Introduction
In each quarter of 2021 new venture capital (VC) records were set across all geographies, stages, and spaces. Despite the seismic impact of the prevailing global pandemic the VC asset class rose above ebbing economic tides to ride the crest of the seemingly limitless wave of capital flooding in.
Market reports and industry media frequently proffer their observations on drivers and outcomes of the torrent. But the immediate and long-term effects for venture capitalists and the entrepreneurs they invest in have received little attention.
Our series of white papers seeks to aid in the understanding of some common challenges, adaptive changes, and potential opportunities affecting early-stage investors. To obtain invaluable insights into how European VCs are thinking, feeling, and behaving in this new buoyant topography we conducted in-depth face-to-face interviews.
In this, the initial report, we focus on the theme of increased competition resulting from the capital tsunami. We asked VCs about their perspectives in relation to the entire venture ecosystem, process and practice implications, and the future of venture capital in Europe. But first let us dive into the heady waters of 2021 venture in numbers.
Setting the scene
Globally 2021 was a precedent-smashing year for venture capital with figures hitting monumental heights across all metrics. According to CBInsights’ 2021 State of Venture Report1 global funding reached a gargantuan $621 billion. This represents an immense 111% year-on-year (YoY) increase from 2020’s previous imposing record of $294 billion. Each quarter set individual records, coming in chronologically at $132.8 billion, $150.9 billion, $160.7 billion, and $176.4 billion.1
Mega-rounds – those greater than $100 million – crossed 1,000 for the first time, up a colossal 147% YoY with a total of 1,556 in 2021 versus 630 in 2020. The global unicorn count, in addition, increased by 517 – up 69% from 2020 – to hit an astounding total of 959. Deal sizes reached new highs too, with an average size of $25 million versus $16 million in 2020, and a median size of $5 million up from $3 million in 2020, bumper increases of 56% and 67% respectively.
Rounds at all stages equally grew to hit new median valuation heights. Early- stage rounds had the least amount of growth, but still managed to swell by 55.5% from $18 million in 2020 to $28 million in 2021. Middle-stage rounds saw the greatest upturn, surging by 120% to $324 million, from $147 million in 2020. And late-stage rounds shot up by a similar 110%, from 2020’s $524 million, to break the billion-dollar mark for the first time ever, coming in at an impressive $1.1 billion.
Europe, in its own right, had an equally record-beating year. As stated in PitchBook’s European Venture Report2 deal value hit a mighty €102.9 billion compared with €46.8 billion in 2020 representing a supersized increase of 120%. Deal counts spiked by a corresponding 19% from 8,893 to a historic 10,583 in 2021. In total, VC funds raised €21.7 billion, second only to 2017’s total of €22.7 billion. And exit value outpaced all other metrics with a leviathan 504% increase from €23.6 billion to a prodigious €142.5 billion.
European tech – the most heavily VC-backed sector2– experienced peak growth to surpass all known milestones. Atomico’s State of European Tech 213 reports a total raise of $113.7 billion, more than double 2020’s $48.8 billion. Throughout 2021 mega-rounds totalled 247 with 152 of these being raised by the end of Q3 alone. The total number of tech companies scaling to unicorn status ballooned by 98, from 223 last year, to 321, up by a staggering 44% and, in the same period, decacorns (those valued at more than $10 billion) doubled to 26.
European tech also created value at its fastest pace, adding $1 trillion in just eight months, to show quicker funding growth than that of the US and Asia. Outcomes defied expectations in private and public markets as Europe continued to produce more tech IPOs than the US and those worth over $1 billion became the norm. To emphasise the success of tech founders in 2021 Atomico describes Europe as a ‘breeding ground’ for companies in all sectors, from frontier tech to crypto and enterprise SaaS.
To understand the data in context and get first-hand insights into the challenges, impacts, and key takeaways we spoke to a number of European venture capitalists from a range of funds. To start off we asked them about competition in light of the tsunami of capital.
Capital tsunami drives competition
A broader and deeper pool of investors
Will Orde, Principal at Conviction VC, tells us that facts and figures are definitely translating through to real life, as demonstrated by the sheer growth in the list of potential investors available to startups compared with just five years ago. Orde attributes this to the recent rise in different kinds of funds like corporate venture, private equity, sovereign wealth, and pensions.
