May 11, 2021

Europe’s Venture Capital Finally Flowers, Luring Institutional Investors

Why big allocators on this side of the Atlantic, like CalSTRS, CPPIB, and OMERS, are seeding Old World newbie companies.

Reported by Larry Light

Art by Anja Sušanj

One sizable rap on Europe has long been that it stifled business innovation. But that is changing. Result: Venture capital (VC), that US-originated method of birthing and nurturing startup companies, is ramping up its European efforts. Institutional investors in this hemisphere now eagerly plug money into nascent enterprises from Manchester to Munich.

While no one has gauged exactly how much Europe-targeted VC allocations come from these shores, a lot of evidence points to a substantial and growing commitment. In 2019, for instance, the Ontario Municipal Employees’ Retirement System (OMERS) announced plans to commit US$364 million directly to European startup companies through its venture capital unit, OMERS Ventures.

“The barriers to startups have fallen in the last few years in Europe,” said Jambu Palaniappan, the plan’s managing director in its London office. “We are on the launch pad for market opportunity.”

Part of the allure of European startups is that they have an international bent, expanding outside of their own borders to other spots on the continent, and often beyond. In the US, there’s plenty of opportunity to expand inside this huge nation’s borders (with 331 million, it’s the third most populous country behind China and India). But in Europe, the largest hives of VC activity are Germany, Sweden, Switzerland, and Britain, all nations with traditions of trading around the globe.

“Europe pushes startups to go global sooner, as European companies more quickly exhaust their local markets than their US counterparts,” said John F. Roberts, associate director at the University of Pennsylvania’s Office of Investments, which invests in European VC.

For a long time, the culture of creating new businesses in Europe was meager. The oddity is that Europe’s university system and its scientific prowess are daunting advantages economically, and only now are they manifesting themselves in meaningful levels of business startups.

With 7% of the world’s population, the European Union has 20% of its research and development outlays. In North America, public pensions have a strong presence in VC, with US pension programs providing 20% of venture funds’ money. For European pension plans, it’s a paltry 2%. The upshot is that institutions on this side of the ocean are heading east to fill the vacuum.

Venture Adventure

Thanks in part to outside investments and also to homegrown non-pension sources, funding for European startups surged in 2020, despite the pandemic, with deal activity totaling a record $55 billion, according to research firm Pitchbook. That’s 2.5 times its tally five years before, and up 21% over 2019’s showing. Certainly, that pales before the $148 billion in the US last year, but it’s a start.

And this year’s first quarter in Europe got off to a roaring beginning, with almost $21 billion for 1,907 deals, amid projections that 2021 will handily out-do last year. What’s more, exits kept expanding, amounting to some $25 billion, as companies left the venture fold after going public or getting bought out.

Global pension allocations to VC have notched up to an average 7% of portfolios in 2020, from 6.2% in 2017, Preqin data show. While the payoff from these investments often takes many years to occur, and most of the fledgling companies the VC bunch supports fall by the wayside, returns overall can be quite rewarding, in the teens annually.

In North America, a hefty chunk of institutional VC money bound for Europe belongs to Canadian plans. The largest, the Canada Pension Plan Investment Board (CPPIB), has US$56 billion in European investments as of 2020, with an undisclosed part of that in VC. OMERS has US$915 million in venture funding, split between Europe and North America.

For the US, perhaps the largest commitment to Europe is from the California State Teachers’ Retirement System (CalSTRS), with $5.4 billion earmarked for that market. The pension plan doesn’t break its allocation out between private equity acquisitions, which are usually confined to established companies, and venture, with its startup orientation. But in last year’s second half, the California plan committed $630 million to four internationally directed VC funds, with a decent amount of that presumably to be channeled to Europe. Globally, VC has done very well for CalSTRS, with a yearly return of 24.7%, outpacing the State Street VC index, which clocked 14.7%.

Some third-party venture funds aren’t European pure plays. The Los Angeles County Employees Retirement Association (LACERA), which has a robust VC effort, last December committed $70 million to Ampersand Continuation Fund. This fund is focused on both private equity and venture deals in both North America and Western Europe.

