18 the Role of Venture Capital in the Success of the Swedish Fintech Industry

18 The role of venture capital in the success of the Swedish FinTech industry Elizabeth Press Introduction In 2015, The Financial Times referred to Stockholm as a “unicorn factory” (Ahmed, 2015), and FinTech is an important driver in the Swedish innovation ecosystem. A small country relative to other European markets, Sweden has been punching above its weight in the FinTech arena. Between 2010 and 2015, Stockholm-based companies received 18 percent of all private placements in FinTech companies across Europe (Invest Stockholm, 2015). Furthermore, Sweden has over eight FinTech investments for every million inhabitants. This compares with 5.2 investments for every million inhabitants in the UK, which had the highest total investment during the corresponding period, according to Atomico (De Lange, 2016). Clearly, venture capital (VC) is an integral factor in Sweden’s FinTech success. This chapter contains an introduction to VC and a discussion of factors that in general make a successful venture capitalist, as well as a more specific discussion on VC in the Nordics and Sweden. The chapter will also provide some detail on which segments are being financed, average deal sizes, and notable FinTech deals, as well as some important sector trends. Although Sweden has experienced some large wins in the past years, there is increasing competition coming from other regions, such as London, Berlin, Frankfurt, Paris, Amsterdam, and Tel Aviv. An analysis of Sweden’s strengths, weaknesses, opportunities, and threats regarding investments in FinTech will be explored in the chapter, as well as a discussion of which trends are industry hype and which are part of longer-term growth. The chapter will culminate in a discussion about the future of FinTech in Sweden and recommendations from a VC perspective. The insights from the chapter are based on both primary and secondary research. The primary research consisted of interviews with the following seven venture capitalists active in the Swedish VC industry: • Oscar C.A. Anderson, Head of Research & Analytics at NFT Ventures. • Henrik Aspén, Partner at Verdane Capital Advisors The role of venture capital 351 • Joakim Dal, Investment Manager at GP Bullhound. • Sofia Ericsson Holm, Investor at Industrifonden. • Dan Ouchterlony, Investment Manager at Schibsted Growth. • Ashley Lundström, Venture Lead at EQT Ventures. • Pär-Jörgen Pärson, Partner at Northzone, currently residing in New York. Secondary research consisted of a review of academic literature, reports from consulting and research firms, reports from a venture capitalist firm, and articles from the media, as well as profiles and publications from business angels and business angel networks on social media. Introduction to venture capital VC is a type of financing provided to startups and small businesses with perceived long-term-growth potential. VC is a high-risk business due to the high rate of failure inherent in businesses based on technological and/or business innovations Venture capitalists earn money through exits, when they sell their portfolio companies to other investors or industrial buyers. In some cases, exits take the form of an initial public offering (IPO), which means the shares of the formerly private startup are offered to the public (Koba, 2012). Most VCs have the goal of exiting an investment, and thereby earning a multiple of the money they invested in the portfolio company. Harvard Business School research found that 75 percent of venture-backed startups in the US failed (Gage, 2012). Because venture capitalists lose money when a startup fails, the survival of a VC firm is dependent on being able to earn high mul- tiples on investment on a small number of surviving companies in their portfolios. The VC process starts when the entrepreneurial team, which is usually the team that founded the company, submits their business plan to the VC. If the VC thinks the business plan has potential, they will perform due diligence, which is a detailed audit of the potential investment object. After the due diligence is completed, which means the VC firm has confirmed all the important facts and believes that the startup will not only survive, but can earn the desired multiple upon exit, the VC firm will pledge an investment, receive a portion of the firm’s equity, and usually representation on the firm’s board (Roth, 2012). At this point, the VC becomes a part owner of the firm, and thus has a say in the management decisions of the startup. The investment horizon for VC investments is generally three to seven years (Venture-Capital-Investment.co.uk, 2011), after which they exit. It is only at this point, if the portfolio firm survives, that most VC firms earn their money. VC is important to any innovation ecosystem because this source of funding is provided by investors who understand emerging technologies. Venture capitalists also possess know-how to identify good entrepreneurs, and networks with customers, service providers, and potential partners, as well as extensive go-to- market knowledge, that help entrepreneurs succeed. 