Less than 10 years ago, if you wanted to find a unicorn in Europe, you had to mount a serious expedition. Today they are nearly everywhere you turn. Herds saunter around the London Eye and the Eiffel Tower. They gallop under the Triumphant Arch in Bucharest, trot around the Mosteiro dos Jeronimos in Lisbon and prance about the windmills of Rotterdam.
Philippe Botteri, a partner at Accel, has seen the proliferation firsthand since he moved from San Francisco to London in 2011. “At the time, people were asking if Europe could generate a $1 billion outcome [aka unicorn],” he says. Now that the question is definitively answered, stubborn skeptics ask if venture capitalists can produce a $100 billion European company. Botteri is nonplussed. “I’d say you just have to wait a few years,” he says. “I think there is a very high chance this will happen in the next decade.”
What Botteri and other European VCs are less certain about is when institutional investors, particularly those outside of Europe, will fuel the burgeoning venture market with large capital commitments. There are signs that some LPs are warming to the market. North American LPs poured $1.7 billion into European venture funds in 2018, almost six times the $300 million committed in 2017, according to most recent data available from Invest Europe, a trade association.
But relative to the size of the US venture market, Europe still has a long way to go. Investors pumped €32.4 billion (about $36 billion) into European VC deals last year, according to PitchBook. That’s less than a quarter the amount VCs put to work in American deals during the same period.
Observers say the relatively small size of the European market has made it hard for European GPs to garner attention from institutional investors. “There’s so much activity and success in Silicon Valley and the US, all of that press tends to kind of drown out a lot of the value being created in international markets in LPs’ minds,” says Miguel Luiña, head of global venture and growth equity for Hamilton Lane, which has $415 billion in advisory assets under supervision.
Tom Wehmeier, perhaps the foremost expert on Europe’s technology ecosystem, says 2019 was a breakthrough year for European startups and their investors. A partner at London VC firm Atomico, Wehmeier oversees “The State of European Tech,” an encyclopedic report that has been published every year since 2015.
“It felt like last year was an awakening moment, like finally everyone outside Europe is catching on to what’s happening here,” Wehmeier says. “There has never been such a strong level of interest from the strongest [VC] brands investing into Europe.”
The percentage of venture rounds for European companies that included at least one US investor hit 19 percent in 2019, which was more than double what it was in 2015, data from market researcher Dealroom.co shows. Also, the total amount of US venture dollars going into Europe has shot up dramatically, from $3.4 billion in 2015 to nearly $10 billion last year, Dealroom.co reported.
There is no single reason for the boom in European venture. One big factor is government action. The European Union and various nations took it upon themselves to jumpstart tech investing by injecting billions of dollars into venture funds. Government agencies are by far the biggest investor in European VC funds raised between 2014 and 2018, investing $9 billion during that period, accounting for 24 percent of total LP dollars, Invest Europe reports. The next two largest LP categories are corporate investors (16 percent) and private individuals (12 percent). All other LP categories account for less than 10 percent each.
The largest government initiative is the European Investment Fund, an EU entity whose mission is to help grow small and medium businesses throughout Europe. The EIF, which has about €2.7 billion in assets under management, has invested in 522 European venture funds to date. Last year alone it committed $1.2 billion to 56 funds, says EIF spokesman David Yormesor.
EIF backs funds throughout Europe, both old and new. Established firms that earned its support last year include Atomico, Balderton Capital of London, Earlybird Venture Capital of Berlin, and Partech Partners and Sofinnova Partners of Paris. Among the emerging managers EIF backed in 2019 are Catalyst Romania of Bucharest; Fil Rouge Capital of Zagreb, Croatia; and Voima Ventures of Espoo, Finland.
