The performance and prospects of European venture capital

By October 6, 2011Uncategorized

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’:

  1. 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.
  2. 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.
  3. 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.

image

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.

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  • Both EIS report and your analysis are insightful. In terms of point 1 regarding VC competition in Europe decreasing, when do you think this will result in better returns for European VC and therefore more professional LP money? 

    No question there is a flurry of activity and there are great entrepreneurs in Europe. Would these savvy founders not choose to raise funds in the US and move there versus take presumably worse terms from a less competitive European VC market? 

  • Hi Sunil – to your two questions:

    – The current crop of European funds need to deliver good returns, for ourselves and for the industry. Otherwise I fear the LPs will be gone for a long time
    – Some entrepreneurs move to the US (including some of my friends), and I can totally understand why, although it hurts every time. Fortunately some people love it here.

  • Thanks for your reply. Keep up the good work and hopefully in the near future there will not be a need to move. 

  • Have always felt one of the significant reasons for the weakness of the European VC industry is the lack of block-buster exit opportunities. IPO markets are not as well-developed as NASDAQ or NYSE. Corporate buyers too are limited. We tend to run after the big US names and they of course show a preference for home grown acquisitions. There have been good exits this year (especially for DFJ Esprit!!) but for a continent as a whole that’s just too few.

  • I agree with most of what you are saying, but I think the solution is linked to getting to critical mass. The US buyers are already more active over here than they have ever been and they will get more so over time as the number of good companies here increases. The IPO markets are here already at a small scale, and similarly that is improving. I just left a meeting with a banker whose opening remark was that he has never known a time when there are so many large profitable internet businesses in the UK.
    What will make a big difference is having a handful of $1bn+ listed tech businesses making large numbers of people rich via their own stock and M&A and providing a training ground for the next generation of entrepreneurs.

  • Not sure whether you saw my take which I wrote a couple of days before you. I too agree that there is an opportunity for the ecosystem to evolve and for better returns in the future. Let’s hope we’re both right!

    http://babblingvc.typepad.com/pjozefak/2011/10/when-bad-news-is-actually-good-news.html