For a while I’ve been saying that one of the biggest problems in Europe was a lack of growth capital.
And I’m far from being alone here.
“European tech companies are better funded today right up until they have a solid product and actually start securing market share. At that point, they often don’t have enough growth capital to accelerate things.” – Nicolas Colin, The Family
This issue is so well-known that it even has a name – the Series B gap.
Growth-stage companies have historically needed to tap into the US market (and most recently, to all-mighty Masa and Softbank) to get the capital needed to take over a market.
The Series B gap is being addressed by U.S. firms, which lead approximately 40% of financings at this stage.
This is a big problem because it throws a went at the European tech flywheel.
To start, I think this leads to smaller rounds, which means less fuel for the flywheel. This is might be a flawed assumption, but I believe that because it’s harder to get a US fund to lead a round in Europe, some tech companies are downscaling their ambitions and raising smaller rounds.
Second, and most importantly, more outside money means less European money. This is a problem because in case of a liquidity event, not all capital will come back to Europe.
Famously, when a company IPOs, a couple thousand employees will become single-digit millionaires and (after drinking some champagne) start new businesses, or start investing in the space.
But if a company raised outside money and hired outside employees, the cascading effects of a liquidity event will get diluted. This makes the flywheel slower.
But the trend is (slowly) reversing
Earlier this week, Dealroom released the Q3 edition of their Quarterly European Venture Capital report.
If you are interested in the space you should go read it, but one of the highlights is that, to date, already €28 billion was invested in Europe & Israel in 2019 compared with €21 billion at same time last year.
But the cool thing is that (as in Q2) the growth is mainly driven by larger rounds, $100m+. It could be argued that rounds below €10 million not growing anymore is a negative indicator, but I’d rather look at the glass half-full – access to growth capital is improving significantly.
The value of rounds above €100 million accounts for 33% of the total investments in Q3 2019. And as Dealroom correctly points out, that’s “a sign of a maturing ecosystem.”
There are other positive signs too.
On top of the €5 billion announced by French president Emmanuel Macron a couple of weeks ago, the European Investment Fund will commit an additional €3.5 billion to VC and growth capital funds, to invest further into growing businesses by 2020.
But public money and corporates (strong armed by the French state) aren’t the only players entering the late stage game. This quarter, two new BIG funds were announced – the Samwer’s Rocket Internet Capital Partners II ($1 billion) and Lakestar III ($700 million, but with ambitions to get to $1 billion).
The tipping point – Directive 2014/107/EU?
Europe has been trailing the US and Asia in investment numbers for a while now. All these measures are definitely good news.
The real question is – will that be enough?
I certainly don’t know, and I’m not the right person to make that claim. But I have a hunch that the tipping point is coming, and it might well be thanks to government.
Directive 2014/107/EU launched in late 2014 to combat the challenge posed by cross-border tax fraud and tax evasion.
To do so, it forces EU member states to collect and exchange significantly more information regarding where taxpayers allocate capital.
What are the consequences? Nicolas Colin again:
“The result, as is the case with the US’s FATCA for European financial institutions, is a heavier burden on those firms to which this capital is allocated, including US-based VC firms. And while some of them are glad to comply with the paperwork, others—that is, likely the ones that are oversubscribed—have decided that it’s too much work and have simply sent the money back.”
If European money is “kicked out” of the best performing US funds (which are, coincidentally, the ones that are oversubscribed and rejecting their money), it still needs to go somewhere. All those doublons won’t lie on a vault à la Scrooge McDuck.
And what’s the next best place to look for outsized, tech-like returns? At home, here in Europe.
In the end, second-order consequences from Directive 2014/107/EU could be the tipping point that brings a stream of late-stage capital to Europe. In this case, regulators failure to predict the ripple effects of their work might work out in our favor.