In defence of European venture

By Ben Tompkins on May 15th, 2012

If you read the press closely and examine recent reports from organisations such as the Kaufmann Foundation and Coutts & Co., you might be led to conclude that the European venture capital industry is in terminal decline.  Certainly European venture is going through a “Darwinian moment”.

The venture capital model seems to work well in the US. Why is this not the case in Europe? I don’t believe that some of the funds currently being raised are the answer. I don’t believe, for example, that investing £50,000-£500,000 per company across a big portfolio is going to create an interesting asset class on its own. Let me tell you why.

Firstly, it takes time, and therefore money, to build great companies. How much capital does it take to build a European business that you can exit for $100 million, never mind $1 billion? I don’t have the magic answer, but I would bet it’s $10-20 million, and then some. And you know, guess what: it always takes more time than you think. And, therefore, more money.

I do wonder what is going to happen to all the companies pouring out of seed funds and accelerators. They are assuming that someone else will back them – an assumption that holds in the US where there is a weight of A, B and C round money in the market. Europe is not at that level yet, which makes me think that the over-abundance of early-stage accelerators currently flooding the European internet industry might be setting young entrepreneurs up for disappointment.

What percentage of those companies that raise seed finance will go on to raise A and B rounds? Jos White of Notion Capital and I discussed this recently. I suggested that 80 per cent would fail at this hurdle.  He thought more.

Secondly, building great companies is hard work. It takes effort on behalf of the entrepreneur and, hopefully, his investors. I look after six companies, all at different stages. That’s a lot of work: at any moment, at least one of them is going through some sort of crisis. And then there is looking for new deals. Is an investor who has ten to twenty companies in their portfolio really going to spend enough time with any of them?

It’s obvious why Limited Partners, the funds that invest in venture capital funds, are dissatisfied with Europe. Frankly, returns in the last ten years have sucked. Against the failure of European venture capital to return money to its investors, concerns about management fees and carry or bonuses pale into insignificance.

But there’s more. The first thing to understand is that LPs think in billions, because that’s typically what they have to play with. When a £45 million VC fund makes 20x on its £1 million investment in its “star” company, it’s a good start but not a home run. To be a home run, the star needs to return the fund.

Obviously, if you had invested $300,000 in Facebook early on, that’s an interesting proposition. But the market is not there yet in Europe. One way that we might change that attitude is by showing that you can invest a meaningful amount of money – at Eden, we define meaningful as $8 million – and show that you can make 10x on this with your stars. This is more significant to the LPs, but it means that we need more, bigger exits in Europe.

That will require a number of things to improve. The good news is that we already have great talent. But we must marry that talent to time, encourage entrepreneurs to hold out for the big prize and not sell too early and encourage VCs to be braver and to invest meaningful amounts of cash. Finally, we need more attractive exit options in Europe. A public market would help.

There are VCs with cojones in Europe. Accel, Index, SEP and Vitruvian have good war chests and the belief to put them to work. We need more, deeper, access to capital.  And there are the US funds who are now deplying more capital in Europe – Sequoia, Matrix, Union Square Ventures and more to come!

Investing in just another online dating company in 2003 was not that obvious at the time. (I remember: I was there.)  Yet the people who did are the heroes of today. Let’s hope we have some heroes in the making out there in Europe right now. And, more importantly, that they can raise the money to make a difference.

Being a VC in Europe today is like being an entrepreneur: it requires a lot of belief.  We are doing it for the love of it. We know that returns in the last ten years in Europe have been bad. But we also know that you have to buck the trend to make real money, and some of us are crazy enough to try.

In other words, it’s a bit early to count European venture capital out just yet.