Nothing Ventured …

Among the VC outfits popular with North American institutional investors is London-based Index Ventures, which has been around since 1996 and has helped birth such successes as Britain’s Deliveroo, a food delivery service that went public in March. Another is Palo Alto, California-headquartered Accel, which, in addition to US commitments, also has a strong presence in new European companies: It was an investor in Swedish audio streaming company Spotify, whose initial public offering (IPO) was in 2018.

In 2018, OMERS began its push into Europe. The operation has sunk money into numerous new enterprises. A lot of the action is centered on tech, which is VC’s traditional destination. The VC expansion into Europe got a boost, noted OMERS’s Palaniappan, because Britain and other nations there set up aid programs to spur small businesses. It helps that asset prices tend to be lower in Europe.

Also spurring VC interest toward Europe, according to analysts, were the Trump administration’s immigration constraints. European entrepreneurs, tech innovators, and finance folks found taking their dreams to America more difficult. So they stayed at home and started businesses. And lately, Palaniappan said, “we find people coming from Silicon Valley to Europe,” a reversal of the long-time pattern.

A number of the OMERS venture investments show great promise. Deliverect, which integrates online ordering from various food delivery services to existing point-of-sales (POS) systems, most recently got US$65 million from a VC round. The Belgian company, founded in 2018, eliminates the headaches of restaurants that must juggle multiple ordering systems from the likes of Uber Eats, the ride-hailing company’s culinary arm (which Palaniappan previously led in Europe, the Mideast, and Africa).

Then there’s FirstVet (started in 2016), from Stockholm, which renders video veterinarian care. Plus, Berlin’s WeFox (2014), an online insurance service provider, which has signed up a network of more than 1,000 brokers throughout Europe.

VC Comes to EU, UK: BioNTech, Anybody?

Why Europe’s late start in VC? The US, that citadel of capitalism, is where venture capital was born, thus it’s no surprise that the American venture scene is much larger (triple the deal amount in Europe) and more vibrant than the European one.

In 1946, a French émigré to the US named Georges Doriot established the first venture capital fund, called American Research and Development. The fund went on to underwrite 150 newborn companies, including iconic tech enterprises such as Digital Equipment, a pioneer computer maker, later acquired by what is now HP.

For a long time, a big problem for VC was that many European nations, in particular Doriot’s native France, made starting a business difficult. Entrepreneurs had enormous bureaucracy to surmount and restrictions on things like laying off or firing workers. Such constraints began easing, starting with Britain in the 1980s. VC caught on in the UK, likely due to its close ties with the US. Then venture spread to the rest of Europe in the 1990s, albeit slowly. Regulatory roadblocks remain, just not as many. “Now it’s easier to start and scale a business in Europe,” Penn’s Roberts said.

But the persisting problems in the European VC ecosystem are vexing. One of them is a lower level of entrepreneurial mojo than in the US, according to a study from consultancy McKinsey last year. Although the report noted a heating up of European VC activity, it pointed to less tolerance for risk there than exists in the US.

For American business founders, the report stated, “having a failure in one’s past is typically seen as a badge of honor (or at least a rite of passage critical for gaining the lessons needed to ultimately succeed).” In Europe, though, a business collapse is viewed as a disgrace, which McKinsey contended made their owners more cautious, when they should be bold.

Moreover, European startups don’t tend to pay talent as well as American ventures do, or give them stock rights that incentivize them, McKinsey declared. In addition, while the EU has made trading between its member nations easier, the union still is an amalgam of 27 different markets. The US has one colossal market.

Time was that banks were the chief means of seeding a new European business. But that practice has waned after the 2008 financial crisis, and Europe doesn’t have much of a bond market. This leaves an opening for venture capital.

Note the important contribution that small VC-supported European biotech outfits like Germany’s BioNTech made in concocting remedies for the pandemic. In conjunction with the US pharma giant Pfizer, Mainz-based BioNTech developed one of the chief coronavirus vaccines.

A Munich VC firm named MIG provided a lot of the startup funding for BioNTech, which went public in late 2019. Since its IPO, the company has seen its market valuation vault 13 times, to $44 billion. MIG did very well with this investment.

Such tales are what could well fuel an ever more vigorous venture environment in Europe.