Friday Letter: That is not a siren song you hear from Europe

GPs and LPs that aren't investing in Europe are missing out on a big opportunity.

What a difference a few years can make. When Venture Capital Journal took a close look at the European venture market in 2019, annual deal-making totaled $49.6 billion. Last year, it hit a record of about $117 billion, and it is on pace to do the same again this year, according to data from Dealroom.

Mind you, these numbers are relatively small compared to the US, where deal-making hit nearly $330 billion last year. But what is important is that the numbers continue to go up for Europe, and that the gains are substantial.

In March 2020, we declared “VC finally makes the map in Europe.” In our cover story this month, senior reporter David Bogoslaw explains why European VC has become a port in a storm, as macroeconomic troubles roil the US. Simply put, the market has matured to such an extent that start-ups don’t have to move to the US for capital and support like they used to. They can stay at home and be successful.

Let’s take a look at three things that bode well for the European venture capital scene.

Unicorns are on the rise

The story is still quite rosy for European unicorns, notwithstanding the negative headlines in July for Swedish payments company Klarna after its valuation plummeted from $45.6 billion to $6.7 billion,

Europe has 113 privately held companies valued at $1 billion or more, including 31 that earned that distinction this year, according to PitchBook. That represents a 3.6x increase from 37 unicorns three years ago. And that is not to mention another 250 or so companies that M&A firm i5invest has identified as “soonicorns,” meaning they are likely to reach a valuation of $1 billion or more in the next 24 months.

“Isn’t that an amazing fact? It’s a forward leading indicator of future growth within the ecosystem,” Ross Morrison, a partner in the London office of fund of funds manager Adams Street Capital, told Venture Capital Journal. “We are creating the same velocity in new companies in tech as what the US has done.”

To be fair, Europe still has a long way to go to match the unicorn production volume of the US, which CB Insights says is home to about 630 such creatures, including 130 birthed this year.

Non-traditional investors are boosting investments

Nontraditional investors – such as corporate venture programs, hedge funds and PE firms – continue to pile into European VC deals. “Highly capitalized nontraditional investors have driven up competition, round sizes and valuations in the European VC ecosystem. Consequently, start-ups across financing stages typically possess a wider pool of investors nowadays,” PitchBook reported in its European VC Valuations Report for Q2.

European VC deals with nontraditional investor participation hit €42.6 billion in the first half of this year, putting them on pace to match the record of €84 billion set in 2021. “The allure of diversification, exciting companies and impressive returns have enticed nontraditional backers to move into the VC landscape,” PitchBook wrote. “VC investing can also deliver returns capable of offsetting volatility from cyclical liquid markets and inflation. As a result, we have seen large organizations commit huge sums to VC funds or carve out their own VC arms to directly invest in companies.”

More bang for your buck

For a variety of reasons, private companies are considerably less expensive in Europe than in the US, both at the early stage and late stage. That means valuations for European companies will likely hold up better than in the US in an economic downturn. As with the US, a recession in Europe appears to be inevitable, as Russia’s war on Ukraine drags on. “A recession is now almost certain, inflation is nearing double digits [it is currently at 9 percent] and a winter with looming energy shortages is fast approaching,” Reuters reported.

“In the first year of the pandemic, the median pre-money valuations for late-stage and early-stage companies in the US were already more than triple and four times, respectively, those of their European counterparts, and the valuation gap has widened over the past year-and-a-half,” Bogoslaw wrote in his cover story.

The pricing difference is quite dramatic. In Europe, the median pre-money valuation for a late-stage company was $20.9 million as of Q2 compared to $110 million for US late-stage companies, PitchBook reported.

Likewise, the median pre-money valuation for European early-stage companies stood at $9.5 million as of Q2 compared with $60 million for US early-stage companies, according to PitchBook.

These are just a few of the factors that make Europe an increasingly compelling market for venture investors, and their limited partners. Read all about it by clicking on the following links: