You’ve probably all heard the cliches about European startups and investors: venture money in Europe is more conservative, entrepreneurs are afraid of risk, the businesses are less ambitious and there are fewer blockbuster successes. These are trotted out all the time to explain why it’s better to start up or invest in America.
Is it true? A new report suggests that the opposite may actually be the case — and that Europe’s venture capital industry may, in fact, be dramatically more successful than its American counterpart.
The report, written by Hendrik Brandis and Jason Whitmire of German venture firm Earlybird, looks at the underlying data behind the two industries, and comes to the conclusion that while the European venture industry is significantly smaller (around a quarter of the size of the U.S. market) it punches well above its weight. This, they say, represents a real comeback for the continent’s investors.
Ultimately, their argument is based around a series of pieces of data that show how European venture capitalists achieve a higher level of success, proportionally, than their transatlantic counterparts.
Over the last two years, European venture-backed companies have made exits worth $ 15 billion (acquisitions or stock flotations). That is half the size of the $ 30 billion American market, and yet the venture market in Europe is just one fifth of the size: US venture firms invested $ 25 billion from 2009-2010, while their European equivalents invested just $ 6 billion.
Across the two year period, Europe had 131 deals with a median exit valuation of $ 173 million, and more than 57 percent of those deals were significant successes that brought investors at least five times more money than they put in. In the U.S. there were many more deals over the same period — 596 in total — and the average deal size was higher, too, at $ 236 million. But the value to investors was lower: less than half of all deals brought in multiples of five times or more.
The average exit capitalization of a large company (worth $ 100 million or more) is almost the same; yet European VCs get there by investing just half the amount of capital that their American cousins do.
In addition, the report points out that the difference in success after there has been an exit can be even more pronounced: this graph shows the relative performances of European and American venture-backed companies, post IPO.
So why is this happening?
Essentially, the report puts forward the case that American VC has had too much of a good thing: too many venture funds drives up valuations, makes it more likely that people invest in bad ideas and get smaller returns. Because venture money is scarce in Europe, on the other hand, companies have to compete harder for funding — which keeps the value of investments down. At the same time, it also means that VCs can cherry pick the very best investments and focus on backing real winners — which keeps their hit rate high. It’s a combination that creates a more efficient ecosystem, for investors at least.
This is encapsulated by a quote in the report from the head of Deutsche Bank Private Equity, who says that “European venture capital is a cottage industry characterized by an insufficient number of private investors with the capacity and willingness to invest in venture capital, mainly due to past disappointments and the resulting lack of confidence which still inhibits the European venture industry today.
Europe, it says, suffered when many of the big organizations that had backed venture companies during the first dotcom boom — the pension and endowment funds — decided that it was too risky for them. They backed off. That meant that those who survived were the best in breed, and have since been able to make the most of the flourishing entrepreneurial scene across many European cities.
It’s a great tale based on great data. But there are a few reasons to remain skeptical about these findings. First there’s the fact that, of course, a German VC has a vested interest in pointing out how successful venture capital in its region can be. Then there’s the fact that venture capital is not the primary vehicle for startup investment in Europe, with private equity much more influential than across the Atlantic. The wider picture may not look quite so rosy if you took into account the entire ecosystem beyond venture-backed firms.
And it is also worth remembering that the American and European markets are different — so much so that pitting the two against each other is a bit like putting Manny Pacquaio in the ring to fight Wladimir Klitscho. Pound for pound, the little Filipino may be the better boxer, but when the punches start flying I’d rather put my money on the towering Ukrainian, who has a full foot in height and around 100 lbs as an advantage.
But perhaps the biggest issue could be that simply discussing this success makes it more likely that others will try and get in on the action — which, in turn, is likely to make it less efficient. If Europe is suddenly seen as a promised land for new venture funds, a place where small investments are magically transformed into large returns, then an influx of competition could dilute the market and end up killing off the very thing that everyone wants. However, given that they’re some of the planet’s most successful venture capitalists, that is a paradox that I imagine Europe’s VCs will probably be happy to live with for now.
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