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Interview: Index Ventures Says This Is Not a Bubble

Ben Holmes, Index VenturesEntrepreneurs in Europe have long complained about the lack of a vibrant venture capital industry —something many feel holds businesses from the old world back. But while it’s certainly true the continent doesn’t boast an equivalent to valley royalty like Kleiner Perkins or Sequoia, it does have its stars.

Chief among them is Index Ventures, the London-and-Geneva based outfit that has scored a sequence of significant victories, primarily from selling young, disruptive European companies to large American rivals — deals like Skype to eBay(s ebay), MySQL to Sun (s orcl), to CBS (s cbs) and Playfish to Electronic Arts (s erts).

And recently the business had some news all of its own: it is planning to open its first office in the U.S. this fall.

A couple of days ago I caught up with Ben Holmes, a partner who has been with Index since 2002 and works across a number of games, e-commerce and new media investments.

We discussed a variety of topics, but I had to ask whether, for an ambitious firm, stretching into Silicon Valley was a move that seems past due.

“I think that’s the best way of phrasing it,” says Holmes. “We’ve always wanted to do occasional deals in the U.S. where it’s a sector or an entrepreneur that we feel we know particularly well, and we’ve always wanted to help our companies out in the U.S.”

The firm has known for a long time that it wanted an American base, he says, but wouldn’t rush into anything.

“The reason it’s taken a long time is because we’ve been trying to formulate how we’re going to do it,” he says. “The history of VC businesses expanding globally has probably had more failures than successes. Mike Volpi joined us and has been a partner for two years now, [and]  Danny Rimer [brother of Neil, the company’s founder, and a Canadian-Belgian with strong links in the Valley] has been at the company for nine years. They are two of our most impactful partners and we’re sending them to the U.S. to make a beachhead there. But we’re not raising a separate fund for the U.S., and the type of deals won’t change. We’ll be acting as one partnership.”

The movement, he suggests, reflects something of the way that gravity has shifted away from the biggest European technology companies — most particularly in mobile.

“Clearly Apple and iPhone (s aapl) and Android (s goog) have totally transformed the market place there,” he says. “To an extent they’ve also shifted the balance of power from Europe a bit — having Nokia (S NOK) here or Sony Ericsson (S SNE) (s eric) here meant it was the center of the world. That’s changed, but there are still some great games companies, though: Angry Birds is Finnish; [recent Index investment] Grey Area is Finnish.”

Not everyone’s doing well, though. While Playfish sold to EA for $400m in 2009, a lot of European games studios have been struggling. The U.K.’s Bizarre Creations closed last month, for example.

“A lot of guys are coming out — and for a VC, that’s quite good,” admits Holmes. “The traditional game factories are dying and it’s because that business model doesn’t hold water any more. There’s some great talent coming out, and they’re building some pretty interesting stuff.”

That’s not to say that the economic downturn has made it easier or cheaper to invest, however. We talked for some time about the current increase in valuations and the sense of a looming bubble. He thinks there are very specific reasons behind it all.

“My sense is it’s driven by a very specific dynamic driven by Google (S GOOG) and Facebook. Google’s absolutely petrified that it may be undermined in search by some new social-driven search, powered by Facebook. And so anything that Google can throw at the problem, they will. The way they think about acquisitions is not, ‘Is it worth paying $300 million for two developers and an idea?’ they just think, ‘This is our business; this is what we risk losing. Is it worth giving up 0.01 percent of our market cap to acquire this team?’ So a lot of people coming out of Facebook know that even if their idea doesn’t have much traction, there’s probably an offer from Google out there. That’s what’s driving these valuations.”

Does that help a company like Index? Does the increase in angel funding help?

“No. Ideally, we’d like to get in earlier. But having said that, it’s great that we’ve got businesses like Google — huge revenue, cash balances — who can make acquisitions.”

And what about the sky-high valuations that companies like Twitter and Groupon are receiving at the moment? Cynics would argue that most of Index’s biggest sales have been businesses that don’t have clear revenue models — and many of them have gone south after selling. Just look at Skype, bought by eBay for $4.1 billion, before the deal was written down, mired in legalities and then ended in the company being sold back to its founders. Similarly, MySQL was hurt when Sun Microsystems collapsed and has struggled under its corporate parent.

Holmes suggests these revenue-light businesses don’t indicate that there’s a bubble — or at least that it’s not the same sort of bubble as we saw a decade ago.

“Usually revenue and multiples would be the best way to get a valuation — but not always,” he says. “Twitter would be an example of that. Is it worth $5 or $6 billion? I don’t know. Would it be possible and logical that Google might acquire it for that much? Probably.”

“On the one hand we want to chase business that can become ‘real’ businesses, but on the other hand a lot of the most exciting growth opportunities come from driving some other vector more aggressively than driving revenue. This philosophy is different from what happened in ’99, 2000, because for a lot of these business there are levers that could be pulled to monetize quickly in the short-term, but you don’t maximize the value of the business by doing that.”

“With MySQL, could we have suddenly started to charge much more aggressively for components of the software?” he asks. “Could have done it, maybe, but clearly the usage and the community and the developer buy-in was as big — if not a greater component — of the value that Sun placed on it.”

What he doesn’t have much time for is companies that have limited appeal and are really little more than a feature disguised as a service.

“There’s a type of deal in the U.S. which we don’t see so much of in Europe, were there’s a software service which is really designed to serve a real digerati clique. They may love it, and lots of companies get funded — but a disproportionate number launch to attack that. There was something I saw recently called Buffer that time-delays your tweets. I’m not being critical of it, but it is not going to be something my mother needs to use.”

So where is Index putting its money now? Where does it see the deals come from?

Holmes says there are two big areas he’s concerned with: e-commerce, where he says there is still plenty of room for retailers to come in and make more use of the web. British fashion retailer ASOS is one example. Index also recently put money into notebook maker Moleskine in the hope of making it more web-friendly.

Then there’s games — and here Holmes says he’s expecting a rash of acquisitions by Asian companies looking for a way into Western markets.

“I think the big change that’s going to happen is that Asian buyers are going to be the bulk of acquirers in that space. That will be the trend that we see,” he says. “We have a vested interest in a greater base of European acquirers, but to an extent it doesn’t matter to us where acquirers are. And there’s a wider set than people perceive.”

So maybe the next office Index opens should be in China?

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