Even more capital
Not content with the results from the EIF, the European Union created VentureEU in April 2018, putting €410 million into six fund of funds managers: Aberdeen Standard Investments, Axon Partners Group, Isomer Capital, LGT Capital Partners, Lombard Odier Asset Management and Schroder Adveq. The hope is that each firm will raise additional capital from private sources, bringing the total amount to €2.1 billion, which would then be invested in venture funds throughout Europe.
The EU’s efforts have been bolstered by investment by individual nations. For example, Poland’s Krajowy Fundusz Kapitałowy helps capitalize venture funds to jumpstart Polish company creation. KFK put up half of the 80 million zloty ($21 million) for Experior Venture Fund’s debut seed fund. With KFK as an anchor investor, Experior was able to convince high-net-worth individuals to put up the other half of the capital. “The majority were [individual] investors who were willing to put in a small part of their assets into a complete unknown,” says Experior founder and Managing Partner Kinga Stanisławska.
A self-reinforcing cycle
Another reason for the European investment boom: “There has been a pretty dramatic maturation of the entrepreneurial ecosystem,” says Michael Treskow, a partner in the London office of Eight Roads Ventures, which invests on behalf of Fidelity. “You have more funds now, more people who have done investing before, more people who were entrepreneurs and are doing it again. All of that is accelerating.”
In other words, success begets success. A survey of more than 1,200 founders for the latest “The State of European Tech” report found that eight out of 10 were “living comfortably” before they started their companies. That contrasts with a survey by Eurostat, which found that four out of 10 Europeans described themselves as “living fairly easily, easily or very easily.”
Probably the most famous example of Europeans not content to rest on their laurels are Sweden’s Niklas Zennström and Denmark’s Janus Friis, founders of internet phone service Skype. After selling Skype to eBay for $2.6 billion in 2005, Friis and Zennström kept investing and founding more companies. They co-founded internet television service Joost in 2006, later selling the assets in 2009. Friis then founded video streaming company Vdio in 2011 and co-founded robotic delivery vehicle company Starship Technologies in 2014. Meanwhile, Zennström in 2006 launched Atomico, which has raised four funds totaling close to $1.5 billion and has invested in more than 150 companies.
Then there are the many entrepreneurs and investors who worked alongside Friis and Zennström and have gone on to do their own thing. Most recently, Atomico Partner Mattias Ljungman announced last July that he was leaving the firm after 13 years to start his own firm, Moonfire Ventures, which will make early-stage investments in Europe.
Skype is just one example of what Botteri calls “a self-reinforcing cycle.” Every success story spawns a new generation of entrepreneurs and investors. Spotify, Supercell, Yandex, Delivery Hero, MySQL, Betfair, Rocket Internet. Each successful venture-backed company strengthens the ecosystem in addition to producing a hefty return for its backers.
All of this is playing out as students make their way through school, giving them the courage to try their hand at entrepreneurship rather than join a safe, established corporation. An analysis of seed-stage startups by Dealroom.co found half were started by people under 30.
“If you look back 10 years ago, very few of the best students at the best universities in Europe were thinking about starting their own companies,” Botteri says. “Today, probably 20 percent are working at startups or starting their own companies.”
When an entrepreneur takes the leap, he or she finds that Europe has a wealth of development talent, even more than the US. Europe is home to 6.1 million software engineers, compared to 4.4 million in the US, according to Stack Overflow, an online developer community. And while the number of developers has been static for the past three years in the US, Europe has gained 600,000 developers since 2017.
Europe’s largest tech hubs also notched sizable year-on-year gains: Germany’s developer pool grew nearly 6 percent to more than 900,000, the UK’s pool grew 2.3 percent to nearly 850,000, and France’s shot up more than 8 percent to more than 530,000.
Europe’s first-time entrepreneurs are also finding more hands-on help. For many years, European entrepreneurs had to travel to the US to participate in accelerator programs like Y Combinator, TechStars and Plug and Play. Not a great option for first-timers with little capital. With the maturation of the startup scene, more accelerators have popped up around the continent.