PitchBook data certainly supports this assertion, as of 31 December 2021, non- traditional investor participation increased by just over 52% from 2,366 deals in 2017 to 3,601 in 2021. Over the same timeline, deal value for non-traditional investors increased by a staggering 406% from €15.5 billion to €78.4 billion.2
Crossover investors
As a multi-stage investor in post revenue high growth software companies, Orde reports seeing non-traditional players mostly in the later stages of venture. He attributes this to a phenomenon wherein successful companies and unicorns are remaining private for longer and explains that: “If investors are used to investing in growth-stage companies when they IPO on the public market, this option is no longer available, so they have to cross the divide to private to access them.”
This reality is especially evident in European tech investments. In 2021 alone the top twelve active crossover investors – typically public asset managers that also invest in privately backed companies like Tiger Global and Coatue Management – participated in 32% of rounds versus just 12% of rounds between 2017 and 2020.3
Macroeconomics
Isabelle O’Keeffe, Partner at Sure Valley Ventures, highlights the low interest environment as a fundamental driver. O’Keeffe explains that finding returns has become “tricky for traditional asset classes like bonds and, to a degree, equities”. General Partner at Auxxo Female Catalyst Fund, Gesa Miczaika, agrees stating that ‘given the 0% interest rate capital markets have discovered venture capital as an attractive asset class’.3
William McQuillan, Partner at Frontline Ventures, and a Kauffman Fellow, believes that, in conjunction with low interest rates over the last five to 10 years, the way in which markets have priced public companies has contributed to the capital tsunami. McQuillan said: “Companies have been going public later so the market has been losing out on a lot of the value gain that the private markets have been benefiting from. So, this has caused a large wave of capital to move into venture. All that said, over the last five months markets have seen large drops in public tech valuations and many governments are announcing planned interest rate increases so this could put a slow down to this wave of capital.”
Nevertheless, tech companies remain particularly eye-catching, and given the sheer number of such companies, and the assumed rationality of the markets, there’s still enormous scope for capital to come into the European ecosystem.
A new reality for venture capital – increased competition
The rapid acceleration in velocity and volume of capital deployed, coupled with an increase in the number of active investors in the European venture capital ecosystem, has resulted in an intensification of competitive dynamics.
Competing for funds
When competing for funds, Will Orde of Conviction VC tells us one distinct challenge is apparent. Big established managers like Accel, are growing exponentially and expanding their operations in Europe and attracting more attention from funds. In their recent ranking report4 Dealroom concluded that Europe is now firmly on the global investor map, as some of the biggest US funds have voted with their feet and set up European offices.
In March 2022 Sequoia Capital, for instance, launched an outlier accelerator in Europe that they’ve named Sequoia’s Arc. The initiative provides 15 regional seed-stage founders with an 8-week catalyst programme which covers the fundamentals tailored to European companies. And, perhaps even more noteworthy, Sequoia’s Arc is investing $1 million upfront, in the form of equity to the participating companies.5 The result of such initiatives? Smaller less well- known firms are being squeezed out of funding opportunities.
Competing for opportunities
Competition to invest into companies is high across the board but the biggest perceived change in competitive intensity took place at seed-stage, where, in 2021 93% of respondents to Atomico’s annual State of European Tech survey reported increased intensity compared to 57% in 2020.3
Conor Mills (CFA), Principal at Act Venture Capital, and a Kauffman Fellow attributes this increase in competition to capital from non-traditional and crossover entering the mix:
“Many different formats of capital started to enter the venture ecosystem from different players, i.e., high net-worth individuals, family offices, private investors, angel investors, CEOs etc., and it’s taken a lot of money off the table at a very early-stage. This has created a much more competitive nature around the VC ecosystem.”
The increase in competition brought about by the recent tsunami of capital means life as a VC is harder. A recurring theme throughout our interviews was the fact that startups now have more choice when looking for investment.
Principal VC Will Orde reveals that “it used to be easier to win deals, nowadays prospective investments are talking to more investors so they’re getting more offers, it’s much more competitive now.”
