The great European venture capital crisis

By Fred Destin on May 9th, 2012

Over the past few quarters, I have had to organise or assist in refinancings of some of the companies I work with on European soil. The exercise of drawing up a target list of investors has been a depressing one, for the European venture landscape is starting to look extremely depleted. We have three clearly dominant firms based out of London, in the form of Accel Partners, Balderton Capital and Index Ventures. We have regional champions like Northzone. But one struggles quickly to add new firms to the list of potential investors.

It’s a tough market out there. Take France as an example: while Philippe Collombel at Partech valiantly managed to close a fund on the back of a string of strong exits, he’s the exception rather than the rule. Many bank-sponsored funds have been disbanded or scaled down. Funds like Banexi managed to raise but in dramatically scaled-back fashion. A once dominant Sofinnova killed its tech team and is now focused entirely on biotech, while old favorites like Innovacom are simply absent.

Others are struggling to raise new funds. Funds that are considered to be doing well, like Alven or Partech, are, again, the exception rather than the rule, and a shining new initiative like seed-focused ISAI hardly makes up for such a dramatic market contraction, leaving active later-stage funds like Benoist Grossman’s ID Invest able to clean up. Accel Partners also recently hired a French principal to take advantage of this.

European venture capital is out of favour with LPs. Even the word seems toxic: I know of one fund who dropped “venture” entirely from its pitch, focusing its messaging on “growth capital for technology companies”. Struggling venture capitalists have to first convince hesitant investors that Europe is a good place to put their cash before they can talk about the relative merits of their particular fund. It’s tough when you have to evangelise your region before you can even get into your own story.

Ironically, the best new initiatives end up relying on public money. The wonderful Passion Capital initiative is one such example. The European Investment Fund (EIF) is seen as the great white hope anchor investor you need to get. (I used the word “ironically” because during the Great Internet Bubble the EIF stood behind a gazillion regional fund alternatives, most of which produced disastrous results.)

From a policy standpoint, governments realise of course that innovation is the key to their future, so it’s naturally tempting to focus on the “equity gap”. After all, spending money on funds is measurable and actionable (so many Euros invested, so many funds backed, so many start-ups created, so many jobs). You can understand the angst: an informed look at the barren field of venture capital makes for a scary outlook.

Going back to France, the French state is fast becoming the primary purveyor of venture money. On the one hand you see partly state-owned France Telecom ploughing money into their new Publicis-Orange initiative, thereby also rescuing Iris Capital as manager. The Caisse des Depots (CDC, an extension of the French Treasury) is the anchor investor behind many of France’s venture firms.

In an even more obvious statement of intent, the Fonds Strategique d’Investissement (FSI) is now probably the largest purveyor of venture capital in France. Think about it: the French state, with political and macro-economic political goals, is the largest provider of capital and in direct competition, sometimes outbidding local firms, with independent venture funds, each scouring the market to win the best deals.

Yet I remain convinced of two things. Firstly, government entities are badly set up to deliver attractive returns on cash deployed. Ploughing money into venture capital is a bad use of taxpayers’ money, because the returns simply are not there. And the job of government is not to keep venture capitalists in business.

More fundamentally, the market may need to contract even further before battle-hardened new managers emerge – teams that can raise the bar to funding innovation in Europe. The truth is, there is plenty of money out there, waiting to be invested. The test of market attractiveness, while harsh, is necessary to allow deserving managers to emerge, and to allow the market to sustainably restructure itself.