Everyone has an unanswered question.

The City and the Stars, the wonderful novel by Arthur C. Clarke, takes place one billion years in the future, in the city of Diaspar.

In Diaspar, the entire city is run by the Central Computer and as far as the people know, theirs is the only city left on the planet and the outside world is a terrifying, dangerous and obscure place.

But Alvin, the main character, is different. Instead of fearing the outside, he feels compelled to leave. His obsession with the question of what's outside Diaspar leads him to an exciting quest and wonderful discoveries.

I won't spoil you the book but like Alvin, I have a question of my own:

What are the biggest bottlenecks holding more people back from starting companies?

I'm starting to slowly realize that my life work will be understanding (and accelerating) the policy, cultural, or societal changes that can enable & encourage more people to start companies.

Naturally, I've been thinking about COVID-19 and how this entire thing will play out for European tech. After all, that's what this newsletter is about.

A usual way of looking at the health of an ecosystem is the amount of money raised on a certain period of time. But as Tom Wehmeier, partner and Head of Insights at Atomico, said while presenting the State of European Report 2019 in Munich, that is a lagging indicator.

A better (and leading) indicator is the number of early stage companies formed on said period and how many of those successfully raised funding.

Data on startup formation is incredibly hard to find (although I do have some ideas for it) so I decided to start with something easier to pull - early stage fundraising events in 2020 and 2019.

Well, I should've known better.

What started as an innocent Crunchbase search ended up taking me through a very interesting rabbit hole that required a 2 cups of coffee and 1 green tea.

The result is a complete spreadsheet of (almost) every round raised in 2020 up until yesterday broken down by period, country, company size and more.

Impact of COVID-19 on fundraising in Europe

Feel free to play with it and share it around. I certainly did so I wanted to share two things I found quite interesting.

The Early-Stage Crunch

Anecdotal data by Y&S (n=64) gives us a clear warning: the venture market is slowing.

51.6% of funds have revised their number of yearly deals and lowered their forecast. 73% are expecting less than 5 deals per year (23% only 1-2, the rest 3-5). If you compared that to a normal pace of 8.

But if we move away from anecdotal evidence and towards actual data we can see that early-stage (Angel, Pre-Seed, Seed and Series A) is showing a significant slow down, even compared to 2019.

# of Early-stage Deals in 2019 vs. 2020 
Amount of Money Raised in 2019 vs. 2020

But here's the kicker. From the survey:

"More than 40% of respondents are planning to increase their allocations for follow-on investments, presumably expecting their portfolio companies to require more support than previously budgeted for."

Most of those respondents are Seed-A investors who are preserving cash to provide necessary follow-up funding to current portfolio companies, while earlier-stage are responding primarily "No", probably restricted by the fund size.

As a result:

  • Accelerators, angels and pre-seed are slowing down and won't be able to support existing investments due to fund size.
  • Seed and Series A are slowing down as well and preserving cash, making first-time Series As harder to pull off.

As Fred Destin puts it:

"You're looking at the combined impact of liquidity pressure on pre-seed investors and a Series A Crunch driven by reallocation of capital to reserves and decreased risk appetite."

This will drive a negative loop that cascades down all the way to company formation:

  • Series A is saving money for and thus will slow down new investments.
  • Raising a Series A becomes harder.
  • Seed investors might be less likely to invest pre-Series A because follow on investment is less likely.
  • Raising a seed or pre-seed becomes harder.
  • Founders are less incentivised to start a company or take a moonshot due to the lack of available capital.
  • And so-on-so-forth.

Not fun.

Missing by a mile: comparing 2020 versus 2020

My Twitter feed is full of "VCs are open/not open for business" hot takes, using 2019 data to back up their claims.

That's a good start.

Looking at 2019 fundraising data is a way to figure out how many backward steps we are taking (if any) and at what pace.

But 2020 wasn't supposed to be like 2019. 2020 had everything to be our best year yet.

Last year European funds raised €13 billion and a whopping 136 new funds were started, a record since Y & S been tracking it and, according to them, since the beginning of European venture times.

2019 was the first year that venture capital outperformed indices for both US VC and, importantly, European Private Equity. I already covered it before, so here’s a snippet from my Europe has Major Bragging Rights edition:

Suddenly, the data (and the general consensus) says that European tech is not a risky investment, but a “sure thing.” Local Private Equity, family offices and pension funds have woken up to the fact that European tech returns are actually quite good.

On top of all that, Directive 2014/107/EU put extra stress to foreign money, who needed to find a new home.

The “European tech” narrative was as strong as ever, and the world was catching up.

And this was actually happening.

Cumulative money raised - 2019 vs. 2020

You can clearly see how 2020 was significantly outpacing 2019 until March, where things slow down considerably.

Comparing 2020 to 2019, not seeing the expected 1929-esque drop and dusting off COVID-19 as a minor event is missing by a mile. It will lead you to drastically underestimate the impact of the pandemic.