Challenges bring changes
To succeed under new competitive pressures, venture capitalists are altering established working practices and processes. Evidence collected by Atomico posits over 90% of VCs, representing all fund sizes (<€25million to >€500million), are rolling out at least one or more new initiatives or changes in strategy to stay competitive.3
During our discussions with VCs we identified three key strategies: spot opportunities earlier, move at a faster pace, and differentiate from the competition.
Spotting opportunities early
When considering changing practices William McQuillan offers a compelling perspective:
“The key thing to remember is the number of companies getting funding is increasing but nowhere in comparison to the increasing amount of capital getting invested. So really what you’re seeing is a lot more capital being put into the best ones – that’s where you’re seeing a lot of competition.”
McQuillan adds the main impact on funds like Frontline Ventures, is they’re now having to make sure they see companies as early as possible, so they have time to understand if it’s a good company. By spotting opportunities early VCs have the time to build up relationships and trust with entrepreneurs.
“Different firms compete to their strengths” notes Conor Mills. But he adds, “the relationship between founders is probably the most important consideration.” Being able to source founders at the start of their journey, so relationships have time to develop, is key and relies on spotting these opportunities early.
Moving at speed
All the VCs we spoke to reported increasing the timeframe in which offers are made and deals are done. Will Orde emphasises that one of the easiest ways to win a deal is to be the first to offer a term sheet to an entrepreneur. He tells us Conviction VC have reassessed their investment process from top to bottom and take an approach of continual improvement. In practice, their decision- making process is now more predictable and repeatable so upon meeting an entrepreneur they know what data to request from the off. In this way they can come to a decision point much quicker than before.
Conor Mills, by the same token tells us, to avoid losing out on deals his firm Act Venture Capital is now making decisions with more focus, attention, and teamwork than they did before. In so doing, they are ensuring their resources are aligned sufficiently to act on an opportunity faster than the competition.
Due diligence is another area VCs are speeding up. William McQuillan explains that 10 years ago, firms could take as long as three months to complete due diligence. In this present climate, it has to be done in a 7–10-day timeframe, and for particularly fast-moving deals that window shortens to less than a week. McQuillan adds that to compete his firm Frontline Ventures is now structured in ways that allow it to move quickly and flexibly.
Differentiating
In terms of competing with non-traditional sources, not all capital is created equally, says Conor Mills. He highlights what matters when talking to entrepreneurs is differentiating his fund from other potential sources of capital. Mills adds that, with traditional VC, startups know what they’re getting over time and over their lifecycle because investors and firms have a history which can be reference checked. This is unlike the newer forms of capital, where there’s more vagueness around how they perform and how they behave over the investment term.
In the world of increased competition between traditional VCs, Mills emphasises differentiation by explaining: “You’ve got to lift your head above the parapet” adding, to secure deals VCs have to communicate to founders why they’d be a great fit for their particular company.
Will Orde expands this idea of differentiating to highlight the role of specialism in firms like his:
“We only invest in B2B SaaS which means we know exactly what kind of metrics we’re analysing because every company we invest in or review has the same revenue model so we can compare apples to apples and rate them accordingly.”
Specialising in certain spaces or stages, also brings the added competitive edge of expertise and knowledge. Isabelle O’Keeffe adds that generalist investors will always have a role to play, but specialist firms tend to have management teams with a greater skill set necessary to make those businesses work. To attract founders in highly specific spaces or stages, VCs with experience and particular capabilities in the same space or stage, are more attractive because they can offer more tailored support and can demonstrate a proven track-record.
Key takeaways
Perspectives are obviously subjective, so opinions on and attitudes toward any given issue will always vary. The increase in competition driven by the tsunami of capital is no different. We found different players and commentators all had slightly different takes. However, between our individual VC interviewees, ranging secondary accounts, and multi-sourced research reports, some consensus is discernible. We present the thematic outcomes and discuss the associated nuanced viewpoints.
