Mountside Ventures and Allocate have released a new report, “The Capital Behind Venture 2020”, with the support of key ecosystem stakeholders like us at Silicon Roundabout.
The first sentence of the Foreword sums up nicely the present status of the industry: “Despite COVID and BREXIT, this remains a very exciting – albeit challenging – time for the European technology venture capital ecosystem.”
Today I’ll be digging into its data for you and show you why this is so.
2010-20: The European startup scene blossomed
According to Beauhurst, one of the input partners in the report, European tech VC is rapidly closing the gap with its US and Asian counterparts.
As we discussed in our previous article, “The Rebirth of European Venture Capital,” a decade ago Europe was approximately 50 years behind the US and China in VC-funded startups. But that gap has been reducing. By 2019 European the VC industry has matured to levels similar to the US a mere 10 years ago.
Meanwhile, European startup hubs have been sprouting all over Europe, fuelled by over EUR 110b in investments in the last 5 years.
The Capital Behind Venture report surveyed investors in VC funds ─the infamous “LP’s”─ to uncover what is the sentiment behind this engine, and where it might lead the tech ecosystem going forward.
Then covid…
Unfortunately, the COVID-19 pandemic derailed all the best laid plans.
The resulting uncertainty caused investors to hold back. And while investments in seed stage startups did not completely come to a halt (the report mentions that only 20% of respondents think the pandemic affected their investment activities), they slowed down considerably and threatened to break the momentum of Europe’s VC and startup ecosystem.
Interestingly enough, despite this slight hiccup, the outlook for European VC remains bright. Money continues to be available, with a large portion provided by government-backed LPs.
Yet the cake is only getting bigger
Perhaps the biggest opportunity for fund managers and, consequently, startup founders lies in the emerging openness of some of today’s LP’s.
In the past, asset allocators tended to be conservative, cautious, and incapable of appreciating opportunities, especially in unproven fields such as high technology and deep tech. If there was no existing model to validate an idea, then they considered it too risky. They entrusted their money only to “bankers” who shared the same cautious aversion to risk.
Yet today’s investors are beginning to change.
A new tech world for new bold VCs to capitalise on
The report states that 90% of their respondents are willing to take a risk with emerging fund managers.
This is significant because it opens up the playing field to newer, more agile tech savvy players.
The Silicon Roundabout Ventures fund, as an example, is managed by former tech people. We are not ex-bankers or management consultants, but we do understand the numbers having lived startups as founders, investors and tech operators. And more importantly, in my opinion, we are techies who understand and appreciate the underlying technology of a startup concept and its economic potentials.
That is one of the key value we add to a venture.
If there is anything that modern investors share with their traditional counterparts, it is the value they place on cultivating relationships. According to the report, more than 70% of LPs try to get into a startup (via their VC stakes) as early as possible: presumably to get to capture more of the growth.
This is great news, especially for seed stage startups. It means that there could potentially be more money available to them during this stage.
Asset allocators are getting more involved
Today’s LP investors are also open to exploring other options beyond merely investing in VC funds. This reveals a mindset that is closer to that of Silicon Valley capitalists than traditional European asset allocators.
Startups benefit, of course, as there is yet more money available to them. VCs benefit as well, though, because the smartest LP’s don’t plan to replace their investments in funds. Instead they seek to invest alongside their managers, especially at later stages, where a company has proved itself but requires bigger cheques.
Overall, it’s an advantageous development for the ecosystem.
With new opportunity comes corresponding scrutiny. The report quotes Sam Ettelaie, an Investment Manager for British Business Bank, saying, “Potential fund managers need to be able to clearly articulate their value propositions above that of purely being able to leverage their network; having a clear differentiation will not only allow you to raise from LPs but also allow you to access competitive deals.” indeed for VC fund managers, it is crucial to clearly communicate to investors not just the value proposition, but also the value add and what they can leverage beyond access to founders.
The game is still hard hard to get into…
The majority of investors still consider a fund’s track record to be the most important factor in their decision. This is a disadvantage for the newer and less experienced funds. A few LP investors, however, do consider other elements such as the fund investment thesis, the size of the network, and the manager’s experience as an operator.
Strangely enough, despite this constraint, the report states that 82% of the LPs surveyed have invested in emerging fund managers ─albeit most of these investments are done in the 2nd or 3rd fund, not the very first one.
Does this mean that asset allocators are willing to forego track record and gamble on other advantages that new and more diverse fund managers offer?
It certainly seems so. As Martin Punt, BVCA, points out, “It is very hard for emerging VC funds to raise… It’s also hard for LPs to build conviction on new VC managers, but it happens.”
…but those that manage continue to show convincing results
Apparently, higher returns, closer relationships with founders, competitive differentiation, and drive are also important considerations for investors.
Yet, even so, LPs do get frustrated sometimes when VCs pitch to them. Among their pet peeves are demonstrated lack of investment understanding, lack of transparency, weak competitive differentiation, and the inability to bond and connect with LPs. Investors dislike in particular the use of hyped words and the banality of language used by some as a way to impress.
What most LP’s do like is managers who aim to recycle early exits to recoup the management fees: only pension funds and a few other respondents opposed this.
Betterfront, another of the report’s input partners, shares this advice: Share your track record in spreadsheet format and keep updating it. LP’s seem to like managers who keep investing even as the fund gets built and reflect this in the material they share.
So, we’re still down to the track record as an important factor in VC fund success, but it seems that the attitude is shifting.
Certain LP’s are beginning to accept different ways of proving “track record”, perhaps not necessarily as an investor at a previous fund.
A new hope ─post-covid
Covid might have dropped a cold shower on the emergence of new VCs. However, if LP investors are willing to keep their mind open as we go into 2021, a new breed of emerging VC managers might just be able to “get back to work”. And with new funds coming to the market, capital will continue to flow to an ever broader and more diverse pool of European founders.
Sure, we need to work harder. For example, whilst 64% if the LP’s want to increase exposure to female-led VC’s, only 18% have set key performance indicators to measure progress. Most LPs still do not yet have a policy to actively try and increase capital deployment into funds led by managers from ethnic minorities. Furthermore, those investors who regularly back truly new first-time funds are still a very limited and hard-to-access pool.
The trend is nonetheless positive.
Catching up to the US? I think we still can!
Get the full report, “The Capital Behind Venture 2020”.
You might also find this interesting. It’s an actual review by a Draper Esprit LP of Silicon Roundabout Fund’s pitch deck. See what goes on under the hood.