Europe putting venture capital back in the game

Resurrected after the global financial crisis, the venture capital market in Europe is luring institutional investors back from the sidelines.

The pace of European venture capital dealmaking has been accelerating since 2016, fueled by the surge in unicorns, primarily fast-growing technology firms that have achieved $1 billion-plus valuations. Last year, there were 61 such unicorns, up from 44 in 2017, according to London-based venture capital firm Atomico. Data by Preqin showed that 2018 was a record year for venture capital fundraising in Europe, with $22.9 billion flowing into venture capital funds, up 24% from $18.4 billion in 2017 and $13.1 billion in 2016. Deals are up as well, to a record 2,938 in 2018, up 7% from 2,741 in 2017 and 2,658 in 2016.

Of course, those record amounts pale in comparison to the amounts raised by U.S. venture capital funds, some $132.1 billion in 2018, according to a report recently issued by PitchBook and the National Venture Capital Association. Last year, there were 1,853 deals completed in U.S., the report noted.

Still, successful exits of European ventures in 2018, including Swedish audio streaming platform Spotify Technology SA, which listed directly on the New York Stock Exchange, have helped foster interest in the asset class as well as lay the groundwork for further growth as established entrepreneurs turn their attention to launching new startups across the continent. With companies now being originated in most major European cities, beyond the traditional hot spots of London or Paris, investors are finding that access to venture capital investments also is improving, industry experts said.

In another development advancing the market, the European Union's venture capital platform launched in April last year. Dubbed VentureEU, the pan-European fund-of-funds program was seeded with €410 million ($460 million) and aims to raise up to €2.1 billion in public and private investment to support local startups.

"The extent of opportunity in European VC has grown substantially," said Carolina Espinal, managing director at private equity manager HarbourVest Partners LLC in London, adding that "the breadth of opportunity is materially different than 20 years ago."

Diverse market

Sources praised the European venture capital market as diverse geographically and in terms of offering a variety of startups at different stages of growth.

In March, the C$97 billion ($72.6 billion) Ontario Municipal Employees' Retirement System, Toronto, announced plans to commit €300 million directly to European startup companies through its venture capital arm, OMERS Ventures.

"European venture has had an amazing run in the last 10 years," said Harry Briggs, London-based managing partner at OMERS Ventures, in a telephone interview. "There have been some 10 exits valued at (more than) $5 billion. VC has proven itself as a high-achieving asset class. ... People that have invested in Europe in the last 10 years have done well."

Mr. Briggs said OMERS intends to deploy capital between €5 million and €15 million toward the end of next year in relatively early stage companies across Europe. OMERS Ventures has C$800 million in assets.

But sources said even though the European market has improved for investors, challenges remain. Atomico's latest annual State of European Tech report, cited by sources, said there is a big gap between how investors in Europe view the risks of venture capital compared with other segments of private equity, such as buyouts.

But Ms. Espinal said: "There is a difference between target return and actual returns in (venture capital)."

In a venture capital investment, investors expect outperformance to compensate them for inherent risk. Buyout firms seldom generate a three times multiple on a net fund basis, she said, adding that accessing venture funds may enhance performance, she explained. Good venture funds could achieve a five times multiple.

Another challenge for European asset owners has been access to top venture capital managers as well as finding funds capable of accepting more allocations, sources said.

Michael Collins, CEO of Invest Europe, the European private equity and venture capital association, said there's a mismatch between the scale of European venture capital funds and how much institutional investors want to invest.

Too many venture capital fund managers in Europe still don't have a vehicle that is a viable proposition for these investors, he said.

"Although venture funds in Europe are now raising on average almost €100 million at final closing — almost double the average of 10 years ago — many global institutional investors, such as pension funds, often make minimum investments in between €20 (million) and €50 million bracket," Mr. Collins said.

The U.S. market, said Sebastiaan Ranner, senior fund manager private equity and infrastructure at MN in The Hague, Netherlands, is overcrowded, a development that has pushed managers and networks to expand into Europe.

In January, the €71 billion Pensioenfonds van de Metalektro and the €49 billion Pensioenfonds Metaal & Techniek, both located in The Hague, for which MN provides outsourced CIO services, each allocated €75 million ($84 million) to Innovation Industries II, which focuses on Dutch technology startups.

Direct investments

OMERS is taking the approach of investing directly with companies rather than through funds.

"We are not investing in venture as an LP. The reason for it is that there is little information flowing back to the LPs in traditional (venture capital) funds," Mr. Briggs said. "There might be quarterly updates but each LP is making a small commitment and receiving relatively little information."

And he said: "If a traditional venture fund achieves five times multiple, the limited partner would only receive three times multiple," due to fees, he said.

Still, some managers said the best way for investors to limit the risk in venture capital is to invest through funds of funds.

"LPs should build, or use, a significantly diversified program to decrease the risk intrinsic in venture capital," said Joe Schorge, founder and managing partner at Isomer Capital, one of the managers selected by the European Commission's VentureEU funds-of-funds program.

Properly diversified investments by geographies and sectors also can minimize the risk, Mr. Schorge said.

"For example, some of our Asian investors are well-covered in Asia and fund of funds offers a way for them to quickly gain access and insight on Europe."

Overall conditions, he said, are "exciting" for investors.