“There are a huge amount of quality mentors in the market now, and the ecosystem has become much more collaborative,” says Eamonn Carey, managing director at Techstars London.
Techstars has expanded throughout Europe since 2013. Besides London, it now offers its services to startups in eight other cities in seven countries: Amsterdam, Berlin, Lisbon, Munich, Oslo, Paris, Tel Aviv and Turin.
The number of Techstars alumni grows larger with each passing year. The London accelerator alone has seen eight batches of startups go through its program. That works out to more than 130 companies, of which about 80 percent have been acquired or are still active and have collectively raised about $600 million in follow-on venture funding, Carey says.
It is not in the same league as the US or China, but Europe is building a name for itself as a prolific producer of billion-dollar companies
Europe is making strides as a unicorn hatchery, but it has a long way to go to catch up to the US and China.
Worldwide, there are 448 unicorns (private venture-backed companies valued at $1 billion or more), says market researcher CB Insights. Most of them (215) are located in the US, followed by China (109). Coming in a very distant third is the UK (24), just beating out India (20).
Combined, the countries that comprise Europe are home to 57 unicorns, CB Insights says. (The researcher actually puts the number of European unicorns at 55, but two companies on its US list are based in Europe: Romania’s UiPath and Ireland’s Kaseya.)
Besides the UK, European unicorns can be found in Germany (12), France (five), Switzerland (four), Spain and Sweden (two each), and Estonia, Ireland, Lithuania, Luxembourg, Malta, the Netherlands, Portugal and Romania (one each).
To its credit, Europe has also produced another 61 unicorns that went on to be acquired or go public, says research firm Dealroom.co. That group includes Sweden’s Skype and Spotify, Germany’s Rocket Internet and Delivery Hero, Finland’s Rovio and Supercell and the UK’s Farfetch and Funding Circle, PitchBook reports.
Strong home for startups
An explosion of startup accelerators on top of increased public and private investment and widespread embrace of entrepreneurship is now paying dividends. Of the 10 nations with the strongest startup ecosystems, seven are in Europe, according to an analysis by StartupBlink. The US tops the list with a score of 44.1, far outpacing its nearest rival. But
European nations are gaining. StartupBlink ranks the UK second with a score of 16.7, Israel fourth (14.6), the Netherlands sixth (12.9), Sweden seventh (12.8), Switzerland eighth (12.5), Germany ninth (12.5) and Spain tenth (12.4).
So why aren’t non-European investors bigger investors in European venture funds? The simplest explanation is that it isn’t easy to pick the managers who are going to produce the best returns. That is the case for venture capital in general. When you factor in the relative youth of Europe’s venture business, it makes it even more difficult to pick winners.
There just aren’t very many European VC funds with track records of 10 years or more. “You’ve got asset owners trying to invest into a relatively small portion of a universe of 600 managers,” says Thomas Kristensen, a principal with LGT Capital Partners, which manages about $60 billion on behalf of 550 institutional investors as well as the Princely Family of Liechtenstein. “Trying to find the ones that will be winners can be very tricky.”
On par with the US
That isn’t to say it can’t be done. LGT has invested about $1 billion over 20 years in more than 100 European VC funds and has “seen very strong performance in our European portfolio,” Kristensen says. “It’s fully on par with what we’ve seen in the US.”
Kristensen estimates that LGT’s venture portfolio has generated an average total-value-to-paid-in-capital (TVPI) “of 2.2x to 2.4x over past 10 years.” To put that into context, 23 US venture funds from vintage 2009 generated a TVPI of 2.15x as of June 30, 2019, according to research firm Cambridge Associates.
But it is important to note that LGT is an outlier. Overall, long-term performance of European venture is quite poor compared with US venture. The 20-year return for Cambridge Associates’ Europe Developed Venture Capital Index was just 8.9 percent as of June 30, compared with 13.6 percent for the firm’s US Venture Capital Index.
