture Capital Funds

Source: VentureOne

Roughly $2.5 billion has been invested in almost 400 European companies in the first half of 2006, 42 percent in Series A transactions.10

A friendlier regulatory environment?Once these companies are ready for prime time, Europe’s more accommodating regulatory environ- ment is able to offer increased access to public markets. While U.S. public companies are governed by the stringent and costly requirements of Sarbanes-Oxley in order to maintain a listing on the Nasdaq or the NYSE, companies that go public on

London Stock Exchange’s Alternative Investment Market (AIM) exchange have fewer requirements. The AIM is much like the Nasdaq of the early 90s — an opportunity to access public capital and a market for smaller companies unable to generate enough mainstream investor interest on the NYSE. Although the AIM is still developing, it offers better liquidity than the LSE and the EURONEXT for companies with a market capitalization ranging from £75-500 million, and even better liquidity than the Nasdaq for smaller companies under £100 million.

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PerspectiveWith a firm belief in Europe’s world class technological innovation, SVB Financial Group established its European arm, SVB Europe Advisors Ltd., in London in 2004; and opened SVB Alliant Europe, a subsidiary of its M&A and private placement advisory firm, in 2006.

The evidence of European innovation is every-where: in the leading universities and tech clusters; a small but nonetheless vibrant venture capital community, which is beginning to produce some global players; and a resurgent entrepreneurial environment. SVB Europe Advisors and SVB Alliant Europe are part of an emerging group of service providers bringing more infrastructure and support to the venture community in Europe. After two years located in London and several years building relationships throughout Europe, we have seen a steady sea change in the way European VCs approach their business, even taking on some best practices from the U.S. and other regions. We continue to feel bullish about the prospects of European venture capital and the entrepreneurial environment overall:

° The afterglow of Skype is still visible in the form of firms like Index Ventures and Mangrove, which routinely syndicate with leading U.S. VCs.

° Market trends in Europe tend to lag the U.S. by six to twelve months, and the activity level has picked up over the past nine months. SVB’s lending activities in the U.K. reflect this increase in activity.

° The mix of Series A deals also means that European VCs are back to company creation rather than supporting existing investments. ° The majority of European venture-backed technology and life science companies are acquired by U.S.-based businesses.

About SVB in EuropeSVB Europe Advisors Ltd. is part of SVB Global, a member of SVB Financial Group. SVB Alliant Europe is the U.K. subsidiary of SVB Alliant, the M&A and private placement subsidiary of SVB Financial Group. Both organizations are part of SVB Financial Group’s global network.

With dedicated teams serving China, Europe, India and Israel, and 27 U.S. offices, SVB Financial Group helps technology companies and private equity firms navigate foreign markets and identify opportunities internationally and in the U.S. More information about SVB Financial Group and its subsidiaries can be found at www.svb.com.

The AIM has acted as a magnet for the small and mid-sized companies it was designed to serve, holding more than 2,000 IPOs since its formation in 1995, and raising €29.0 billion.11 Even some U.S. startups are gravitating to Europe for a friendlier IPO environment. Mayfield Fund took Mountain View, California-based PolyFuel, Inc., public on the AIM exchange in July of this year, and Hyperion Partners introduced New York-based Allied Healthcare on the same exchange last year.

Increasing risk toleranceIn addition to globalization, a change in attitudes toward risk is benefiting European venture capital. This is driven in part by LPs increasing pressure on European VCs to adopt U.S. VCs’ best practices. In addition, experienced entrepreneurs and local VCs, led by the example of U.S. colleagues, are developing a higher tolerance for risk, willing to be more patient and allow their big winners to mature to achieve higher exits. They are no longer settling for lower multiples for the sake of realizations and low capital loss ratios in the near term.

The development of a VC ecosystem plays an important role too. A number of significant local VCs have emerged over the last 10 years, generally cooperating rather than competing with each other and sourcing increasingly high quality deals that are shared within this elite group. Furthermore, the emergence of professional service providers such as venture debt, investment banking, and legal firms specializing in venture-backed companies is strengthening the market.

In the midst of these changes, a number of government programs are effectively supporting early-stage investment and venture capital. For example, since 2002, nine Regional Venture Capital Funds established by the U.K. government have raised £250.5 million and invested in more than 200 companies to date.12

Where to beginWhile Europe is a legitimate part of the global VC world, European funds have yet to convince institutional LPs in the U.S. to take the region seriously. One of the reasons for this lack of interest is that institutional LPs make their investment decisions based on historical returns, which have not been attractive in Europe. To complicate matters, the European market is fragmented, with each country dominated by a few relatively small players. Such fragmentation, though, has led to some promising pockets of regional expertise that could ultimately prove attractive to more U.S. investors. The presence of Nokia in Finland and Ericsson in Sweden, for example, has created fertile ground for mobile communications, while Ireland has developed a strong software business culture, and the research centers clustered around Cambridge University have led to a vibrant community of semi- conductor companies.

