On A Key Measure, European Venture Capital Now Out-Performs The U.S.
For over a decade European venture capital has been a backwater, and U.S. VC has been flying high since 2010. Europe is raising its game, however, and Silicon Valley looks over-inflated. On a key measure — the ratio of exit value realized to capital commitments — European venture capital now outperforms the U.S.
Received wisdom holds that European venture capital funds are a poor investment, with narrow exceptions. For example, a 2014 survey conducted by the European Venture Capital Association (EVCA) found that international investors rank European venture capital 15th in attractiveness among private equity asset categories. One well-regarded European fund with a strong track record has tried to attract U.S. investors to each of its recent fund-raisings, and is yet to close with any. Venture capital fundraising in Europe has been weak, averaging 22% of the amount raised in the U.S. since 2007, and it missed out on the sharp uptick that the U.S. has enjoyed in recent years (see chart below).
What drives this? The EVCA in November, 2014 cited several factors: fragmentation of the European industry into many small funds, resulting in investment bite sizes that are too small for many institutions, and imposition of tighter EU regulations on private equity investment such as AIFMD and Solvency II. The poor returns of many European VC funds in the post 2000 period are no-doubt a major factor. And over the last seven years institutional investors have been dazzled by the success of the Silicon Valley social/mobile/cloud companies, to the exclusion of many other venture investment opportunities including other regions of the U.S. This led to the unicorn phenomenon: private venture backed companies with value over $1 billion, most of them located in the U.S. As a result European VC has contracted and then languished.
The Financial Times last week noted the low rate of creation of European unicorns: since 2011 they counted 16 European unicorns versus about 120 in the U.S. Does this indicate that European venture capital is still underperforming relative to the U.S?
The FT goes on to observe that creation of unicorns is driven to a large extent by supply of capital, and there is 14 times more later-stage venture capital available in the U.S. than in Europe. Valuations at every stage are lower in Europe, due to limited capital available and, many think, more conservative investors. Plus unicorn valuations in the U.S. now look hollow in many cases: valuation multiples for U.S. venture backed companies are down 30%-40% since last year. And there is increased awareness that many unicorn financings contain “dirty terms” that make the headline valuation an exaggeration.
European entrepreneurs and venture investors have been gaining momentum in recent years. This reflects a build up of resources, skill base, ecosystem, and cultural support for start-ups on many dimensions. There is only one payday for venture capital investors: the liquid exit. In fact, one of the big concerns about the U.S. unicorn boom is a drop-off of liquid exits. Europe has enjoyed a substantial stream of exits recently and a few very high profile companies, such as Supercell, Spotify and Skype.
The ratio of exits realized to capital committed in a time period is a key measure of the performance of venture funds. It’s imperfect because the the lag time between investments and exits and choppiness of the data, but still useful if averaged over a longer period. On this measure Europe is now out-performs the U.S.
There is a bit of tortoise and hare going on here: Silicon Valley is like the hare, producing huge successes but also absorbing huge amounts of capital and over-inflating from time to time. Europeans (especially in the north, where most start-ups are) tend to be serious people who do very good work. A presenter at Slush, the annual Finnish venture conference, put it well last Fall: “In Silicon Valley it’s about jumping to the next rocket ship as fast as possible — they are very good at sprinkling stardust. [Here] it’s about great teams building great products.”
Originally published at www.forbes.com on June 23, 2016.