Entrepreneurial Finance in Europe: Overcoming Bottlenecks
Prior to the recent meltdown, venture capital had been in the midst of an unprecedented global boom. Buoyed by low interest rates, the digital transformations precipitated by the disruptions of the Covid-19 pandemic, and the promise of emerging technologies such as blockchain and its speculative cousin “cryptocurrency,” vast sums of money have poured into the technology sector around the world.
Surprisingly, Europe has also witnessed enormous growth in its venture capital and startup ecosystem. This is surprising because while Europe has long been renowned for its scientific achievements, it has traditionally fared poorly in the risk-taking, high-stakes endeavor of building technology companies through venture capital.
Case in point: the underlying science of the biotechnology industry was invented by Dr. James Watson and Mr. Francis Crick of Cambridge University when they discovered the double helix structure of DNA. This along with the realization via experimentation that genetic instructions could be inserted into the DNA of a living cell so as to manufacture a desirable protein is the foundation of the modern biotechnology industry.
However, due to constraints in the UK, this lucrative technology has been overwhelmingly commercialized in the United States by scientists enabled by a dynamic venture capital industry. Now, as venture capital robustly flows into the European technology sector, there are signs that the bottlenecks that have long hindered European entrepreneurship are beginning to be overcome. Why? What is happening in Europe to facilitate its rise as an emerging player in the venture capital-driven technology sector.
The Global Venture Capital Boom
In 2021, global venture capital investment totaled $643 billion, a 92% increase over the $335 billion invested in 2020:
Europe has not been on the sidelines of this global boom in venture capital investment. In 2021, with $116 billion invested, funding to European startups increased by 159% from the $45 billion invested in 2020:
These figures are astounding but even more astonishing is that only 10 years ago, a mere $8 billion was invested in European startups which was only 13% of all global funding versus 18% in 2021. According to European data from PitchBook, there were 10,583 venture deals in Europe in 2021 which represents an over 200% increase from the 2,457 deals in 2020.
Despite the recent dynamic growth of venture capital investment in Europe, the continent has long had a serious problem. It is underrepresented in terms of successful startups which means those that survive long enough to reach Series C funding, go through an IPO, or are acquired. Moreover, as of 2019, Europe generated 36% of all funded startups but only 14% of all unicorn startups (companies valued at over $1 billion). Indeed, adjusted for population and GDP, the number of seed-stage startups developed in Europe is only 40% of that developed in the US. This disparity points to bottlenecks to be overcome.
Europe’s Entrepreneurial Challenges
Europe has a number of structural bottlenecks that have long inhibited successful technology-driven entrepreneurship. Part of the reason that the science of biotechnology was not commercialized in Great Britain is that in the UK specifically and in Europe generally “academic entrepreneurship” is not encouraged either culturally or politically.
Until recently, commerce has been regarded as being beneath a true academic. In Europe, a true scientist is purely concerned with the pursuit of knowledge. This is in marked contrast to the United States where scientists such as Prof. Robert Langer achieve fame and wealth because of the successful commercialization of the innovations that originate in their labs.
In contrast to their American counterparts, European universities, particularly British ones are often criticized for impeding entrepreneurship. According to a study by Air Street Capital, two of the top universities in the UK, Oxford and University College London (UCL) are actually regarded as among the worst for entrepreneurship due to their onerous policies:
A critical challenge experienced is that two-thirds of university spinouts — businesses converted from academic research with the assistance of an educational institution — indicated that it took more than 6 months to complete an investment versus only 3 months for a regular seed investment, which is a dangerously long time in the fast-moving technology arena. Another problem is that UK universities demand too much equity — over three times as much as in the United States:
A compounding problem is that UK universities also insist on being actively involved in governance: 37% of spinouts in the UK have a tech transfer board director who is all too often regarded as not the highest caliber person but rather someone who was merely available. If these individuals can’t add value, then they will be regarded as a nuisance or a strategic impediment.
Finally, aside from equity, 45% of all analyzed deals included the payment of royalties (a regular payback from net sales after a company achieves a certain revenue threshold) that can exceed 20% in some cases. This is regarded as exploitative and inspires resentment. Undoubtedly, all of these factors collectively disincentivize ongoing, iterative collaboration between entrepreneurs, capital, and universities because the experience of the former is that it is simply a bad deal.
Another challenge that has long inhibited entrepreneurship in Europe is scale. It is true that Europe is a high-income market twice the size of the United States. However, that is not the whole story. The largest country in Europe both by geography and population is actually Russia with 145 million people but it has long been isolated from the rest of Europe.
