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European VC: out of Silicon Valley’s shadow

27 Oct 2017

For as long as European venture capital has existed, it has sat in the shadow of its bigger, bolder transatlantic counterpart. However, as the European industry continues to expand, there are growing signs that Silicon Valley no longer has a monopoly on producing “unicorns”.

For as long as European venture capital has existed, it has sat in the shadow of its bigger, bolder transatlantic counterpart. While Europe has had many notable success stories in recent years – from Skyscanner and Spotify to Supercell and Zalando – for every tech giant over here, there are plenty more U.S. equivalents. However, as the European industry continues to expand in scale and depth, there are growing signs that Silicon Valley no longer has a monopoly on producing “unicorns”. Nor should investors consider U.S. funds as the sole source of superior VC returns.

European VC is less than half the age of its U.S. counterpart and a fraction of the size, but the industry in Europe is far from immature. Many managers have seen multiple cycles, with more than half active for over 12 years, according to data from Invest Europe. Moreover, the continent now has experienced serial entrepreneurs and over 100 start-up accelerators providing seed investment and mentoring.

Last year, European VCs raised $7.1 billion (€6.4 billion) – the highest amount raised since 2007 and a continuation of several years of steady growth. Nearly 10% of this capital was from North American institutional investors, who over the last five years (2012-2016) contributed double the average percentage from the previous five years. Europe’s VC fundraising is still well behind the U.S., but it is catching up. 

A further positive sign is the economy. It has been a bumpy ride since the global financial crisis, but Europe’s economic performance is now robust. GDP across the 28 European Union economies grew by 1.8% in 2016, with growth seen across all countries, according to European Commission data, outpacing the U.S.’s 1.6%, as reported by the U.S. Department of Commerce. Even with the UK’s upcoming exit from the bloc, economists expect the EU’s GDP to expand by 1.9% a year over the next two years. And Europe’s policymakers are committed to supporting that growth: the Commission’s Capital Markets Union plan is championing more forms of funding for businesses, including venture capital, and is creating a €1.6 billion fund-of-funds VC programme to facilitate more investment into the market by large institutional investors.

However, the world’s top ten corporations by market cap are still all from the U.S., with the top four – Apple, Alphabet, Microsoft and Amazon – being the biggest VC success stories of all time. So how can Europe compete?

One possible answer is that the continent’s perceived disadvantage – not having an established and world-leading hub such as Silicon Valley – may actually be an advantage. Its large number of diverse start-up hubs, including Amsterdam, London, Paris, Stockholm and Zurich, are pioneering the next wave of tech development, from fintech, to artificial intelligence, biotech and robotics. Building leadership in these fields could bring Europe’s VC industry a strong competitive advantage on an increasingly globalised stage. Indeed, the World Intellectual Property Organization lists Switzerland, Sweden and the UK at the top of its ranking of most innovative countries, with European nations holding eight of the top ten places.

European stock markets are becoming increasingly receptive to VC-backed flotations. In the first 11 months of 2016, Europe saw 12 venture-backed tech IPOs, raising $760 million, according to Pitchbook data. That compares with 17 IPOs by U.S. firms, raising $1.6 billion, in the same period. The continent’s VC-backed companies are attracting growing interest from global corporate acquirers: China’s appetite for European tech was demonstrated by last year’s sale of Finnish gaming group Supercell for $8.7 billion to TenCent and Ctrip’s acquisition of airline price comparison site Skyscanner for $1.8 billion.

Of course, the ultimate proof of European VC is in the returns. UK venture capital funds last year – many of which invest on a pan-European basis – recorded their highest returns since 2003, according to the British Private Equity & Venture Capital Association.

Meanwhile, the European Investment Fund (EIF), the largest investor in European VC, has seen ten-year net annualised returns (IRRs) at 5%, five-year returns at 9.5% and three-year net returns at 12.2%, indicating strong upward progress and outperformance in today’s low yield environment. Furthermore, the EIF’s top 30 funds from 2007 onwards delivered a median net return of 27%, demonstrating what a targeted investment approach can achieve.

Investors who are not familiar with Europe’s opportunities may overlook this VC market, but ignoring its potential could mean missing out. Valuations are a fraction of those in the US: in Europe: $1 billion-plus tech companies are priced at 18x earnings, compared with 46x for their U.S. counterparts, according to GP Bullhound. But this wide pricing gap may not persist for long. By getting involved now, investors have an opportunity to back better-valued companies that are disrupting industries, and to benefit from their considerable returns potential.

First published in Pensions & Investments.

Nenad Marovac, Chair for 2018-2019, Invest Europe

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