Explosion in scale and pace of activity
To illustrate the exceptional pace and scale seen in 2021 we look at the case study of JOKR:
‘In June 2021, Ralf Wenzel founded the grocery delivery startup JOKR to meet the demand of millions of people who had discovered the convenience of online shopping for food. One month later, the startup had raised $170 million to build “a new Amazon,” starting with grocery delivery in nine cities. By December, JOKR had raised another $260 million, at a $1.2 billion valuation. Technology startups are supposed to move fast, but this was a new kind of velocity: JOKR went from being a twinkle in its founder’s eye to a hot-shot unicorn in just six months.’ (first reported in Wired6).
Granted, not all startups proceed on this trajectory but when asked about the market in relation to scale Isabelle O’Keeffe states: “It has been crazy, we’ve been in a bull run for so long and there’s so much capital in the market – all sorts of capital – and there’s loads of startups so it’s very much been a buyers-market for entrepreneurs.”
William McQuillan welcomes this shifting undercurrent, seeing it as a short-term challenge, leading to future benefits:
“We will lose deals we want to do because there’s more competition and we will potentially have to pay more (i.e., give a higher valuation to that company) to get into deals, which has a knock-on effect for potential returns for our own fund.
BUT, and it is a big but, because there’s more capital in the market, once we’ve got companies in our portfolio it’s easier for them to raise money in future valuations, which has a positive knock-on effect for our returns as those valuations go up higher.”
Isabelle O’Keeffe is more circumspect in her take, explaining her fund has seen valuations that aren’t correlated to the actual intrinsic value of where the business is, or where it might potentially land. Sure Valley Capital’s response has, in contrast, been to try and maintain some discipline and offer valuations they think are appropriate for the business at the stage at which they’re investing.
O’Keeffe warns: “we are seeing investors out there who are less price-sensitive and, as a result, they’re driving increased valuations.”
In the same vein, Will Orde tells us Conviction VC are continually reviewing term sheets in respect of what terms they’re asking for, what kind of multiples they expect to pay in terms of valuation, all to make sure they’re sensibly competitive. Orde adds “we don’t want to get ahead of the market, but we want to make sure we’re sensibly competitive.”
In connection to pace Conor Mills tells us that for some investors moving at light speed can be an extremely uncomfortable position to be in, because they’d normally like to take their time and get their hands dirty feeling out a sector or a team; but the market dynamics, especially for the best companies, are so fast there’s a risk that investors may have to make offers before doing all that, or with never having had a chance to do all that. Obviously, this is not ideal in an ecosystem that relies on an acceptable level of risk-management. The fear is deals, done under these circumstances, have unexpected negative outcomes for startups and firms.
Accounting for this amplified risk is another challenge to negotiate. Will Orde points out that for small funds competition comes from the ‘Tiger Globals’ of this world who have large armies of analysts that can ‘pre’ analyse any business that they want to reach out to. Consequently, Orde states: “we have to think on our feet as we go, but we have to think carefully about where we focus our diligence, where we spend time and effort, and where we can make really high- quality decisions really quickly – and doing that is the real challenge.”
Effects on the European ecosystem
On the plus side, the chasm between Europe and Silicon Valley has closed in terms of the number of startups and amount of venture capital backing. A gap persists but it is narrowing for younger VC-backed companies. Indeed, venture capital has been one of very few success stories to come out since the start of the pandemic in early 2020. So, according to Forbes7 it is now shedding its ‘ugly duckling’ reputation.
In terms of other benefits William McQuillan points out that the increased availability of capital has meant, statistically, it’s easier for funds to raise capital. Similarly, Isabelle O’Keeffe highlights that LPs who are fairly established, have seen quite large returns and are, as a result, allocating more of their portfolio to venture capital. Consequently, this creates more emerging managers, more funds, more capital, and is a self-fulfilling cycle.
Changes to the ecosystem resulting from the tsunami are however not always so clear cut. We found they are largely viewed in the same light as those associated with scale and pace, which is to say, with a degree of ambiguity because they have interrelated positives and negatives. For instance, when asked about associated challenges, Will Orde states:
“Thinking of it as a challenge is a mindset, because the quality of deals didn’t used to be as good, and the VC industry in the UK and Europe didn’t used to do as good of a job as it is now. So, yes, it’s hard work, but it’s the right kind of work to be doing.”