Otherwise, Germany with 83 million people and the UK with 67 million people are the largest populations in Europe. This has enormous ramifications because while the European Union is a currency and trade union, laws and regulations that impact entrepreneurship and venture capital are quite fragmented and differ significantly from country to country. Germany with its social market economy, strong labor unions, and apprenticeship system is greatly different in its approach to entrepreneurship from the UK with its laissez-faire, finance-oriented capitalism; and there are many other differences between countries in Europe.
Likewise, customer behavior, distribution, and marketing channels are all distinct across Europe. Language and culture matter in business so Europe’s heterogeneity is problematic. The US — and now China — with their common language, large markets, and entrepreneurship-friendly laws have greater appeal for venture capital investments because products and services that are developed therein can immediately be sold without all of the legal, linguistic, and cultural impediments that exist in Europe.
This is especially true of the capital-intensive products in the healthcare arena that tend to attract venture capital investment. In the US, once a drug obtains approval from the Federal Drug Administration it can be sold nationally whereas in Europe there are likely other national regulatory bodies that must be appealed to although efforts are underway to streamline these processes. Due to this fragmentation, European entrepreneurs must not only expand more rapidly but also earlier beyond their smaller domestic markets in order to achieve scale.
In essence, the US market alone is worth more than 28 European countries. This is a serious constraint. It explains why 70% of European unicorns had to establish a global presence in order to reach unicorn stage whereas this was required of only 50% of US unicorns. The imperative to expand internationally as rapidly as possible also means that the skill sets of successful European entrepreneurs must be more expansive.
To succeed in Europe, technical acumen must be balanced with an understanding of cultural nuance because what works well in one market may easily fail in another country. However, the pandemic may be producing a solution to this challenge.
A great enabler of the success of the venture capital ecosystem in the United States has been the availability of large sums of funding from well-financed entities such as retirement and pension funds.
For example, the Harvard Management Company which is the largest academic endowment in the world with $53 billion under its control and the California Public Employees’ Retirement System (CalPERS) which administers $469 billion are not above making alternative investments in either private equity or venture capital.
This is in contrast to the more conservative approach in Europe which has inhibited entrepreneurs’ access to larger amounts of capital particularly in the later stages of their development. In Europe, the biggest sources of funding for European venture capitalists tend to be governments and corporate investors.
However, there are signs that pension funds are beginning to take a more active interest in venture capital investment in Europe. In 2018, 230% more pension funds committed to European venture capital investments than did so during the period between 2013 to 2017. There are also signs that late-stage investment is growing in the European startup milieu. The increase began in 2021 when late-stage funding grew from 51% of funding in 2020 to 66% of funding in 2021.
Not surprisingly, 80% of all European unicorns have at least one US investor on their cap table. Still, a structural problem remains. While European governments have filled a market gap, government funding tends to be hostage to political priorities that can change depending upon who is in power.
It is safer for the long-term viability of the venture capital ecosystem in Europe to explore prudent ways of tapping into capital from endowments and pension funds. This is likely both a policy and a cultural issue. However, as Americans are currently rediscovering, it should be emphasized that venture capital is an inherently risky asset class for which prudence is a virtue.
Finally, there are important cultural bottlenecks to entrepreneurship in Europe.
Europeans are simply not comfortable with failure which is a critical part of successful entrepreneurship. In the US, for the most part but certainly, not in every case, a failure is often regarded as an opportunity to learn a lesson, particularly for young entrepreneurs. In contrast, Europeans seem to be more willing to hold past failures against entrepreneurs and there is greater pressure to perform better and earlier. That cultural reality along with less access to capital means that there is less runway available for European entrepreneurs to launch their startups. Entrepreneurship is just not sexy in Europe.
According to McKinsey & Co, only 17% of press coverage in Germany portrays entrepreneurship in a positive light versus 39% in the US. Europeans have been far too risk averse for far too long. But in a world in which rapid, incessant technological and social change is the norm, it is becoming more dangerous to resist change than to embrace it.
The Geography of Innovation in Europe
Unlike in the United States where technology-based entrepreneurship tends to be overconcentrated in a few tech hubs such as Silicon Valley, New York City, and Cambridge, innovation in Europe is more dispersed. Major cities like London, Berlin and Stockholm do play a leadership role especially because they tend to be financial hubs in their respective countries but only a minority — 30% of European startups — locate their businesses in one of those locales versus 50% of American startups who almost seem forced to do so.
The pandemic has accelerated the rise and enablement of remote work and since European entrepreneurs are actually already working from home, they are more than ready for it. To be sure, global financial, manufacturing and cultural hubs like London, Berlin and Stockholm will continue to be of strategic importance but the European approach to interacting with them seems to be healthier and more balanced.
