The State of European Venture Capital

The State of European Venture Capital

          
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The State of European Venture Capital

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    Most European VC Firms Are Subscale, and Many Underperform

    One of the most striking features of the GP landscape is the glaring absence of data transparency. For example, because most information is produced voluntarily and based on self-evaluation, the performance of a VC fund can be reliably determined only at the end of its lifetime, which can span ten years or more.

    Europe’s GP landscape consists of more than 800 VC firms that average €70 million in size. The number of European VC firms actively engaged in fund-raising shrank by about 40 percent from 2012 through 2014, which indicates robust market consolidation. The average VC fund’s size decreased by 13 percent—from €85 million, an all-time high, to €74 million—during the same period, widening the distance to the average U.S. fund’s size by 30 percent.

    Furthermore, compared with their U.S. counterparts, European VC investments as a percentage of GDP are not gaining ground. In 2009, European VC investments equaled 0.03 percent of EU GDP, and U.S. venture investments were 0.14 percent of U.S. GDP. In 2014, Europe’s ratio grew to 0.05 percent, while the U.S. ratio more than doubled to 0.29 percent.

    Looking at performance, we begin to see why. Many European funds don’t have the sort of records that attract flocks of new investors. According to Cambridge Associates, from 2005 through 2014, European VC funds turned in an overall net internal rate of return (IRR) of 7 percent, while the top quartile of European funds turned in an average IRR of 14 percent. Low-performing funds have trouble closing fund-raising, while a handful of large, successful funds are oversubscribed and crowded with well-connected investors.

    Our analysis revealed that top funds were characterized by their global investment expertise and strategies (most invest in ten or more countries), large fund size (on average more than €130 million), and concentration in a few industries. Low-performing funds were marked by their narrow regional focus and small size (roughly €60 million on average).

    Performance data from Preqin on the ten best-performing VC funds from the vintage years 2006 through 2012 reveals that seven of the funds were based in the U.S. and averaged US$139 million in capital. Three of the seven had fund sizes of US$3 million, US$5 million (focused primarily on seed and early-stage funding), and US$50 million.

    Of course, small can be beautiful, as the strong performance of many U.S. microfunds illustrates. In addition, the one European fund that made it onto the Prequin list of the ten best-performing VC funds was capitalized at €14 million. The GP landscape needs differentiation, and no single fund profile ensures optimum performance.

    The need for differentiation was also evident when we analyzed the EIF performance data on 78 funds launched from 2008 through 2012. The funds were pan-European with no regional focus. The larger funds slightly outperformed their smaller peers. Thirty-five percent of funds with €50 million or less in capital posted IRRs greater than 10 percent. This compares with 43 percent of the funds with €100 million or more in capital, which racked up IRRs greater than 10 percent. Given the vintage years and times to maturity of the funds in the sample, all return figures are interim IRRs.

    Our analysis of the relationship between fund value and net multiples shows that there is on average a positive correlation between fund size and performance, which suggests that the larger the fund, the lower the risks and the higher the performance. In particular, the national focus of many small, largely government-funded VC funds further discourages private investors, who are wary of the lack of scale effects and the increased risks that stem from low regional diversification. Another important feature of the landscape is that small funds are limited in their fee budgets, and, therefore, many of them struggle to attract and retain top management talent and to conduct thorough due diligence. Such small funds are also unattractive to large institutions, many of them global, whose minimum investment amounts can easily exceed the size of a single European VC fund (of which approximately 80 percent manage less than €100 million in assets).

    Furthermore, as we describe below, many European VC funds rely on U.S. capital for support. It is especially challenging for smaller VC firms to develop transatlantic footprints, experience, and expertise.