In his balanced appraisal Orde reveals that working in this new ecosystem rubs both ways. On one hand VCs have got to be on-market offering good terms which is an onerous task. On the other hand, owing to the expansion of options and investors, VCs benefit since they can now secure follow-on funding more easily.
One sentiment that resonates with most VCs we spoke to is the idea that a healthy level of sensible competition keeps them sharp and focused. From the perspective of a VC, an ideal world is one in which they have free run on all the investments they want to make without being outcompeted. However, power law returns mean VCs want to back the very best entrepreneurs, from this angle competition functions as a form of feedback. This is a double-edged outcome for the ecosystem as Orde explains. On one side, it might mean VCs end up losing out on valuation or on terms. On the flipside, VCs can console themselves with the fact they were looking at a deal that others thought was interesting too. Naturally, no VC wants to lose out, but vigorous rivalry keeps them on their game performing at the highest levels which can only ever boost the ecosystem.
Outsized impact on economies
As Conor Mills told us “If we take off the glasses of a VC and put on the glasses of economic development, including job creation, entrepreneurship, innovation, etc., we see increased competition is a good thing!” Governments must agree with this sentiment as they have been allocating capital to startups like never before. In fact, in 2021 an astronomical 52% of VC funding raised in Central and Eastern Europe originated from government agencies.3 The figure was lower in the UK & Ireland (12%) but still represents a considerable proportion of public spending.3
Reports suggest that the outsized impacts of VC, fuelled by the tsunami of capital, include improving jobs and elevating standards of living. Dealroom estimates that startups have added around 400,000 new roles to the employment market over the last two years and that in 2021 there were over 2.4 million startup jobs in Europe.3 In the opinion of one VC, the effect on quality of life and salary inflation is the most profound impact.
What we are seeing is that it’s a great time to be beginning a career in technology because the talent pool is limited, the amount of venture capital going into companies at the early stages is expanding, and all those VC-backed companies are going after the same talent pool. “What’s happening is that we’re getting this natural inflation, which it’s not wage inflation, it’s flexibility of work, it’s benefits and it’s other positive work/life changes, all of which makes tech startups a great industry to work in” said Conor Mills.
The downstream impacts and how capital tsunami driven competition affects wider society, is still up for debate though adds Mills. If you look at heavily tech- driven cities like San Francisco for example, the income per capita or GDP is really high but the societal problems are really pronounced. Mills is not wrong about the social issues in San Francisco; The Spectator8 recently reported that out of a population of around 900,000, more than 100,000 residents are unsheltered. It would be unfair to wholly lay the blame for such problems at the doors of the Silicon Valley VC ecosystem but as The Spectator notes, high-tech companies like Twitter and Stripe attracted thousands of employees who drove up rents which perpetuated the resultant evictions.
William McQuillan lends his view which expands upon this idea:
“I’m happy there’s more capital available to support entrepreneurs but, the reality is, capital is finite so if more is going in to support tech entrepreneurs it probably means it’s not going into something else. There’s still a lot of improvement needed in the healthcare system, the education system, dealing with climate change. Some of the capital is being directed towards start-ups that are hoping to help in these areas, but what we need to be careful about is, if that wave of capital isn’t directed intelligently, we could end up benefiting a few people not a lot of people and that would create more imbalance. If I was in government, I would specifically be saying I want to put almost all my capital towards companies that are having a positive impact on society.”
What McQuillan and others do highlight in response to this point, is we are starting to see money being directed into impact funds to a degree. The European Investment Fund and the British Business Bank are two prime examples. But what is also stressed is the importance for redirection of funds into worthwhile projects to continue and to be better, given the outsized impact VC has on economies.
Driving social change
The outsized impact on economies coupled with ESG scrutiny from stakeholders, mean the startup community is laying the foundation for long-term value-focused metrics. Many are embracing growth with purpose and investors are pouring more money than ever into socially driven and planet-positive investments.3
In 2021, for example, planet positive tech captured 11% of all European technology funding with clean energy and climate showing the biggest areas of growth.3 Furthermore, over the last five years more than $31 billion has been invested in European purpose-driven tech companies representing 15% of all funding and a 57% YoY increase.3 The tsunami of capital, and the competition it brings, is then empowering the brightest minds to develop new technologies, products, and services which improve lives and make efficient use of resources.
