Venture capital: nothing to be afraid of

Incubators

Hungary’s software development sector has seen some success stories in the recent years. But for all startups that have made enough publicity, fame and revenue to succeed, 100 more could be found that failed for one reason or another.

It would be a gross overestimation to describe the role of venture capital as important in Hungarian financing. However, its importance can be positively influenced in the near future as country risk deteriorates, the number of investments backed by the EU-funded Jeremie program grows, and banks’ lending activity does not show any significant improvement. 



Under the framework of Hungary’s Új Széchenyi Terv development plan, HUF 36 billion was earmarked to spur small- and medium-sized Hungarian businesses. The eight venture capital funds created under the program had invested HUF 8.2 billion into 39 separate projects by the end of March. The funds started their investment activities in the second half of 2010 and will have to invest the available funds by the end of 2013. Some 70% of the resources these venture capital funds use come from the Jeremie program of the European Union. (The joint initiative of the European Commission with the EIF and the European Investment Bank helps SMEs access finance and financial engineering products.) According to the existing rules, funds can only invest in SMEs no older than five years and with revenue of less than HUF 1.5 billion, and at least 30% of funds have to be invested into startup and innovation businesses.



As with all these venture capital sources, the fund behind the investments of PortfoLion, OTP Kockázati Tőke Alap I, is closed-end and has a maturity of eight years. The existing rules allow firms to allocate investments funds for three years (until the end of 2013) and then recollect them in five years. Therefore the fund emphasizes five-year investments into the potential cooperators. 

“Our existing portfolio was selected from about 200 business plans,” András Molnár, investment director of OTP Bank’s venture capital firm PortfoLion said. The company’s portfolio is built up of ten different investments, all with a share bought between HUF 200-400 million. It includes Leonar3Do, the world’s first three-dimensional virtual reality desktop utility and Cellum, one of Hungary’s leading mobile payment solutions developers. 

“Based on our experiences, we can pinpoint the most common mistakes companies make while looking for venture capital. One of these is that small enterprises want to involve venture capital to start up their company instead of using it to speed up growth. However, funds do not invest money into ideas, only into already working businesses. The other is that small businesses – sometimes only a sole programmer or a couple of developers – do not have the necessary management framework that could successfully control a fast-growing company,” Molnár added.



Owners of startup businesses are often technically minded and not too familiar with the financial aspects of successfully conducting a business. But the rules of thumb are easier to grasp than it may at first seem. “There are two main criteria a startup has to meet in order to attract our attention,” said Molnár. “First of all, we need a business model that is viable on the international market as well. And second, the business model has to outline a product cycle that promises fast growth and fast return in exchange for the higher risks taken by the joint venture capital business.”



Prezi, the cloud-based zoomable presentation software, is one of the best-known success stories among Hungarian software startups, along with remote access software LogMeIn and NNG, the makers of navigation software iGo. The company raised $1.5 million in 2009 and another $14 million at the end of 2011 from Accel Partners and previous Danish investors Sunstone Capital. “We had positive cash flow from the very beginning, and users just loved Prezi,” Péter Árvai, co-founder and CEO of the company said about the keys to successfully involving VC. 

Venture capital firms are often badmouthed on the grounds that they only want to invest into sure-fire businesses. In fact, they just want to avoid all the unnecessary and unforeseeable risks they can. To successfully work together, both parties involved must make efforts to take care of uncomfortable issues. “The relationship between startups and VCs is like a marriage,” Árvai pointed out. 

A great deal of startup owners are unwilling to involve venture capital simply because they fear losing control and ownership of their business. But this is a common mistake.

After the fixed-term investment period, the VC fund could exit successfully in three different ways. “One is that the original owners buy back their share. However, this is highly unlikely, as – to spur on the growth of the company – paying a dividend is not allowed. And earning enough money just from salaries over five years to buy back the share originally sold is not an option in most cases. The second option is having an IPO, but stock exchanges in Central Europe are not too attractive these days. And the third and most likely exit is the involvement of another professional investor, either a bigger rival acquiring the company or another venture capital firm,” Molnár said.

 

Venture capital investments in Hungarian IT-sector 
Date Company Field of activity Raised amount Investor 
07/2012 Real5D Interactiv 3D visualization $1.2 mln DoubleRock Venture Capital
07/2012 MixGar Interactive social jukebox $80,000 Phoenix Investment
04/2012 Netlock Electronic authentication n/a (51.02% share) Docler Investments
01/2012 THX Games Games developing HUF 400 mln Sándor Andó and Euroventures VC Fund Manager

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