On the other hand, short-term performance is better: Cambridge reports Europe beats the US on one-year returns (23.5 percent vs 21.8 percent) and three-year returns (21 percent vs 15.5 percent), and Europe and the US are neck and neck for five-year returns (13.8 percent vs 14 percent).
More potential investors are looking at the return data and seeing dollar signs. “Institutional investors are very much driven by numbers and by performance,” says Atomico’s Wehmeier. So the improvement in fund returns “has been a critical factor in driving investment in Europe.”
Of course, quite a few potential LPs remain skeptical. Geoffrey Love, Head of Venture Capital for London’s Wellcome Trust, is among those who remain uncertain about European venture.
“We used to invest in a number of European managers, as you might expect given where we’re based,” Love writes via email. “We invested in pan-European funds, single-country funds (Germany, France, Ireland, UK, etc), transatlantic funds. However, over time it became apparent that the returns from these funds was not worth the illiquidity, fees and uncertainty, particularly given more attractive alternatives in the US where returns were objectively superior. We terminated all but one European relationship, which we’ve had since 2000, and they have done very well for us.”
The dot-com bust was bad for LPs in US venture funds, but even worse for those who committed to European vehicles. Cambridge tracked 151 vintage 2000 US funds and found they had generated a distributions-to-paid-in-capital (DPI) multiple of 1.0x, meaning they returned $1 for every dollar invested, as of June 30. Comparable data isn’t available from Cambridge for European funds, but the European Investment Fund reported that the 10 vintage 2000 VC funds it backed returned an average of just 39 cents on the dollar as of June 30, 2017.
The bitter taste of a loss of that magnitude can take a long time to go away. “An industry consultant recently joked to us that European pension funds would only invest in local venture capital firms again when the managers who remembered the dot-com boom had retired,” the Financial Times reported in December 2017.
Kristensen of LGT cautions institutional investors to recognize that many of the dot-com era European funds were investing their debut vehicles and the tech ecosystem was just getting off the ground. First-time fund managers lacked the experience of their Silicon Valley counterparts and couldn’t access additional capital for troubled-but-promising companies. The maturation of Europe’s tech ecosystem and proliferation of capital sources makes it unlikely that European VCs will suffer a repeat of the dot-com bust in another economic downturn.
What’s the best strategy?
For LPs looking to get exposure to European venture funds, there are a variety of strategies to pursue. Cautious investors may take an indirect approach by investing in large US growth funds that have a global footprint. “US growth equity funds have been expanding heavily into Europe – they really like the opportunity set relative to valuations,” says Luiña of Hamilton Lane.
Another lower-risk approach is to go with an advisor with a solid track record in Europe. You will pay more in fees, but you’re paying the advisor to get you into the best funds and keep you away from the dogs.
LGT has found a fair amount of demand for its Crown Growth Opportunities Europe III, a fund of funds that invests in growth equity and venture capital in western Europe. LGT expects to hold a final close on about $300 million for the fund early next year and for it to be fully committed by the middle to end of 2021.
Crown Growth made its first investment in 2017. “Today we’ve made 15 fund commitments, completed three or four secondary transactions and made four or five co-investments,” Kristensen says.
LPs in the Crown Growth fund include the Princely Family and “a large number of other institutional clients who are looking to increase their venture capital exposure,” Kristensen says. “Some are looking for dedicated European exposure.”
Cautious LPs may also get European exposure through established US funds that invest globally. “It’s becoming apparent that more and more US VCs are looking to Europe,” says Love. “For instance, Adam Valkin at General Catalyst is here a lot, as are Matt Miller and Pat Grady from Sequoia, David Skok from Matrix, and Matt Cohler, Peter Fenton and Eric Vishria from Benchmark. So LPs in US-based funds will (hopefully) get access to some of the better European startups without having to have a dedicated European manager.”
