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The case for European venture

I was chatting with a friend last night about the lack of institutional investor (LP) interest in European venture capital as an asset class. We both believe that now is an attractive time to invest in European technology startups and started why we think so differently to most of the people we would like to invest in our funds. Having thought about it for a few hours I remain convinced that there is a strong case for European venture, but I think it is a case  built largely from anecdotal and circumstantial evidence which is impossible to prove conclusively and it is a case that is difficult to grasp unless you have intimate knowledge of the market. Most LPs lack the contacts or the time to build up that intimate knowledge and they (regrettably) choose to stay away from our asset class.

The good news lurking in here for those investors who are able to grasp the case in favour of European venture is that less capital in the market should mean less competition for deals leading to lower valuations and higher returns.

That’s a nice piece of logic, but it leads to the obvious requirement to set out this difficult to grasp case for European venture, which is why I’m writing this post. I’m betting my career on this case and I’d like to get it right, so don’t treat this as a polemic from an interested party, but as an honest, intellectual enquiry. Please chip in with your thoughts.

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I think that if you believed everything in the table above and you backed yourself to be able pick a good fund manager you would be pretty keen on investing in European venture. The difficulty is that there are no statistics or hard evidence to back up the reasons to believe. Let’s take an example – when I look at the success of companies like Mind Candy, Wonga, Criteo, Graze and Just-Eat and compare the strength of the ecosystem when they started out to where we are today I conclude that in 3-4 years we will have another, larger, clutch of similarly successful companies, but to an investor less familiar with the market it is hard to know for sure just how valuable those companies are today let alone whether the ecosystem has strengthened and we will have more of them next time round.

Moreover, the problem is compounded by the hard stats that are available. Unfortunately they show that historically European venture hasn’t made money. So, would be investors have to be intimate enough with the market to not only believe the reasons listed in the table above but also to argue that the future will be different to the past with enough conviction to overcome the scepticism of their colleagues who don’t know the market and hence can only look at the historical statistics.

Along with many of you, we at DFJ Esprit are doing all we can to help grow the venture industry and startup ecosystem here in Europe, and having written this post I believe more than ever that we will succeed. But I don’t think it will be easy. There have been many difficult periods for the industry in my 13 year career as a VC, most notably after the internet and banking busts of 2000 and 2008, and I expect there will be more in the future. There are also other significant difficulties that we face in Europe which I haven’t discussed because I wanted to keep the post short, not least the headaches of operating in many European countries vs one large US market. However, overall I think the reasons to be optimistic outweigh the reasons to be negative by a significant margin, and that VCs and entrepreneurs with a commitment to the local startup ecosystem will find a way through the challenges we will face and get us to a situation where people are making money and everybody accepts that European venture is a solid asset class.

I’d love to get your feedback on this post, more so than on anything else I’ve written recently. Are my reasons to believe flawed? or do you have other ‘reasons to believe’ that I should add to the list? or any hard evidence to back any of them up?

  • http://www.facebook.com/alessandrosanto Alessandro Santo

    well, not much to disagree as any poiny you make is not backed up with data. The overall idea I take out is the same of recent Earlybird deck, scarcity of capital creates a supply gap that propels return by lowering the valuations.

    I believe in growth/huge exits more than lowering the entry valuations and growth is lacking in Europe and companies dont pay high exit multiples. The great success stories you mention are not enough for an entire continent neither are to create enough returns for the €B invested yearly.

    As far as I know Rocket Internet moved the European teams it created in 2011 in France/Italy to Asia…

  • http://www.theequitykicker.com brisbourne

    Hi Alessandro,

    You make a good point. Venture success is predicated on home run successes of billion dollar proportions. We will know when we’ve made it in Europe when we are (finally) producing our fair share. I also agree that when the outcome is that big the entry valuation is less important, at least up to a point.
    However, I don’t think it is wise to have a portfolio that relies on getting a billion dollar exit to deliver good returns. The numbers should add up with more realistic exits in the model, with upside coming from a home run.
    Most funds in Europe at the moment won’t get a billion dollar success, but if they follow the advice above they can still make good returns and attract more investors into the market. That job gets a little easier if valuations are lower.
    In other words we need to grind it out. I also think that if corporates start to see VCs being successful they will believe more in the quality of local innovation and might start to pay higher multiples.