Venture capital has recently gone through some challenges on both sides of the Atlantic. The worldwide VC-industry is dominated by the US, then the EU with Asia catching up. Whilst the decline of worldwide venture capital in 2016 had a significant effect both in the EU and the US, experts predict an excellent year in 2017 for venture capital particularly with an increasing number of venture-backed IPOs and corporate VCs intensifying their activity.
Decline of VC activity in 2016
In 2016, VC-backed companies globally raised $127 Billion in 13,665 deals. This is a decline of 24 % against 2015. In the US, the deal count plummeted from its all-time high of 10,468 in 2015 to 8,136 in 2016. In the EU the number of VC deals closed, fell from 4,378 to 3,142. The total amount of venture capital invested in the EU fell from US$ 18 Billion to US$ 16 Billion compared to a decline in the US from US$ 79 Billion to US$ 69 Billion. Analysts blame this on a more realistic approach being taken by the investors, who woke up to the disconnect between the valuations being agreed in 2015 and reality. Brexit and the US-election also added uncertainty in the market, although this appears to have been largely overcome.
While the significant crash of the share price of German market leader Rocket Internet following its IPO in October 2014, has made companies and investors more cautious when it comes to European IPOs, the trends in the second half of 2016 and the beginning of 2017 suggest that the VC-markets on both sides of the Atlantic may head into a new optimistic era of IPOs. September 2016 saw Amsterdam-based takeaway.com perform a successful IPO valued at US$ 1.1, Billion followed by Snap Inc.’s recent IPO being the most successful IPO since Alibaba in 2014. It was particularly positive that its share price rocketed by 44 % on the first day of trading, leading to a valuation of US$ 33 Billion.
US ecosystem out ahead
As promising as those figures appear, they clearly display a huge gap between the VC industry in the US and in the EU. Despite being equal to the US in terms of GDP and possessing a larger population, Europe sits very far behind the US in terms of venture financing. In the last year, investors invested more than 4 times more capital in the US than in EU.
So what is the difference between the EU and the US and why did Europe with its equally strong economy not manage to create a VC ecosystem as powerful as the system in the US?
Access to funding
First of all, as the figures above clearly show, access to funding is in general much better in the US than in the EU. In particular, Europe shows a distinct lack of bigger follow-on investment.
The ability to raise money is often crucial to the success or failure for start-ups regardless of location. Europe has many strong players in seed and early stage funding but very limited when it comes to growth funding.
The main start-up hubs in the EU such as London, Berlin or Paris all possess a strong start-up community. These include the companies themselves, the talent of software engineers, the mentorship of business angels and the funding by institutional investors. But only London provides a network of high-level VCs like Accel Partners or Index Ventures. Berlin, for example, is a great place to start a company, thanks to its comparatively low living costs and a highly international and skilled tech community. Berlin also provides easy access to early stage funding by the presence of company builders like Rocket Internet or Project A Ventures and internationally recognized early stage VCs’ such as Lakestar or Earlybird. However, as soon as those companies need growth stage funding, their options are limited and they tend to head overseas.
Profit v growth
Another significant difference between European and US start-ups can be brought down to a single question: “Profit first or growth first”. For most US VCs, if a firm is generating profits it’s a sign they are not growing fast enough. US VCs want growth – double digit, quarter on quarter, growth – with a view that this growth leads to a bigger customer base, bigger market and a stronger defensible competitive advantage, which almost but not always leads to a bigger exit. Often these exits, both IPOs and to strategic buyers, are pre-profit, if not pre-revenue. Twitter and Facebook, for example, first focused on building their user numbers. Only once they were established as global forces did they focus on making money, through advertising and other strategies. In contrast European companies, tend to cut the growth at a certain point in order to make profits.
There is certainly a place for everyone in the global start-up community and funding remains available to those with vision and clear growth plans. For those in Europe, it can just take a bit more time to find the capital – but that opens up huge opportunities for US based VCs who are interested and willing in making overseas investments.