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Industry Voices

Commentary: European venture capital – Out of Silicon Valley’s shadow

For as long as European venture capital has existed, it has been in the shadow of its bigger, bolder trans-Atlantic counterpart. While Europe has had many notable success stories in recent years — from Skyscanner and Spotify to Supercell and Zalando — for every tech giant over here, there are plenty more U.S. equivalents.

However, as the European industry continues to expand in scale and depth, there are growing signs that Silicon Valley no longer has a monopoly on producing "unicorns." Nor should investors consider U.S. funds as the sole source of superior venture capital returns.

European venture capital is less than half the age of its U.S. counterpart and a fraction of the size, but the industry in Europe is far from immature. Many managers have seen multiple cycles, with more than half active for more than 12 years, according to data from Invest Europe, the association of European private capital managers. Moreover, the Continent now has experienced serial entrepreneurs and more than 100 start-up accelerators providing seed investment and mentoring.

Last year, European venture capitalists raised $7.1 billion (€6.4 billion) — the highest amount raised since 2007 and a continuation of several years of steady growth. Nearly 10% of this capital was from North American institutional investors, who over the five years through 2016 contributed double the average percentage from the previous five years. Europe's venture capital fundraising is still well behind the U.S., but it is catching up.

A further positive sign is the economy. It has been a bumpy ride since the global financial crisis, but Europe's economic performance is now robust. Gross domestic product across the 28 European Union economies grew by 1.8% in 2016, with growth seen across all countries, according to European Commission data, outpacing the U.S.' 1.6%, as reported by the U.S. Department of Commerce. Even with the U.K.'s upcoming exit from the bloc, economists expect the EU's GDP to expand by 1.9% a year over the next two years. And Europe's policymakers are committed to supporting that growth: the European Commission's capital markets union plan is championing more forms of funding for businesses, including venture capital, and is creating a €1.6 billion fund-of-funds venture capital program to facilitate more investment into the market by large institutional investors.

However, the world's top 10 corporations by market capitalization are still all from the U.S., with the top four — Apple, Alphabet, Microsoft and Amazon — being the biggest venture capital success stories of all time. How can Europe compete?

One possible answer is that the Continent's perceived disadvantage — not having an established and world-leading hub such as Silicon Valley — might actually be an advantage. Its large number of diverse start-up hubs, including Amsterdam, London, Paris, Stockholm and Zurich, are pioneering the next wave of tech development, from fintech to artificial intelligence, biotech and robotics. Building leadership in these fields could bring Europe's venture capital industry a strong competitive advantage on an increasingly globalized stage. Indeed, the World Intellectual Property Organization lists Switzerland, Sweden and the U.K. at the top of its ranking of most innovative countries, with European nations holding eight of the top 10 places.

European stock markets are becoming increasingly receptive to venture capital-backed flotations. In the first 11 months of 2016, Europe saw 12 venture-backed tech initial public offerings, raising $760 million, according to Pitchbook data. That compares with 17 IPOs by U.S. firms, raising $1.6 billion, in the same period. The Continent's venture capital-backed companies are attracting growing interest from global corporate acquirers: China's appetite for European tech was demonstrated by last year's sale of Finnish gaming group Supercell for $8.7 billion to TenCent, and Ctrip's acquisition of airline price comparison site Skyscanner for $1.8 billion.

Of course, the ultimate proof of European venture capital is in the returns. U.K. venture capital funds last year — many of which invest on a pan-European basis — recorded their highest returns since 2003, according to the British Private Equity & Venture Capital Association.

Meanwhile, the European Investment Fund, the largest investor in European venture capital, has seen 10-year net annualized internal rates of return at 5%, five-year returns at 9.5% and three-year net returns at 12.2%, indicating strong upward progress and outperformance in today's low yield environment. Furthermore, the EIF's top 30 funds from 2007 onward delivered a median net return of 27%, demonstrating what a targeted investment approach can achieve.

Investors who are not familiar with Europe's opportunities might overlook this venture capital market, but ignoring its potential could mean missing out. Valuations are a fraction of those in the U.S.: in Europe, $1 billion-plus tech companies are priced at 18 times earnings, compared with 46 times for their U.S. counterparts, according to investment banker GP Bullhound. But this wide pricing gap might not persist for long. By getting involved now, investors have an opportunity to back better-valued companies that are disrupting industries, and to benefit from their considerable returns potential.

Nenad Marovac is vice chairman of Invest Europe, and founder and managing partner of DN Capital, London. This article represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.