For European VC to truly flourish, private sector funding must increase, argues Joseph Mariathasan
Whether European venture capital is falling behind the US or Asia is of importance for more than just venture capital investors. New companies at the forefront of innovation can act as catalysts for stimulating economies way beyond the immediate returns for the investors – the rise of the internet economy is testament to that.
There is an opinion that Europe is falling behind in one key area – investing in big ideas, the breakthrough innovations and highly disruptive companies most talked about in the media. I wrote about this a few months ago. Joe Schorge, founder and managing partner of Isomer Capital, has come back to me rebutting this view, and his arguments certainly deserve a hearing.
Schorge says much of the analysis and negative perceptions of European venture are based on outdated data. He argues that the way innovative companies are built and financed has changed since the financial crisis, driven largely by the rise of smart phones, app stores and cloud-based computing, yet it takes years for such results to be reflected in backward-looking performance indices.
Meanwhile, he sees a great investment opportunity in funding the future, today. More recent analysis by the likes of the Boston Consulting Group in a 2015 report suggests VC performance is trending upwards, driven by high US investments in Europe. What is a worry, though, is that the average fund size of the more than 800 VCs is small, and small, nationally focused funds have often underperformed. What is very positive is the development of venture hubs in Europe, with Schorge seeing London, Paris, Berlin and Stockholm leading, and a range of other cities following closely.
Where Schorge differs from others is in the view that Europe is falling behind in ground-breaking innovation. As he rightly points out, in recent years, European companies have led the way in areas such as gaming, music streaming, blockchain and smart cities, among others. A good example is the British artificial intelligence company Google Deepmind, which is at the forefront of artificial intelligence. It made global headlines earlier this year when its programme beat a human professional at the game Go, which has never been done before.
But perhaps the flip-side of that is that the company was acquired by Google in 2014, its biggest acquisition in Europe to date. How effective can European innovation be at the creation of unicorns (private companies valued at more than $1bn) if any potential contenders are rapidly acquired by the US mega companies? There may be some hope in that BCG does estimate that, as of August last year, 13 of the 129 global unicorns were based in Europe, including global names such as Shazam and Spotify.
Other reports claim even larger numbers, with GP Bullhound identifying 40 in Europe. The UK is by far the leading creator, with Germany some distance behind. What is interesting, they find that the vast majority of new additions are consumer-focused, with all new unicorns in Germany being consumer-orientated. The mix in the UK, they find, is more diversified, with software companies dominating the new additions. The strongest sectors are e-commerce, software and marketplace, with each representing 20% of the total number of European unicorns. The fintech share is growing the fastest, with seven companies, and more than half of the fintech companies are UK-based.
As GP Bullhound points out, London’s unique position in global finance is driving this growth. Schorge sees London as being on track to earn the title Fintech Capital of the World, given its strong growth as a start-up hub, wide talent pool of finance industry executives and the presence of all the large global financial intuitions. A key issue, of course, will be the potential impact of a Brexit. Proponents of Brexit will argue there will be no detrimental impact, but, the truth is, no one knows.
So, should we be complacent about the strength of European venture? GP Bullhound reports that the new generation of European unicorns has raised significantly more capital than in the past but adds that now it is more important than ever to keep momentum in “winner takes all” sectors.
Yet, despite the glowing reports that they, Schorge and others are reporting on European venture, the fact remains that it is difficult to get private sector funding from large institutions such as European pension funds. There are many reasons for that, including the fact small fund sizes preclude many large institutional investors from taking stakes, given the amount of due diligence required for relatively small investments.
Not surprisingly, as BCG reports, the absence of private investors has led to governments becoming the largest LPs in Europe, with 35% of the market. For European venture to truly flourish, that figure has to be reduced through increased private sector funding, rather than reduced government investment. And in the UK, a possible Brexit may very well become the more important issue.
Joseph Mariathasan is a contributing editor at IPE