We believe that Europe should not be ignored as a part of a diversified international portfolio. However, investing in individual European funds is complicated and raises many questions. For example, how do LPs determine the best countries in which to invest? How do they decide which area will produce the best returns? How do they deal with different cultures and languages associated with pan- European investment?

And how do they enter the market when there are few funds to consider, and those with a proven track record of success are often oversubscribed or impossible to join?

When investing in individual funds is not the most attractive or the most viable strategy, one alternative way for institutional LPs to ease into the European market and avoid these challenges is through funds of funds. This approach allows LPs to participate in the market without having to become experts themselves while spreading their risk across multiple funds and various geographies.

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A fund of funds approach can also allow LPs to gain access to the small number of closed or restricted funds, and participate in emerging funds whose identification and selection require local knowledge.

The European venture capital ecosystem is quickly evolving. Current financial, demographic, and cultural trends suggest it makes sense to consider

Europe as a part of a global investment strategy. And with word of early returns spreading fast, demand for European venture deals is only going to increase. The time may well be right for giving European venture capital a chance.

1 Thomson Financial Venture Economics, 2 DowJones VentureOne, 3 DowJones Venture-One, 4 As of 9/15/2006, 5 As of 9/15/2006, 6 As of 9/15/2006, 7 DowJones VentureOne. 8 DowJones VentureOne, 9 TLcom Capital Partners, 10 DowJones VentureOne, 11 AIM presentation, 12 EVJC, March 2006

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investment strategy outlook

SVB Asset Management, SVB Silicon Valley Bank’s registered investment advisor affiliate, publishes a weekly newsletter offering timely economic insight and analysis about the technology and life science markets, and the private equity and venture capital industries.

http://www.svb.com/services/iso.asp *

second quarter 2006 u.s. private equity snapshot

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Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

U.S. VC-Backed M&A Activity

Source: Fenwick & West L.L.PAverage per share % price change from previous round of Silicon Valley companies receiving VC investment in the applicable quarter Complete report available at http://www.fenwick.com/vctrends.htm

Fenwick & West’s 2Q06 Venture Capital Barometer

Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

U.S. Venture Capital Investing Activity by Quarter

Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

U.S. Venture Capital Investing Activity by Year

Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

U.S. IPOs vs. M&As

Source: VentureOne

Most Active Investors - 2Q06

Source: Fenwick & West L.L.P

Price Change

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Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

U.S. Deal Flow by Round Class

Source: Thomson Financial Venture Economics/ National Venture Capital Association

Cumulative Fund Type Performance as of 3/31/06Calculation Type: IRR

Source: Thomson Financial Venture Economics/National Venture Capital Association

Cumulative Vintage Year Performance as 3/31/06Venture Capital Funds (only) Calculation Type: IRR

Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

U.S. VC-Backed Liquidity Events by Industry

Source: VentureOne

Post Money Valuation Report ($M) - 2Q06

The direction of price changes for Silicon Valley companies receiving financing in the applicable quarter, compared to their previous round.

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Cumulative Fund Type Performance as of 3/31/06

* Equity financings include cash investments by professional venture capital firms, corporations, other private equity firms, and individuals into companies that have received at leastone round of venture funding

Source: VentureOne/Ernst & Quarterly Young Ventura Capital Report

Equity Financings* for U.S. Venture-Backed Companies by Industry Group

Source: VentureOne and Ernst & Young, Quarterly Venture Capital Report

Region Focus All Industries - 2Q06

* This update is for informational purposes only and is not a solicitation or recommendation that any particular investor should invest in any particular industry, security, or fund.

SVB Asset Management, a registered investment advisor, is a non-bank affiliate of SVB Silicon Valley Bank and member of SVB Financial Group. Products offered by SVB Asset Management are not FDIC insured, are not deposits or other obligations of Silicon Valley Bank, and may lose value.

SVB Europe Advisors Ltd. is a subsidiary of SVB Financial Group, is not licensed to conduct banking business in the United Kingdom and does not engage in unlicensed banking activities. Banking services are provided by Silicon Valley Bank, a member of FDIC and the California bank subsidiary of SVB Financial Group.

SVB Alliant is a wholly owned broker-dealer subsidiary of SVB Financial Group, and a member of NASD and SIPC. Products offered by SVB Alliant are not FDIC insured, are not deposits or other obligations of Silicon Valley Bank, and may lose value. SVB Alliant Europe Ltd. is registered in England and Wales at 34 Dover Street, London, W1S 4NG, U.K. under No. 5572575 and is authorised and regulated by the Financial Services Authority. Silicon Valley Bank is the California Bank Subsidiary of SVB Financial Group.

Fundraising by Venture and LBO/Mezzanine

Source: Thomson Financial Venture Economics/National Venture Capital Association