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News & opinion

More Unicorns, More VC

02 Dec 2015

Finally, there is an air of Silicon Valley in Europe. A host of start-ups has emerged in good old Europe and grown to the magic $1bn valuation at which they transform into unicorns. Transferwise, Bla Bla Car and Delivery Hero are only a few names among the 13 European companies that entered the unicorn club in 2015, most of them in the consumer space. Yes, the US is still doing better – they have produced 22 unicorns this year. But Europe is catching up.

Now, let’s take a closer look at where the funding for these early-stage successes comes from. While it was pretty much down to government grants and VC funds ten years ago, the investor landscape has changed quite a bit.

Nowadays, the pre-venture rounds are getting more and more important for entrepreneurs. Crowdfunding platforms and serial entrepreneurs who are happy to write big cheques are making it easier for young companies to get started. There is not much robust data out there but it seems that €5m series A rounds are no longer the exception.

It is not only angels that engage at this early stage. We see more and more growth capital firms investing early on and even hedge funds and investment banks are keen not to miss out on the opportunity to back the next Spotify or Skype. While the latter investors used to only come in once the companies went public, they realise now that the unicorns of tomorrow will stay private much longer and so they come in early too.

Venture capital, anyone?

A look at our Invest Europe data shows that VC investments in Europe were flat over the last five years – on average a total of €3.5bn a year. Same with VC fundraising: these firms managed to raise a total of about €4bn on average every year.

So while venture has been very stable over the years and has demonstrated its important role in the early stage ecosystem, it has not really benefitted from the new wave of entrepreneurialism in Europe. US VC raised €24bn last year while in Europe the total was a mere €4.5bn. We do note an uptick in VC fundraising over the last 12 months, confirming that European venture is seen as an attractive asset class by investors. Yet VC fundraising accounts for a tiny 0.03% of GDP in Europe while in the US it is at least 0.17%, even though each has a GDP of about the same size. The problem for European VC is that the funds still lack scale. The average venture fund in Europe is about €65m but you need to be able to raise at least €150m if you want to attract the large institutional investors, like pension funds and insurers. To make their asset allocation efficient and effective, most of them have minimum ticket sizes around €20m. If you apply the golden rule of fund investments, that no investor should have more than 10% of the capital committed, you see that this requires fund sizes of €200m-plus.

Europe has hundreds of VC funds but most of them are really small. 75 percent of all the funds raised in Europe were smaller than €70m.

The conclusion is obvious: European VC funds need to scale up. That will only happen if large private sector investors invest in them. Right now, the national and regional governments of Europe and the EIF together make up the biggest investor group in European venture, accounting for about 35% of the committed capital each year.

As long as small fund sizes remain the norm in Europe, larger investors will not invest. A catch-22 situation.

At Invest Europe, we thought long and hard about how to attract more institutions into venture capital. The plan we have worked on with the European Commission is for Europe to channel public funds into private sector funds of funds, which will then need to raise a similar amount from the private sector. Fund of funds managers have the contacts – they deal with large investors, like Canadian pension funds, Asian sovereign wealth funds and European insurers on a daily basis. Their venture fund of funds would also have the major advantage of being large enough to allow for €20m-plus ticket sizes.

The fact that venture capital funds of funds have been put forward in the Commission’s action plan for a Capital Markets Union as a potential promoter of innovation and growth in Europe is a great endorsement.

Once raised, the funds of funds could start investing in European venture firms that the institutions cannot reach directly. Now, it is important that their investment decisions should not be influenced by public policy. Some government investment bodies do aim to stimulate venture capital where it is underrepresented, but the role of these funds of funds will be to draw in private investors – and that can only be achieved with focus on excellent
managers producing the best returns.

Over the longer term, with proven results, pension funds and insurers might be inclined to invest directly in European venture funds. And when that time comes, there should be more European firms with strong track records raising vehicles big enough to digest their large cheques.

European venture capital plays a key role in the early stage ecosystem that is growing world-class companies. Unicorns are a rare enough species in Europe. Let’s make sure that we protect them and feed them enough capital and expertise so that they have a fair chance to flourish.

Dörte Höppner, Chief Executive Officer, Invest Europe

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