Emerging Europe from a Venture Capital point of view

By Roland Manger, Earlybird Venture Capital

The partner team behind Earlybird´s Digital East Fund (DEF) for CEE and Turkey came together from different backgrounds: one partner covered the region for a US corporate investor, two had built a reputation as successful angel investors, and I had engaged in opportunistic investments in the East from previous funds. Through research and personal experience, we came to the conclusion that the region provided a medium to long-term buyers´ market for earlier stage technology investments and the resulting economic advantages were outweighing the specific risks.

While most Private Equity funds invest in good companies to help them become even better, grow faster or generate more profit, VC funds look for groups of people that can either create large new markets or turn existing ones on their head. The risk inherent in an individual investment might be high; however, research into VC returns and their volatility has shown the total portfolio risk of well-managed funds to be relatively low.

Like in any market and for any business, the economic upside of VC investing depends on supply and demand for some key factors. More specifically, VCs rely on having access to the best possible human resources: entrepreneurs, engineers and commercial specialists who are able to create or disrupt major markets — all of that against tremendous headwind from large incumbents and significant resistance to change from potential customers and users.

We believe that raw entrepreneurial talent can be found anywhere in the world. As technology investors, we also realize that the standard of technology and engineering education in our region is quite high.

Unlike China, India, the US or parts of Western Europe, Eastern Europe and Turkey have not been the global hot spots of VC investing, with hardly any experienced fund managers looking at opportunities in an area whose population is not much smaller than that of the US. Few VC teams on the ground means much less capital chasing available opportunities and an environment in which founders have realistic valuation expectations. In this type of buyers’ market for start-up equity, entrepreneurs know how to do more with less. Both factors, lower entry prices and higher capital efficiency, have a direct and positive impact on investment returns.

Based on this favourable supply and demand situation, DEF is pursuing a two-pronged strategy:

On the one hand, we look at large local markets that are ripe for digital disruption, such as intercity transport, real estate, and property management. Segments within these markets that are undergoing offline-to-online conversion are facing software-driven transformation are particularly interesting. We can usually avoid technology and business model risk, as often there have been similar winners in other, more advanced markets.

Following the example of Wayfair, the US leader in online furniture retail, our Istanbul-based portfolio company Vivense has become number one in the Turkish online furniture market. When the company started in 2013, only 3% of all sales were online compared to 8% in the US[1]. By 2017, its turnover (GMV) reached USD 30m. We expect the online share of furniture sales to increase to 9% by 2023 while Vivense will be growing its own market share even further.

For this first strategy, presence in large local markets is critical. Our second investment strategy, however, does not rely on the location of the team. We look for world-class founders hailing from CEE and Turkey, that are driving innovation in enterprise technologies and addressing the global market from the outset.

When we first met UiPath in Bucharest in 2015, the company wasn´t looking for money, had less than USD 1m of revenues, and hardly any were recurring. Its Robotic Process Automation software, however, had already caught the attention of some enterprise early adopters and leading-edge tech analysts. By the end of 2017, the company recorded mid double-digit million dollar Annual Recurring Revenues (ARR), moved its headquarters to the US, raised more than USD 150m from top-tier US investors just recently, and is continuing its meteoric rise.

Still, we are aware that investing in this particular market entails certain risks, like the currency risk due to part of the region not being within the euro zone. However, a large share of our portfolio companies — the ones that sell to enterprises around the world — draw most or all of their revenues in hard currency. Those that address local markets, specifically in Turkey, are subject to currency risk but their expenses are also mostly in local currency and their growth rates on a US Dollar basis are still quite high.

There are also political and regulatory risks. Not all of them can be mitigated, but we set up holding structures in Western Europe or the US to take advantage of superior governance standards and strive to avoid heavily regulated industries.

Whatever risks remain in our region we attempt to balance by taking advantage of favourable supply and demand conditions and the resulting proprietary deal flow. In any case, we are convinced that the economic advantages of the area outweigh the risks — so far, we have been proven right.

[1] Source: Euromonitor