For those willing to put in the time and resources, the biggest reward – and risk – comes from investing at the earliest stages. That means kissing a lot of frogs. Virtually all the 126 funds raised last year are focused on early-stage deals. And more than 70 of those firms are emerging managers, including at least 35 raising their very first fund.
Whatever path an LP takes, it should at least include a look at Europe. “If you’re not allocated to Europe, you’re missing out on an opportunity to build a diversified portfolio that can deliver benchmark-beating returns,” Wehmeier says.
If Wehmeier is right, there is no time like the present to invest in European venture funds. The clock is ticking.
Europe’s venture industry is just getting off the ground; more than half of firms in a recent survey are less than 10 years old
In a poll of 538 European venture firms last year, the European Investment Fund found that 56 percent launched in 2010 or afterward. Of the remaining firms, 28 percent started between 2000 and 2009, and 15 percent began in 1999 or earlier, EIF reports. (One percent declined to disclose their age.) The past five years have been especially active, with 129 new firms launching since 2015, or 24 percent of the total.
The typical firm has an average of €204 million in assets under management, with the median AUM coming in at €70 million, EIF says. The vast majority (about 70 percent) of the firms surveyed report AUM of €199 million or less. Of the remainder, 16 percent report AUM of €200 million to €499 million, 4 percent state AUM of €500 million to €999 million, and 5 percent claim AUM of €1 billion or more. (About 6 percent declined to disclose AUM.) And 60 percent have raised no more than two funds.
Early-stage and seed funds dominate the landscape. Most of the firms surveyed (368) say early stage is the most important stage, while 325 say seed is tops and 144 say late/growth is most important.
Information and communications technology is by far European VCs’ favorite market. More than 500 respondents call it their most important industry sector. Life sciences came in a distant second, with 143 describing it as most important. Few say cleantech, manufacturing and services are key markets.
Overall, European VCs have a rosy outlook. They rate the long-term growth prospects of their local venture capital markets at 7.7 on a scale of one to 10 (with 10 being most confident). They are equally bullish on the overall European venture industry, giving long-term growth prospects a rating of 7.5.
For full details on the “EIF VC Survey 2019,” go to https://www.eif.org.
Where are the exits?
Lack of exits is typically the first issue raised in any discussion about challenges facing European venture capital. Unicorns are great, but how about consistently big liquidity events?
The year 2018 looked like a turning point for venture-backed exits in Europe. Bottles of Veuve Clicquot popped as venture capitalists celebrated a record €52.9 billion in value for portfolio companies that were acquired or went public that year, including Adyen, Farfetch and Spotify.
The big result put European VCs in the same ballpark as their American counterparts: the outcome represented 45 percent of the $130.2 billion in value that US venture-backed exits produced in 2018, more than double the percentage of any previous year.
Alas, 2018 was an anomaly. For 2019, European VC-backed exits generated just €14.7 billion in value, a mere 6 percent of the $256 billion in value that US VC-backed exits produced (on a dollar-for-dollar basis).
US-based Cendana Capital is intrigued by Europe’s burgeoning venture market, but the $1.1 billion fund of funds manager has not backed any European VC funds because exits have not been big enough, Managing Partner Michel Kim says in a recent interview.
Europe’s lackluster exit environment is the number 1 concern in a survey of 538 European venture firms conducted last year by the European Investment Fund. Just over 40 percent of the respondents name “exits” as the first, second or third biggest challenge for the overall industry. To put that into perspective, just 10 percent of the VCs say they are worried about Brexit.
Boosters say it is just a matter of time before European VCs regularly generate big exits. Atomico Partner Tom Wehmeier points to the proliferation of unicorns. Close to 60 European VC-backed companies now boast private valuations of at least $1 billion.
“That’s the largest-ever pipeline of incredibly valuable late-stage, private European tech companies that will go on to be blockbuster IPOs,” Wehmeier says. “And the fact that they have access to late-stage capital gives them the freedom to stay private longer.”