European VC closes on Silicon Valley

Europe has delivered 30 unicorns over the last decade and the region's tech ecosystem has blossomed to the best the industry has ever known.

Europe is giving Silicon Valley a run for its money when it comes to launching global technology platforms, and private equity investors are paying attention.

While the US had 55 start-ups that reached unicorn status – a $1 billion-plus valuation – last year, Europe gave chase at 14, according to research from CB Insights. These include Munich-based SaaS company Celonis, Cambridge-based AI company Darktrace and Lisbon-founded cloud computing company OutSystems.

Europe had 30 unicorns active between 2009 and last April, according to data from PitchBook. Almost a third are based in the UK, five in Germany, three in France, and the rest are in Estonia, Switzerland and Spain, among others.

Europe’s tech ecosystem has blossomed, to a point where it is the best the industry has ever known, LPs and GPs told Private Equity International.

There are three reasons: the emergence of companies that are best in the game, a self-sustaining tech and venture capital ecosystem, and value creation shifting from the public markets to private equity.

“There is a very healthy pipeline of companies that are going through their evolution of scaling and these are becoming billion-dollar, if not multibillion-dollar-type companies,” said Ross Morrison, a London-based partner at Adams Street Partners.

Where previously US and China tech companies were the only players battling it out on innovation, European tech companies such as Stockholm-based Spotify and Dutch payments processing company Adyen are now on the stage and grabbing headlines with record-breaking listings.

This did not happen overnight, Morrison pointed out.

“The evolution of tech within Europe was initially unfortunate in its timing. Between 1999 to 2000 Europe tech was just getting going and the party ended pretty quickly and abruptly when the tech bubble burst. The consequences lasted for a really long time, as they did elsewhere.”

Europe therefore did not have as many tech poster-child companies or role-model repeat entrepreneurs and lacked long-term capital to get back on its feet. The US tech scene bounced back and Asia scaled from a low base very quickly, but it was only post-2009 that tech companies and VC firms in Europe came into the public eye and began generating returns for institutional investors. This has accelerated, Morrison noted, and the list of exits and value creation from VC-backed winners is extensive: Spotify, Adyen, Farfetch, Elastic, Avast, Funding Circle, plus notable M&As such as Zoopla and iZettle.

According to PitchBook, VC investing in the region has been trending upwards since 2013. Close to €20 billion of VC-backed deals were recorded last year, more than twice the figure in 2013. This year is also set to break last year’s record, with €5.3 billion of deals completed in the first quarter alone.

LPs previously looked at VC almost as a hedge on their investments in traditional businesses, but no longer. Data from Invest Europe show European VC fundraising reached a high of €11.4 billion last year, up 11 percent year-on-year. Private investor interest increased with family offices and private individuals accounting for 20 percent of capital raised, closely followed by funds of funds and other asset managers at 19 percent.

Outperformance is also feeding increased LP appetite.

Previously, the relatively poor performance of European VC funds led to some LPs withdrawing from the asset class in Europe. One European fund of funds manager told PEI the firm decided to phase out its exposure to venture less than 10 years ago because of the “elongated J-curve and the absence of distributions from vintage 2002-07 funds”. That manager has now re-entered the VC space, albeit more actively looking at late-stage growth tech investing.

Top-quartile returns in Europe VC in 2014, 2015 and 2016 show 22 percent, 14 percent and 38 percent internal rates of return, respectively, according to Burgiss performance data. Those compare favourably with the US equivalent for the period – 22 percent, 21 percent and 18 percent – as well as with Asia at 34 percent, 49 percent and 38 percent.

“The same risk-return that you would see in the most successful VC firms in the US is now beginning to happen within Europe. So that outperformance created by companies that drive large outcomes, is driving VC returns in Europe and this level of returns is putting them on par with other regions, albeit on a lower invested capital base,” Morrison said.

This outperformance has made large institutional investors take notice. Abu Dhabi sovereign wealth fund Mubadala Investment Company is an investor in London-headquartered parking start-up ParkJockey. Singapore’s GIC has backed German fintech company N2 and Adyen was backed in its earlier funding rounds by Temasek Holdings and General Atlantic. Adyen listed on the Euronext Amsterdam last June and is considered one of the largest initial public offerings in Europe at a valuation of between €6 billion and €9 billion.

London-based luxury fashion company Farfetch, which listed on the New York Stock Exchange in October at a market capitalisation of $8 billion, is another success story. Farfetch was backed by Eurazeo, Temasek, Geneva-based Index Ventures, London private equity firm Vitruvian Partners and Chinese e-commerce giant

OMERS Ventures, the venture capital arm of Ontario Municipal Employees Retirement System, opened a European outpost in London this year. In March, it launched a €300 million fund that will make Series A and B investments of between €5 million and €10 million per company. French sovereign wealth fund BpiFrance is also spending a huge amount of money in the sector by helping both early-stage and growth companies in France, creating a vibrant ecosystem for these start-ups.

Thinking global

The prognosis of European venture is very promising, said Alan Feld, founder of Israeli fund of funds manager Vintage Investment Partners. Having invested in European VCs and in later stage European tech companies in the last decade, Feld noted he has seen in recent years “great companies coming out of Europe, building significant global businesses”. Driving this is VC firms’ strong relationships not just with their entrepreneurs but also with American VC firms, bringing them into subsequent rounds to help build out the US strategy and non-European strategies.

“European VCs are thinking much more globally than they did 10 years ago. Some investors look at Europe and see Brexit and uncertainty. I think that this is the wrong way to look at tech investing. The great entrepreneurs build their companies to be global leaders, and not only European market leaders. Their success is much more dependent on the demand for the product or service being offered, the global competitive environment, as well as the size of the market globally for that product and service than the political situation in Europe,” Feld said.

Will Europe create tech giants that can compete with Facebook, Amazon and Google?

Not quite, said Saam Golshani, a Paris-based partner at law firm White & Case. Europe’s equity markets are still unable to provide a proper exit for these companies, while Silicon Valley’s key success has been its ability to list companies, he said.

Another challenge is the universe of aggressive buyers. “When European tech companies become successful enough, they most often get bought by serial buyers located in the US or large tech funds like Thoma Bravo, Insight Venture Partners or Carlyle.”

US companies are also benefitting from the “double dip effect” in Europe. The going rate is now in their favour because European companies are acquired in US dollars, which means these are bought 20 to 25 percent cheaper and then scaled back to the US, which makes them more attractive for buyers, Golshani added.

Looking ahead, industry participants agreed Europe tech’s renaissance will continue and continue to accelerate.

“You’ve arguably been waiting for 10 to 15 years for this kind of renaissance to happen, it’s happening right now, and considering where we are in the innovation cycle of a lot of investment themes, it’s arguably only a more positive outlook overall for attractive returns in the next 15 years,” Morrison said.

Vintage Investment Partners’ Feld warns of a fear-of-missing-out mentality among LPs which will affect the current industry dynamic.

“One issue we are seeing is marginal funds being funded,” he said. “Investors feel they have an obligation to invest in venture, so they are not necessarily investing in the best funds.”