VC Perspective — “Great Companies Can Be Built Here In Europe”

This article was originally written by Sarah Gill for Strategy Eye Digital after a panel she moderated this month on “VC in Europe” at the Pirate Summitin Cologne:

Twitter: @sarahgillmartin

Sarah has four and a half years’ experience analysing businesses, startup ecosystems and investment trends in technology. She’s interviewed many of the most influential entrepreneurs and investors in the European tech scene and has co-authored reports on subjects ranging from fintech to fashion tech. She’s currently a senior reporter at StrategyEye. Before joining the StrategyEye team, Sarah was based in Buenos Aires working as a reporter for the Argentina Independent.

At first glance there’s never been a better time to be an entrepreneur in Europe. There’s more venture funding with each successive quarter, companies with billion-dollar valuations are emerging with increasing frequency and Silicon Valley investors are becoming noticeably more activein the region. In reality of course it’s much more complex than that, with funding unevenly distributed across the region, a bottle-neck of funding from Series A upwards and ongoing debate over where are the best locations for entrepreneurs to build their businesses.

Here, venture capitalists (VC) based in Germany share their thoughts on the changes taking place in Europe and what needs to happen for the region to sustain its recent momentum. Here are some insights from Chiara Sommer at Germany’s most prolific seed investor, High-Tech Gründerfonds(HTGF), and Videesha Kunkulagunta at Redstone Digital, which is building a new model for venture capital in Europe.

Germany’s VC Landscape

In Germany, it’s Berlin that gets the lion’s share of coverage as the country’s biggest Leuchtturm (lighthouse) city. That’s not too surprising as it’s where the bulk of venture capital is flowing, thanks in no small part to the activities of Rocket Internet. But taking a step back, what does the broader German VC landscape look like and how does it compare to places like London?

First off, the activity of corporate venture capitalists is pronounced. “The key thing I’ve noticed having worked in both the London and German ecosystems is the influence of corporate VCs,” says Kunkulagunta. “There’s a lot more corporate activity in Germany than in London. Last year for example we had the launch of CommerzVentures from Commerzbank and at Redstone we often work alongside many corporate investors. Second, would be that Rocket Internet has such a huge influence on the type of business models that are being built here, especially in the business-to-consumer sector.”

Sommer points to the wider transformation in the country over the past decade: “A lot has changed over the last 10 years. When HTGF started there was almost no VC financing, which is actually why it was founded. Since then the market has developed to what we see today.”

She also highlights the significance of Germany’s strengthening business angel network as more second-time founders come into the ring, as well as the growing impact of international investment.

“There are a lot of international VCs doing later stage rounds and their impact has increased drastically,” she says. “Last year for example 40% of the external financing for our portfolio companies came from international investors.”

Silicon Valley Touch

The uptick in investment from outside Europe in European tech companies is happening right across the region. Atomico research lead Tom Wehmeier recently released research on that found in the first half of 2015 only 30% of rounds Series B and above came from all-European investors. Though it does not break out where firms with cross-border operations sit within this, it’s clear that Silicon Valley VCs are plugging a fair share of the funding gap for now. For example, Andreessen Horowitz leading the January round that made London’s TransferWise a unicorn. That statistic seems stark, but is it that surprising? And what impact is it having on Europe?

“I’m not surprised,” says Kunkulagunta. “When I was in London I worked at PROfounders Capital and many of our growth stage fund raisings were follow-ons by US investors.”

“More and more US investors will come here and it’s only a good thing for the ecosystem. It’s good to have competitive energy from new VCs entering the ecosystem. European investors have to raise their game and US investors will bring more experience, education and increase the level entrepreneurs expect from the investors that invest in them.”

Key Developments In Europe

As well as more funding coming into Europe, more funds are also being announced including Mosaic Ventures and Felix Capital in London this year. With Felix focusing exclusively on what it calls the creative classes, will we see more vertical-focused funds in the region? Yes, according to Kunkulagunta, but this isn’t a novel idea.

“If you look at the VC landscape you see established funds like Notion Capital in London — specifically focused on business-to-business (B2B) cloud and software-as-a-service,” she says. “So it’s not anything new, but it will become more important for VC funds to differentiate. You’ll see verticalisation in the early stages where there are relatively a higher number of companies but as you get to growth and then buyout stages where there are far fewer so they won’t be so sector-specific.”

The same thing is happening in the accelerator space, with programmes increasingly focusing on a sector such as smart cities or healthcare. Here, too, corporates are important.

“There are also incubators from corporates popping up all the time so they have a very specific focus on what they’re looking for,” says Sommer. “It’s a good development because if you’re investing at a later stage and you’re looking for something specific you know where to look.”

Which Is The Best City For Startups?

Clearly there are advantages and disadvantages between different tech clusters, but how much of a difference does it ultimately make and will that change?

According to Sommer, there’s no denying the strength of Berlin’s ecosystem in Germany, but that doesn’t mean a startup necessarily needs to be based there. “Berlin on average performs better among our portfolio companies,” she says. “The ecosystem can be the only explanation for that and that’s down to the talent and previous experience, plus the learning available from other founders and peers. But in life sciences for example there are numerous other hubs in the country and for B2B Munich is strong. It’s not just about Berlin.”

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What about Europe versus the US? “At the moment there is definitely a problem of talent leaving the region mainly because of the historic lack of management with experience of scaling and there is also generally less capital in Europe,” says Kunkulagunta. “I have seen a brain drain of startups moving from Europe to the US. But I believe that in the long-term, location is going to start to matter less. Facebook for example started in Massachusetts, not in a big metropolis. The company eventually had to move, but there can be advantages to being under the radar initially.”

What Does Europe Need To Do To Sustain Growth?

“Success story are the key words here,” says Sommer. “There need to be more category-leading companies or ‘Leuchtürme’ in Europe that attract the best talent.”

“European-based entrepreneurs need to stop leaving to the US,” says Kunkulagunta. “Great companies can be built here in Europe. The newly launched growth stage funds in London like the new Business Growth Fund and Eight Roads are starting to slowly fill the growth stage funding gap. US funds are also scouting here so at least entrepreneurs are at an advantage on home turf.”

“Also a lot depends on what type of company you’re building. If it’s something in the B2B Automotive space, there is nowhere better to be than Germany,” she says. “It’s an opportunity to be close to the major manufacturers based here. It’s similar for insurance. If we want to keep the momentum going, the key is for entrepreneurs to stay here, fight the good fight, get those exits and promote their success stories.”

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