Nicolas Colin

By Nicolas Colin

There’s a new approach to funding startups in town: revenue-based financing. Taking on debt, rather than giving away equity, is all the rage in 2020 — at least, that is, in America. 

Europe, as always, is in danger of lagging behind. Sure, there are some startups and investment firms exploring local versions of revenue-based financing: we’ve seen it with new entrants such as Berlin-based Uplift1 and London-based Uncapped, as well as Outfund, another London-based firm. Large companies such as Stripe, Shopify and Amazon are also offering working capital to online retailers and they’re slowly expanding this part of their business in Europe.

But like most financial innovations in the current paradigm shift, it’s the US racing ahead.

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It’s true at the exit stage with ‘new’ practices such as direct listings and SPACs; it’s true at the growth stage with private equity firms exploring new approaches to deploying capital, notably in SaaS companies; and it’s true with revenue-based financing. Europe is even lagging behind when it comes to developing alternatives for less scalable startups, like that pioneered by the likes of Indie.vc, which provides capital for startups whose goal is to reach profitability sooner than the ‘blitzscalers’ (and takes less equity).

VC is not the only option

Whereas there’s a vibrant conversation and visible initiatives around those issues in the US, Europe still generally endorses the idea that ‘tech’ is a homogeneous category and that every tech startup has the same funding needs. We are stuck with the assumption that anything that looks and sounds like it’s a tech startup should be financed by venture capital, with the related dilution and expectations from a returns perspective.

“Europe still generally endorses the idea that ‘tech’ is a homogeneous category and that every tech startup has the same funding needs.”

But then there are also the perennial problems with European startups whereby the traditional model doesn’t always fit: a fragmented market that makes scaling up more difficult than in the US or China; the lack of capital at later stages that forces founders to reach profitability sooner than their US counterparts, thus potentially cutting down on increasing returns; and the lack of liquidity at the exit stage that makes it especially tricky for fund managers to generate the returns that their LPs are expecting. In short, because Europe is so fragmented, the approach to financing as it’s practised in Silicon Valley doesn’t quite deliver the results.

Many segments that European founders chose to explore reveal these typical problems with building blitzscaling companies in Europe. Some founders are attracted to SaaS because it’s (relatively speaking) easier to move across borders and reach a large scale (despite local fragmentation). Meanwhile, other founders are content with a small-scale operation in a sector that doesn’t lend itself to highly scalable business models. 

These two cases reveal exactly where the problem lies. In Europe’s adverse environment, the specific segments where founders find the most traction are precisely those that would benefit from more alternatives to traditional venture capital. European SaaS founders would be better off if they could securitise future revenues; and European ‘indie’ founders would be better off if they were able to find funding options somewhere in-between conservative bankers lending them pennies with many strings attached and returns-hungry venture capitalists taking a large chunk of their cap table.

In the absence of local options tailored to their specific needs, both SaaS founders and indie founders end up in a bind: they have no other choice than to go the route of traditional venture capital, therefore consenting to higher dilutions and having to promise higher returns.

Meanwhile, their American counterparts have it easier: in US-based SaaS, it’s now less necessary to dilute oneself that much thanks to the greater availability of revenue-based financing; as for the indie segment in the US, it’s now possible to raise capital without promising the high returns that make traditional venture capital viable. On the financing front as on others, European founders are at a disadvantage — and on market segments that particularly fit the local context of a fragmented and cash-constrained continent!

What’s holding Europe back?

To be clear, despite seeming to be an environment crying out for such innovation, Europe still faces significant hurdles. We need to start debating the issue, for starters, as has already happened in the US thanks to this article from Alex Danco. We would also benefit from having large European tech companies, the local equivalents of Amazon, Stripe and Shopify, embracing the cause of financial innovation for startups — which brings us back to the problem of not having such champions in the first place.

Then there are also legal issues, from both tax and regulatory perspectives, that governments and the European Commission should try to solve — for instance to facilitate bundling venture capital with marketing advances without incurring tax frictions. In this more favourable context, the financial services industry, from banks to fund managers to limited partners, would eventually wake up and build better instruments that can better meet the alternative needs of tech companies in Europe.

Maybe this would start by having sovereign investors, such as the European Investment Fund or its national equivalents, deploy capital to fund vehicles targeted at these fast-evolving segments — revenue-based financing for SaaS as well as the European equivalent of Indie.vc?

Recent initiatives show that Europe is capable of catching up. We now see frequent use of convertible notes at the pre-seed stage, with most European ecosystems now having their equivalent of the US’ SAFE instrument. There’s also movement toward solving the liquidity issue, as more and more funds are focused on secondary transactions, in addition to the prominent VC firms that have decided to tackle the issue themselves, such as with Balderton’s liquidity fund.

But it would be a welcome sight to not just have Europe playing catch-up, but instead rushing to take the lead when it comes to revenue-based financing and indie venture capital. Because one thing’s for sure,  the world isn’t waiting. 

Nicolas Colin works for investor The Family. He writes a regular column for Sifted.