Last week the European Investment Fund (EIF) released a thoughtful paper on The Performance and Prospects of European Venture. It is a comprehensive discussion and analysis of how European venture has performed and the main arguments put forward to explain the underperformance versus the US.
I agree with their conclusion, which has three strands:
- European venture capital has performed badly over its history
- The industry lacks critical mass and performance will improve as it scales
- Venture capital needs to grow as part of the wider startup ecosystem, which will take time
This leaves one obvious question unanswered: given the European is still sub-scale, will poor performance continue to prevent growth?
I think there are three reasons to believe that we will reach critical mass and the answer to the question is ‘no’:
- Competition in the European VC industry has decreased and returns should therefore improve. Most observers estimate that the industry has contracted by around 80% over the last ten years. Anecdotally, most participants today report that there are few active funds, and over the last couple of years relatively low valuations over here have attracted increasing numbers of US VCs to cross the pond.
- The number and quality of startups and entrepreneurs is increasing. It is harder to put numbers on this one, but I can feel it in my gut and see it at networking events every night of the week.
- Governments across Europe now understand that startups are the engine of employment growth and are pump priming the VC industry by investing in VC funds and adopting policies that encourage entrepreneurship. The Prime Minister’s highly visible support of the Tech City initiative in the UK is a) a new development here, and b) being replicated by other politicians in the UK and around Europe. The chart below shows just how important government funding is to the European VC industry, a good proportion of which comes from the EIF.
If I’m right then the VCs that are currently active in the market should make good returns. If we do then pension funds and other professional investors will come back to the asset class, the industry will grow, governments can scale back their commitments (probably slowly), and our sources of funds bar chart will look more like the one for the US.