It is worth exploring the dynamics of the leading tech hubs in Europe as while European entrepreneurs do not ardently migrate to work within them, they are developing strategic relationships with the venture capitalists and affiliated partners that are situated within them. For example, due to common language and historical ties with the United States as well as its status as the leading financial capital in Europe, London is especially important to entrepreneurs seeking larger sums of capital from more sophisticated investors with global contacts. London is the epicenter of US venture capital investment in Europe as 75% of US funds are in London. More broadly, the UK has emerged as a leader in venture capital investment in cleantech in Europe. In 2021, UK companies attracted 18% of the total investment in European cleantech. Also, 23% of the 8,500 European companies that create technology in renewable energy, agritech, decarbonization and related industries originate in the UK. The scientific competencies that enable British entrepreneurs to attract these investments is undoubtedly a driving force behind the current venture capital boom in Europe.
Berlin is another dynamic tech hub in Europe. Nationally, the Germans are committed to manufacturing and industrial capitalism. As a consequence, there is a huge pool of technical talent in the country, particularly with all of the advantages intrinsic to the German apprenticeship system that exposes Germans to industry from high school.
Germany is a global leader in many technologies including automobile manufacturing, enterprise software, and biotechnology — a consequence of its early leadership in the chemistry field. There are a number of well-known Berlin-based startups including Delivery Hero, an online food ordering site that like its counterparts in the US took off during the pandemic; N26, a pan-European mobile banking startup; and HelloFresh, a food subscription company that has gained significant market traction in the US.
Promisingly, the ongoing German commitment to manufacturing has transformed Germany into a European epicenter for 3D printing/additive manufacturing. There are an estimated 168 3D printing startups in Germany. Firms like 3YOURMIND, which provides cloud-based 3D printing management software; and Hyperganic, a provider of 3D model fixing software, are global leaders in this emerging technology. Both of these firms attracted significant venture capital investment.
Although it only has a million people, Stockholm has emerged as a European leader in fintech and eCommerce. Brand name firms such as Klarna and Spotify are based in the city. Despite its small population relative to other European tech hubs, Stockholm attracted 1.5 billion euros in venture capital investment in 2019, a large figure on a per capita basis. This speaks to the quality of the talent and the dynamism of the entrepreneurial milieu in the city.
Venture Capital Investors in Europe
An important commonality of venture capital in the United States and Europe is that while US investors are becoming more active recently in large late-state investments in Europe, the vast majority of venture capital is local. European venture capitalists financed 80% of startups in the European Union and US VCs financed 90% of startups in America:
Origin of VC funds involved in deals targeting EU-27 companies
Origin of VC funds involved in deals targeting US companies
Whether it be the United State or Europe, the art of venture capital involves leveraging not only financial acumen but also local knowledge and networks that are very context-specific and require years of cultivation.
Important investors include Karma Ventures, an early-stage VC firm that is based in Tallinn, Estonia. It is a 70 million euro pan-European fund that is backed by Skype’s founding engineers and specializes in late seed and A round investments. Credo Ventures, which is in Prague, Czech Republic, is a VC that focuses on early-stage investments in the information technology industries of Central and Eastern Europe.
80% of its investments have been at the seed and series A stages and they range between 50K euros and 6 million euros. Founded in 2000, Switzerland’s Emerald Technology Ventures has become a globally recognized cleantech VC. It has raised three funds, made over 50 investments and manages more than $660 million in assets.
Collectively, all of this investment activity, which originates from myriad countries and distinctly oriented VC firms across Europe, includes everything from biotechnology to electric cars and luxury goods. Technologies that disrupt existing industries are being targeted as well as those that enhance the competitiveness of existing industries.
All of which speak to the newfound vitality of the venture capital scene in Europe. While most of this activity is dominated by local actors, the strategic role of foreigners, particularly US investors, should not be underestimated. US venture capitalists are important strategic partners not only in larger late-stage investments but in digital companies, where they routinely account for over 50% of all investments in that area and their investments increased more than in companies from other sectors in 2021.
After years of stagnation, European entrepreneurs and their venture capital partners are finally succeeding in overcoming the cultural and structural bottlenecks that have undermined their capacity to successfully commercialize the many scientific innovations that they generate.
The digital leap forward and shift to greater remote work facilitated by the pandemic will enhance the capacity of Europeans to build and manage the pan-European teams that are so essential to the success of European startups while avoiding the overconcentration in tech hubs that even their American counterparts are moving away from.
Europe faces many emerging challenges that will likely stimulate further innovation and the need for venture capital to support it. Demographically, it is the oldest continent so new drugs and healthcare treatments are essential to assist ageing populations. The conflict in the Ukraine, which has wreaked havoc on food and energy prices, will likely stimulate demand for agritech and renewable energy solutions. Yet these complex problems are exactly what venture capital in its purest form is designed to help entrepreneurs address.