European Startup Investment
Europe is seen as a backwater compared to Silicon Valley and the U.S. startup ecosystem. While not a wholly unfair perception, focusing on it means losing real opportunities to improve investor ROI and missing out on potentially greater future returns as the worldwide startup ecosystem evolves. There are a number of factors in Europe that illustrate potential upside.
Value
The biggest upside is low valuations. Unlike in the US, European startups tend to be undervalued. There are many reasons for this, but the main reason is that the early-stage startup environment in Europe does not have many competing firms, and this limits the ability of startups to set the terms of any investment. Startups have little leverage for a variety of reasons, such as few firms ready to lead investments, government grants dependent on achieving some private finance, and lack of founder sophistication. An illustration of this is increased willingness of European startups to accept down rounds in the current environment. The more constrained venture capital environment forces founders to be more realistic in order to survive, to the benefit of early-stage funds.
Opportunity
The vastly more competitive US market, as well as the more aggressive policies of US venture firms, gives American-led firms a big advantage in Europe. Simply put, European investors are slow and conservative. Due diligence is over emphasized in the early stages, investors’ expectations are unrealistic about risk, and the whole process is much slower than in the US. The biggest problem is that unlike in the main ecosystems in the US, continental European startup ecosystems are not comprehensive – they are heavily weighted to early-stage and there is a gap in funding above Series A. Venture is sizable in Europe, but not comparable to the US. As a result of focusing on the earliest stages only 30% of venture investment in Europe is European, while US funds command 70% and capture much of the value because they invest at the later stages.
Eurocentric Industries
Europe has many industries where it dominates, and yet due to lack of timely finance the innovation ecosystem struggles to turn these advantages into world beating startups. Europe competes well in areas like compliance and fintech due to the legal and regulatory infrastructure created by the EU and implemented by individual countries, an example being the regulatory regimes in Lithuania. Additionally, its manufacturing strengths ensure a strong engineering culture, particularly for embedded systems and industrial IOT. Its external trade orientation ensures it is a logistics hub with enormous opportunities for startups to improve efficiencies. And it is a leading producer of AI talent, focused on the application of AI to discreet problems like security and manufacturing. Talent is similarly cheap, as European firms can draw on talent in more middle-income countries to the East like Ukraine, Georgia and the Balkans. Given the right backing, European founders and startups are potentially world-beating, competing well with similar companies in the US.
Government Funding
Government funding is two-edged sword. Properly used it can jumpstart a startup to the growth stage, but over-reliance can cause a startup to eschew private funding until too late. That being said there is substantial government grant funding at the earliest stages of startup development. This funding is generally aimed at early-stage product development and seed stage hiring, essentially what in the US is raised through angels and friends and family funding. This can be a real negative, in that it retards founder growth in developing fundraising skills. However, in technology-centric industries, it is a boon, because it enables the development of world class technology without funding constraints. Additionally, it can allow a startup to hire salaried key personnel earlier, as stock options are not as common nor sought after in Europe. This enables firm to develop viable products and begin the growth stage undiluted, leading smart founders to be willing to give up more equity at first financing. Additionally they are poised for growth, and have mature teams, reducing investor risk.
Conclusion
Europe can be a source of outstanding returns with the right firm discovering and funding the best startups. Even greater returns can be captured by a US firm investing alongside European VCs at the early stages and bridging them to the US in the Series A round. A US style firm, based in Europe and acting quickly and following through on investment until Series A, can capture much of the value from sluggish European funds. Additionally, they could act as a consistent bridge to later stage US funding, something that currently is ad hoc and generally one-off. European funding ecosystems are not complete – they are barren at the later stages. So a bridge between seed and Series funding to bring American VCs in more consistently and provide a path to later stage funding in America magnifies the possibility of successful startup exits and higher investor ROIs.