Amid the good news these days is the fact that more and more capital is flowing into European startups. Research by Dealroom shows that the deployment of capital at seed stage almost tripled between 2013 and 2018, at $1.5bn. As for Series A, the amount deployed has also increased three-fold over the same period to $2.3bn. The UK is leading the way with $7.9bn in total funding deployed in tech startups last year, with Germany second at $4.6bn and France catching up at $4.4bn.
But the bad news is Europe is still a long way behind the US and Asia and the amount of funding in Europe starts to look much worse the larger the startups get. Particularly, there is a so-called Series B gap. European tech companies are better funded today right up until they have a solid product and actually start securing market share. At that point, they often don’t have enough growth capital to accelerate things.
This is because, historically, the rise of venture capital was made possible by the frequent and early opportunities to take companies public. Amazon did it in 1997, when it was only three years old after having raised less than $10m from investors. And for those who didn’t make it to an IPO, the fallback was the likely opportunity of being acquired by a larger company.
But Europe is lagging behind on both these fronts, creating what I would argue is one of the central problems for the European tech ecosystem: the difficulty of an exit.
It’s not as if Europe has its own Nasdaq—which would only really be beneficial if IPOs were an easy option, and that isn’t the case even in the US. Nor are there many acquisitions taking place. In fact, with a recession looming, established corporations are having a harder time acquiring startups in a value-add manner. And with US tech giants under scrutiny by EU antitrust authorities, there could be a deceleration in what is already dismal M&A activity. That lack of liquidity is probably what makes institutional investors so reluctant to allocate capital to European tech.
So what happens now?
The magic of the growing pan-European ecosystem is that early-stage players don’t really care; they expect the liquidity problems will be fixed over time. Optimism and blindness are traits inherent to ecosystem-building after all. Others, however, including institutional investors, are drawing more conservative conclusions: “If I can’t be sure of an investment exit in a reasonable timeframe, then I won’t allocate capital to this niche, illiquid asset class that is European tech.”
And so it’s urgent that we start designing forward-looking yet realistic scenarios.
The first scenario is that Europe’s M&A scene is taken over by those who have capital to deploy and little opposition from antitrust authorities—namely, Chinese tech companies. Those on the ground know that large Chinese ventures are already hunting for European targets. Unlike Europe, China has plenty of IPOs and M&A activity right now, and thus has no liquidity problem, which means that they have the financial firepower to expand by way of acquisitions. And because Chinese companies are barely operating in Europe, antitrust is not really an issue here.
But this scenario has a potential obstacle: European governments could block Chinese acquirers in the name of preserving strategic assets or preventing products being operated from a country prone to mass surveillance.
The second scenario is that governments can help encourage late-stage funding. Emmanuel Macron has recently twisted the arms of reluctant institutional investors and announced €5bn of additional funding, provided by both the French government and large investors such as insurance companies, to fuel the growth of up-and-coming French champions.
There’s a lot to be said against the French statist tradition, but an occasional upside is that it makes it easier for the government to force large corporations to do things that go against their short-term interests. After 15 years of trying to attract insurance companies to invest in startups, the French government basically said “That’s enough” and forced them to commit, despite the dismal returns and the evident lack of liquidity down the stream.
And it could work. Once you have large institutional investors with skin in the game—that is, capital tied up in local startups—they could contribute to finally setting up a stock exchange ready to do more IPOs in Europe.
The third scenario derives from the observation that, despite the recent uptick, IPOs are getting scarcer in the US, too—and it’s not being helped by the WeWork drama and the potential for stricter financial regulations should Elizabeth Warren win the US presidency next year.
And so how have US venture capitalists managed over the last 10 years? By supporting the rise of an alternate ecosystem of secondary investments, which has seen mutual funds, hedge funds, large private equity funds, and various special purpose vehicles take over and provide early, sizeable returns.
Can Europe pull the same trick? It has all it needs to succeed: local ecosystems building up; lots of capital in search of returns; a financial services industry now distributed across London, Paris, Frankfurt, Luxembourg, and Zurich; pioneering efforts with firms like Balderton raising late-stage liquidity funds; and governments determined to make it happen.
The bets are on—mine is bullish.