352 Elizabeth Press Types of venture capital The classification of risk capital is based on Isaksson’s (2006) paper Studies on Venture Capital (see Figure 18.1). Risk capital is equity that is invested either in public equity, such as equity that is available on a stock market, or private equity. Private equity is in turn divided up into three major subcategories, two of which encompass venture capital: formal and informal (Isaksson, 2006, p.16). Informal VC usually consists of private individuals investing their own money (Isaksson, 2006, p.16), which can take the form of angel investors. Angel investors are generally high-net-worth individuals who use their own wealth or a pool of individual investors’ wealth to invest in early-stage investments. Angel investors can organize themselves into business angel networks, angel funds, or invest as individuals. Formal VC consists of investments made by professional firms, usually a VC firm focused on early-stage investments (Isaksson, 2006, p.16). The type of legal entity the VC firm takes can depend on the geography, legal environment, and other factors. Usually, they are set up as a partnership. VC firms generally employ a small team of experts who focus on early-stage investments and rely on their formal and informal networks of mentors and service providers to help them with the investment process, industry knowledge, and support the growth of their portfolio companies. Corporations have entered the VC market as well, setting up funds referred to in this chapter as corporate VCs, which are often funded from assets that are on the company’s balance sheet with the goal of investing in new technologies. Accelerators are another vehicle through which startups get funding and/ or mentoring. Accelerators generally have a structured program for a cohort of startups who apply and often take equity, making them a form of formal VC. However, accelerators often take fees and other types of non-equity remuneration. Risk capital Public equity Private equity Informal venture capital Formal venture capital Other private equity Figure 18.1 A classification of risk capital, private equity, and venture capital The role of venture capital 353 Accelerator Corporate VC Corporation 2% 2% 5% Investment firm, other 11% Angel Investors 56% VC 23% Figure 18.2 Investor type by % of deals, 2015 and 2016 There are other types of private equity as well, such as management buyouts and other forms of private equity that focus on later-stage investments (Isaksson, 2006, p.16). Public equity consists of investments in public companies that typically are traded on stock exchanges (Isaksson, 2006, p.16). According to Industrifonden’s recent report on investor activity in Sweden, angels and VCs fund the highest number of tech startups, providing more investment in terms of number of deals than all the other actors combined (Bergström, 2016). The investment process Raising capital is the first step VC firms need to take to enable their investment activities. Raising capital is the process by which VC firms secure the money for their funds that they will use to invest in the portfolio companies. VC firms often turn to pension funds, banks, and insurance companies for funding. Informal forms of VC, such as business angels, can rely on their own private wealth or pooled private wealth. After the funds have been raised, the VCs scout for startups to invest in. The ability to identify and attract the best investment objects is core to the success of a VC. As described above, the VC must identify and conduct due diligence on their investment object. Through funding and active management, the VC aims to enable the portfolio company to grow. VCs not only position themselves to the providers of capital, but to 354 Elizabeth Press the entrepreneurs as well. Each VC brings their offering of expert service providers, mentor networks, management style, and terms, with which they need to both attract and manage entrepreneurs. Upon exit, the VC hopes to sell its equity for a multiple. The equity invested can take various forms, such as stocks, warrants, options, and convertible notes. After usually four to six years, the VC hopes that this equity can be converted into cash at a value that is a multiple of the investment. Although the initial public offering (IPO) is the most prestigious and publicized means of exiting, most exits take the form of sale to a company or to another investor. Funding rounds Seed investing is the initial round for startups. Seed funding is usually small and aimed at research and development of the initial product (Goldstein, 2015). This is the riskiest round of funding. Startup capital generally goes to startups once they have completed the market analysis and business plan, as well as developing a sample product.

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