Dangerous Paths of European Venture Capital.

Europe seems to be on a roll. The European venture industry in 2017 saw €16.9Bn in venture capital deal value, a 13% increase year-over-year [1]. And

“2017 proved to be a rebound year for VC-backed IPOs, which raised over €3 billion across 53 offerings.” [1]

The SuperReturn/SuperVenture conference in Berlin was drinking its own Kool-Aid, and Nic Brisbourne, who has a terrific blog I always enjoy reading, writes:

“I think we could comfortably deploy more capital into more companies and grow them more aggressively and reach bigger outcomes without the market getting overheated. […] What we do have now is active venture LPs saying publicly that they are making good returns from European venture and that those returns are getting better every year.” [2]

It’s always somewhat dangerous to look at historic performances as past year’s performance is not really any indication of this year’s exits. If you are an early-stage investor then today’s investments will likely find a great exit in seven to nine years. That means you have to think about the exit environment then, not now. As this blog is called “observations”, here are a few of them.

Fewer Firms with Larger Funds

SNAG-3-10-2018 9.55.51 PM
European VC Fund Raising Activity in 2017 [1]
Fewer funds means less options for the next round of funding. Some firms might end up “holding the bag” for longer, so perhaps larger fund sizes is not a bad thing, but it means ownership concentration for founders.

In the past decade, 78% of all funds were less than €100M in size. In the past two years, more than 51% of all funds were larger than €100M in size.  But that also means that these larger funds have to produce larger exits: As a rule-of-thumb, in Venture Capital an exit that would return more than 1/3 of the fund is “meaningful”, an exit that returns the fund is “great”. Assuming a concentration and perhaps 20% ownership at exit, funds larger than €100M should require a €166M+ / $200M+ exit.

 

First-Financing Deals On A Steep Decline

SNAG-3-10-2018 9.59.11 PM.png
European First-Financing Activity in 2017 [1]
This is probably the steepest decline, and the graphs for follow-on investments in early-stage venture looks the same.  That means that all the above funds now have less targets that will come to the market in the next two years. But because they have more funds and need to deploy capital, they will deploy more capital per startup (d’oh!). That graph is also in the Pitchbook report for 2017.

Capital Concentration in Western Europe

SNAG-3-10-2018 9.53.45 PM.png
European Venture Capital Deal Volume in 2017 (per Pitchbook)

Venture funds get concentrated in Western Europe, with UK-based startups capturing almost 50% of the total 2017 deal volume. Western Europe saw a total of 2,634 deals and almost exactly $15.0B (this is US Dollars, per Pitchbook search). However, The top ten deals [3] captured almost exactly $3.0B, or 20% of the deal volume. Over $1.0B came from Softbank alone.

Exit Count is Falling

SNAG-3-10-2018 10.22.17 PM
European VC-backed Exit Activity in 2017 [1]
But the exit count is currently falling.

Median Acquisition/Buyout Exit Size Declining

SNAG-3-10-2018 10.27.46 PM
European Median VC-backed Exit Sizes by Type in 2017 [1]
Even worse, median VC-backed exit sizes are not really encouraging. In fact, there were only four (4!) VC-backed exits with a deal size over $500m: Ziarco ($1,000M), Ogeda ($884M), Delivery Hero ($786M), and Rigontec ($546M). And there were only ten (10!) VC-backed exits in 2017 with a deal size between $200M and $500M.

SNAG-3-10-2018 10.53.15 PM
European Median VC-backed Exit Sizes and Count for Exits Larger Than $200M (US Dollar!) in Past Decade (via Pitchbook)

Pick Your Strategy!

As markets go in cycles, I believe Fred Destin is still right:

“More fundamentally, the market may need to contract even further before battle hardened new managers emerge, teams that can raise the bar on the business of funding innovation in Europe.” (Fred Destin, 05/09/2012) [4]

The contraction in number of funds since 2011 certainly proves Fred right. You can pick one of three strategies (why not try all of them!):

1. True Believer

Believe that you’re the exception to the rule and are going to have one of the maybe dozen larger exits per year. Venture firms also have to believe that they are going to see the very best dealflow first (I hope you can convince your LPs, too).

2. Early Exits

Exit early into (mostly European) corporations. There are a few firms (such as Creathor Ventures) who specialize in building great corporate relationships and exiting somewhat earlier. That can be a good thing: Early exits usually means higher percentage of ownership for founders and employees, and faster return of paid-in capital for investors, potentially with higher IRR than a ten-year ride and dilution. Unless you see a landslide shift in the European exit environment — massive IPOs or faster pace of acquisition at higher valuation by European or US Enterprises / Unicorns — your exit is more likely on the early side. You can make a great return out of an early exit, but everyone around the board and company has to agree that that’s the strategy.

3. US Strategy

The US is still dominating the global VC-backed exit volume and deal count. Some firms have very actively developed a practice and platform to either expand into the US market and subsequently exit there; or to develop a strong value proposition for US enterprises and late-stage startups and subsequently command higher acquisition valuations. Good examples for European-based firms are Atomico or more recently Partech.  Some good examples for US-based firms are Index, Accel, Insight Venture Partners, and more recently also Founders Fund and Foundation Capital.

 

[1] Pitchbook 2017 Annual European Venture Report, 02/09/2018

[2] Nic Brisbourne, A new dawn for European VC, http://www.theequitykicker.com/2018/03/05/a-new-dawn-for-european-vc/, 03/05/2018

[3] Improbable, Deliveroo, Auto1 Group, Truphone, TransferWise, ProdigyFinance, OakNorth, ADC Therapeutics, The Ink Factory, SoundCloud

[4] Fred Destin, The great European venture capital crisis, http://freddestin.com/2012/05/the-great-european-venture-capital-crisis.html, 05/09/2012

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