Diversity and inclusion is another area where competitive venture capital is
producing winners and losers. Chris Grew, Partner at Orrick, for example, points out that fintech companies are levelling the playing field and increasing financial inclusion by helping low-income customers and micro/small enterprises respond to and rebound from the pandemic.3 Isabelle O’Keeffe likewise centres on gains telling us that funds, firms and startups run solely by women or more diverse teams, are now able to go out and raise capital, act as a focus for capital, and be another source of investment whereas previously, the only people able to raise capital were white males in their 40s. O’Keeffe believes this is like a whole new market which will continue to improve because, as research shows, more diverse and inclusive teams perform better.
Yet, despite the opening of avenues for diverse venture capital players, 91% of capital raised in 2021 was by all-male founding teams; 68% of women and 61% of men believe the ecosystem has failed to improve opportunities for underrepresented demographics in the last year; and 86% of non-binary people and 50% of people of colour feel it is failing to provide equal opportunity for their groups.3 The venture capital ecosystem is in essence painfully aware of the need to improve diversity and inclusion but has much left to do to make it happen.
Ultimately, the underlying belief in venture capital as an engine for social change is heartening. VCs freely admit their bias because they literally make a living from finding highly driven, intelligent, hard-working people who are passionate about the specific thing they are building a business around. But that doesn’t mean they’re wrong in the assertion that societies and economies are enormously affected and impacted positively through innovation and through entrepreneurship, not just at an economic level but at a societal level. William McQuillan provides us with a final powerful frame of reference:
“I’ve read multiple research reports over the years that reference the big impacts of the growth in entrepreneurship as being greatly tied to promoting peace in a region because, when there are more opportunities, people are less likely to perpetuate patterns of conflict and violence. So building a more entrepreneurial ecosystem indirectly promotes peace in that region.”
We found one academic study9 which demonstrates this link. It examined the impact of entrepreneurial activity on the peace process in Northern Ireland, and found that business enterprises in partnership with direct investment are capable of incentivising and maintaining conflict resolution and democracy- building processes – a particularly poignant virtue at this present time in light of hostilities in Europe and around the world.
Competition in 2022
In the context of unforeseen events
On 24 February Russia invaded Ukraine and instigated war at a scale unseen in Europe since 1945.10 The effects were sharp and swift as detailed by The National Institute of Economic and Social Research (NIESR)11 just 12 days later. Notwithstanding the humanitarian crisis, NIESR states ‘the conflict changed the global economy in less than a week’. Up until the war Russia was the 11th largest economy in the world and a key supplier of commodities, in particular energy and food. In response to retributive sanctions, Russia raised the price of gas and oil exports; and disruptions to the supply chain meant higher market costs for other Russian commodities, like corn and wheat too – the consequence – higher inflation.
The European Union is the most vulnerable of the major economies, given trade links, dependence on food supplies, and reliance on Russia to provide 60% of its energy requirements. Hence, European banks have risen risk premiums and interest rates, share prices have fallen, and markets are focused on signs of default or liquidity problems.11 The inevitable impacts on the venture capital landscape are however, in the main, yet to materialise but the main assumption we and most other writers are making is we will see more money channelled into bonds instead of stocks, resulting in less capital in the private market.
When looking at predictions for the future of venture capital, in terms of increased competition and the capital tsunami, the vast majority of reports and commentaries were written or researched at the end of 2021 or within the first few weeks of 2022 – including ours. The geopolitical and macroeconomic environment has, for reasons explained above, shifted on its axis since. Optimistic predictions should, then, be read cautiously. Wherever possible we have given specific dates of cited sources to clarify context; and used evidence released since or during Q1’22 to bring information as close to current as possible. Given the levels of unexpected changes and uncertainty, hard predictions are reframed as potential trends structured by broader discussions in light of available data.
The first quarter (Q1’22)
At time of writing financial reports analysing the first quarter of 2022 are being released almost daily. Much of the data comes from the US, where market watchers are more focused and quicker off the mark. According to the authors of The PitchBook-NVCA Venture Monitor First Look12 – a preliminary release of top-line venture industry figures designed as a first-to-market source of datasets – published 05 April 2022 the primary early indications are, in summary:Despite headwinds, many areas of VC data appear relatively unscathed. Movement in Q1’22 is much softer than expected.
