European Venture Capital: Era of disruptive ventures
The use of disruptive technologies is opening up opportunities for European venture capital to build successful global companies
At a glance
• There is renewed confidence in the European venture capital markets.
• A challenge for European investors is to avoid a bubble.
• The US is still the clear global leader in venture capital.
• European venture capital is benefitting from the impact of disruptive technologies.
“Up till two years ago, I was saying be careful with European venture. If you looked at the track records, you would not want to invest there because they were so bad,” says Ludovic Phalippou, associate professor of finance at the Oxford University’s Saïd Business School.
Things may now have changed. “Venture capital works globally. There is no doubt of that anymore,” says Nils Rode, a managing director at Adveq, a specialist private equity firm. That is certainly a relief both for investors and for European governments, given the doubts over that issue 10 years ago and the critical role that new companies can and should play in revitalising the European economy.
But with the renewed confidence come dangers. “There are lots of good things happening in Europe. Lots of places in Europe with good companies and entrepreneurs. But at the moment, valuations don’t make sense,” says Phalippou. “There continue to be MBAs funded by venture capitalists setting up new ventures. They are very popular free online business models but will they be able to ever show some revenues? There is a bit of an internet bubble like the late 1990s going on.”
Moreover, there is only a relatively small group of outstanding venture capital firms. “There is a high dispersion of returns, much higher than in the buyout world and investors need to be in the top decile of managers to get the returns, whether in the US or Europe,” says Helen Steers, who leads European investment at Pantheon Ventures.
For investors and for European governments the real challenge might be to avoid a bubble. They also need to ensure that there is a solid and robust set of opportunities being created. It should not be necessary to depend on being able to pick and gain access to just a select, small group of private equity firms.
What is exciting about venture capital globally is that, as Rode argues, venture capital is disrupting whole industries with hardly any unaffected. “There is very tangible evidence everywhere of that happening. What is also happening and what has changed over the past 10-15 years is that the companies are growing faster than ever before – so that they change industries and attack existing companies within a period of only five to 10 years, which has never happened before. So there is change happening and huge changes coming.”
“Companies are growing faster than ever before – so that they change industries and attack existing companies within a period of only five to 10 years, which has never happened before. So there is change happening and huge changes coming”
Steers also accepts that venture capital firms have changed in their approach. “Frankly, venture in the early days in Europe was not great for anybody and then came the dot-com crisis at the end of the 1990s.” In contrast, she notes that some of the newer groups Pantheon has invested in over the past few years have a much more US-oriented style of approach to venture capital. “They were not so focused purely on the technology,” she says. “The venture capitalists that have come along in the 2000s have been much more concerned about building high-growth companies, with a very strong commercial focus, rather than just backing hot technology ideas.” That approach to venture capital in Europe has been successful.
How does Europe compare with the rest of the world? There are big differences between regions. The US is clearly the leader in venture capital. “It was always that way and that won’t change any time soon,” says Rode. “You can see it, whichever statistic you use. If you look at the so-called unicorns [tech start-up companies that are valued at more than $1bn] more than 60% are in the US. Two-thirds of the big tech and life sciences exits have been in the US. Number two on a global basis is now Asia, led by China whilst Europe has fallen into third place.” As Rode says, in Europe, London leads the venture capital field, followed by Berlin which has overtaken Paris.
While venture activity in Europe may be increasing dramatically, Europe appears to be falling behind in one key area. “An important part of venture is about investing in big ideas – breakthrough innovations, highly disruptive companies which are the areas most talked about in the media and rightly so. That part of VC [venture capital] is mostly taking place in the US,” says Rode.
Steers adds that Europe has the potential to produce disruptive technologies, but it has not converted them into many large-scale businesses as yet. “Europe is still building the ability to take good ideas from the universities and commercialise them,” she says. “There is a cultural change still required. It is not just that doing something commercial is seen as against the ideas of academia, which probably is not so much the case now, but what is still required to be developed is the risk-taking culture seen in the US, where it is OK to start something, fail and start again. It is almost a badge of honour.”
The absence of breakthrough innovations can also be seen in returns, as Rode explains: “Venture funds are driven by the biggest hits. Historically, 7% of VC deals represent 50% of exits. Being in the biggest hits is very important and in the US, the biggest hits are much bigger companies than elsewhere, with $1bn or more exit valuations. Most of these have arisen through breakthrough innovations. In Europe, exit values tend to be lower.”
For Europe, the future looks bright for venture activity. As Toni Vainio, a principal at Pantheon Ventures says, technology is revolutionising several industries. “Developments such as cloud computing, and so on, are disrupting industries such as healthcare and financial services. There is a bigger opportunity set for venture companies. You have seen it with cars with Uber, and Spotify with record labels. The building blocks are there to make disruption so much easier. It is hard to create big companies but it is easier to create globally disruptive companies and you don’t necessarily need to be in Silicon Valley to be able to do that.”
For Europe, that may be the critical factor for the future. “In the past, the US had a huge advantage because of the big home market for any new technology business and Europeans were disadvantaged. Now the disruptive technologies, whether in the medical field or in information technology, are breaking down geographic barriers. These are becoming irrelevant so, therefore, you can build successful companies in Europe as you can in the US,” says Steers. Both investors and European governments will be hoping she is right.