- First financing closed at near-record pace, but shifts are expected over the coming quarters.
- Public market performance and economic uncertainty cause a pause in exit value. The health of the VC liquidity environment depends heavily on how long this quiet period lasts.
- The late stage has begun to show the impacts of the turbulent market. Deal sizes and valuations have started dropping and non-traditional investors are likely to pull back on their activity.
- $70 billion in commitments has been collected through fundraising adding dry powder which will help to insulate the venture market from immediate disruption.
- Emerging managers are expected to have a more difficult time raising new funds over the near term as LPs rebalance their portfolio to more known or established investors and managers.
On 07 December 2021 the Atomico State of European Tech 213 report confidently predicted the trajectory of venture capital would continue and that it would continue to deliver consistently benchmark-beating returns throughout 2022 and beyond. It goes without saying, this prediction requires a significant degree of re-evaluation given the global upheaval and Q1’22 intel; but there are still reasons for European VCs to be optimistic.
Initiatives, conceived during the peak of the tsunami, are coming to fruition. The European Investment Fund (EIF).13 announced on 07 March 2022 the European Union has reached a major milestone in the implementation of the InvestEU programme with the signature of the Guarantee and Advisory Hub Agreements between the European Commission, the European Investment Bank (EIB) and the EIF. The InvestEU programme is a key pillar of the European Union’s largest ever stimulus package as it unlocks billions for investment across the EU. Originally conceived to promote recovery from the COVID-19 pandemic, it would be reasonable to assume that even in this tougher climate, the money will go some way towards improving resilience in the European ecosystem. If so, a continuation in the competitive trend is to be expected. However, only time will tell if the sensibleness VCs craved post-2021 features as a positive unforeseen outcome.
Beyond Q1 2022
The venture industry may be able to weather the current difficulties on the back of sheer enthusiasm for the asset class, but there is certainly reason to doubt that the highs of 2021 can be matched or exceeded in 2022.14
While most US and European venture capital firms will likely be spared the difficult process of extricating themselves from Russia, the war in Ukraine is likely to prompt many VCs to be more discerning about accepting capital from investors based in geopolitical hot zones in 2022 and beyond.15
Despite the new climate of pressure on late-stage VC-backed valuations, there are plenty of reasons to expect the market to ride out the storm. In early April
Marina Temkin, financial analyst turned journalist, penned a particularly confident piece, saying ‘high hopes and a mountain of dry powder have VCs poised for a soft landing’.16 Dry powder is a helpful metric and serves to provide a greater sense of the available liquidity in the market held by local investors.
Having stores of dry powder available during times of hardship enables ongoing competition and investments in less than optimum circumstances. Christoph Janz, Co-Founder of Point Nine Capital pointed out in a January 2022 feature on predictions for VC that “lots and lots of funds have been raised in the last one or two years and that capital has to go somewhere”.17 Dry powder is still available but VCs are more conscious about making the best use of it, and making it last throughout this period of adversity. Andrea Traverstone, Managing Partner at Amadeus Capital Partners, accordingly predicts the outcome will be fewer, yet higher-quality, propositions obtaining backing in 2022 and beyond.18 To put that into perspective, even a 50% reduction in European venture capital activity would result in a tally roughly in line with 2020’s historical results. Slowdown will then hardly prove to be a death sentence.
Ending on a positive note
The tsunami of capital which flooded Europe in 2021 has undoubtedly created challenges for venture capitalists, not least in the form of increased competition. Money poured in and enriched the whole ecosystem. Yet, when raising rounds and competing for opportunities, European VCs found themselves swimming against an influx of new players. Competitive dynamics intensified as large US- based venture funds, non-traditional capital, and crossover investors dipped their toes in Europe’s warm waters.
In response to increased levels of competition European VCs have implemented new strategies and processes. At the top of the list were spotting opportunities earlier, moving at a faster pace, and differentiating from the competition. Resulting and improved workflows, greater focus, and better teamwork are enabling Europe’s VCs to identify then move more quickly and flexibly into deals with the best startups. The actors we spoke to recognise their work is now harder but welcome the challenge because it keeps them sharp, and the resultant entrepreneurial innovations are worth it.
The tsunami led to wider outcomes, beyond the explosion in scale and pace of activity, to include effects on the whole European ecosystem; outsized impacts on economies; and as a driver of social change. In each case there were interrelated upsides and downsides resulting in winners and losers. These nuanced repercussions are ambiguously received. Meaning, the consequences they bring are largely welcomed for the potential good they could or should do, but all are caveated with words of caution.
Looking beyond 2021, unforeseen events stemming from the Russian invasion of Ukraine in February mean optimistic predictions for an ongoing tsunami have been scaled back. Early data from Q1’22 provides some hope for the asset class and its ability to ride out the storm on the back of gains made in 2021, not least the stock of dry powder in stores. What’s expected is a correction from last year’s arguably bull run to a more sensible yet high-quality European ecosystem capable of continued improvement putting it on a par with the US.
The sudden and uncontrollable circumstances of 2022 mean uncertainty and apprehension is rife within the ecosystem. What we want to emphasise is the possible bright side. Venture capital is at its very core, fundamentally powered by hopeful enthusiasm. Entrepreneurs are driven by creative passion and a desire to do good things, VCs confidently back promising startups with assured zeal, and investors up the chain provide funds in the expectation of positive financial and social returns. Yes, we are now in a time of crisis, but that is when we see the greatest wave of innovation.
We need not look further than last year to see that as wider economies are challenged the startup sector responds with new talent and new ideas. The tsunami itself came during the largest global health crisis in a century. As the world shut down venture-backed companies were motivated to develop and release adaptive solutions which enabled societies to function. Pandemic lockdowns inspired digital transformation to boost online healthcare, remote working, ecommerce, and delivery services so much so that information technology and financial service sectors grew exponentially.
The current geopolitical situation will, in our opinion, see the same resolve. There has already been more interest in healthcare, cybersecurity, and sovereign tech. Entrepreneurs are rapidly looking for, and finding, ways to overcome adversity in the agricultural, heavy industry, and energy sectors. As the adage goes: ‘necessity is the mother of all invention’. So, no, the capital tsunami doesn’t look set to continue its storm surge, and yes, we may see the increase in competition turn from a maelstrom to a more manageable tidal wave. But what we’re also certain about is that the European venture capital will not capsize, it will persist on course and land in a more abundant, flourishing ecosystem.
References
1. CBInsights (2021) State of Venture Report – Global 2021
2. PitchBook (2022) European Venture Report – 2021 Annual
3. Atomico (2021) State of European Tech 21
4. Dealroom (2021) Prominence Rank 2021
5. Sequoia Capital (2022) Sequoia Arc
6. Wired (24 Dec 2021) ‘VCs Lavished Startups With Cash in 2021. Now Comes the Hard Part’
7. Forbes (28 July 2021) VC’s Outsized Economic Impact Will Power A New Golden Age
8. The Spectator (13 Feb 2022) San Francisco is Decaying
9. Aliyev, V. (2017) The Role of Business in Northern Ireland’s Peace Process
10. The BBC (20 Feb 2022) ‘Ukraine: Russia plans the biggest war in Europe since 1945’
11. The National Institute of Economic and Social Research (07 Mar 2022) ‘What is the Economic Impact of the Russia Ukraine conflict?’
12. PitchBook Data, Inc. (05 Apr 2022) Q1 2022 PitchBook-NVCA Venture Monitor First Look
13. European Investment Fund (07 Mar 2022) ‘European Commission and EIB Group sign InvestEU agreements unlocking billions for investment across the European Union’
14. PitchBook (2022) US VC: Bracing for Change (11 March)
15. PitchBook (11 Mar 2022) ‘Geopolitical risk threatens to trip up venture
capital’s global strides’
16. PitchBook (08 Apr 2022) ‘Weekend analysis’
17. TechCrunch+ (28 Jan 2022) ‘Bullish or bearish? What to expect for Europe VC activity in 2022’
18. TechCrunch+ (24 Feb 2022) ‘VCs weigh in on Europe’s future in the critical deep tech market’