This article discusses the problems Europe faces in the VC world. There are some that are very relevant. It doesn’t mean that we have a very great Ecosystem here. But it is a tough spot to be in.
Let’s look at the facts. We have some fact issues to take care of before looking at the structural issues,.
- The most active fund – the story of HTGF.
HTGF – probably the most active fund in Germany and among the most active in Europe. But is it a success story? Surely was briding the post 1999 era liquidity dry-out. But does the success rate and the exits they generate really matter?
- The Big Players – a case for or against Rocket:
Rumour has it that Rocket Internet is one of the top players in Europe. When you listen to the streets in Germany, you basically get the idea that Rocket is basically THE company that created the German VC world, it is THE player in the Berlin ecosystem. But, really? Come on, these guys bought some domains, ripped off families by using legal grey areas to generate money using kids and spamming TV channels with their Jamba craze back in the days, their track record mostly included non-profitable companies with big brand names such as Zalando. They built their world on copy-catting products they saw working else where. And if you are really anal about it, they build brands not on superior products, but identifying working business models and putting them into global nieches where people are the most likely to be dumb enough to fall for the marketing buzz they create. Just think about their brand/fashion companies in LatAm. It just plays the fashion and brand name game on poor idiotic consumer behaviour in very poor countries. Their global founders fund didn’t get much endowment money (US) or corporate LP investmentss (Germany and Europe), but they are taking it from banks. Bottom line DCF style choice of investment. Really? Fuck rocket. 700million losses in 2016. Yeah, nobody in the whole WORLD likes rocket and there is a good reason why. Despite bringing coders and cool to Berlin.
- Research hubs continue to build great research. Elite schoold continue to create engineers, developers, business leaders. But is there any ground work and environment that allows them to build the companies of tomorrow? Or are the good ones leaving and selling to established companies that can’t grow from their expertise?
The secondary markets suck
Let’s get to the bottom of it all. If you are starting in Israel and you are funded by government R&D spent, your company is run my seasoned entrepreneurs and the entire game is building IP and moving to the US, that is a surefire and simple game to play. Good for you, Israelian start-up. It is a workable model and you are getting rich on tax money while giving some great IP back to your country and enjoying a very suitable and easy legal environment.
But what is it with Germany and Europe? Let’s do the story.
- Language: Like it or not, Europeans have a disadvantage when it comes to (a) the language or “English speaking capability”.
- Culture: On top of that, you have cultural issues. Germans are globally enjoyed for the German life style, respected for the power play Merkel pulled off and hated for being cold and completely unfriendly compared to Western international standards.
- Labor unions: No matter how smart you are and how well you do, the German job security, social welfareand labor unions completely kill the flexibility and fluidity that is needed to grow and scale companies. Add the regulation overhead and the privacy issues, and you are simply not competitive on the global markets. How are you going to scale if (a) you struggle meeting regulation goals, (b) you think over-complicating governance and architecture issues by complying to governance issues serves you any good, (
- Sales: There really is no “play” for claiming European companies outperform on global roll-outs and market expansions. Call it the language barrier, call it the business conduct and culture, there are many reasons why Europeans don’t match the US capability to sell and grow and scale globally. TAMs, SAMs, etc. suffer on the top line. And still, the bottom line suffers from regulation and all that jazz. Does the Chinese buyer care about European regulation? Nope.
- Secondary markets: Household sentiment doesn’t really focus on IPOs, secondary and public markets. Bad for IPOs. Regulation around pensions is tough. Pension fund and endowments do not exist and are in Government hands. Also regulated and diversifying. Not willing to bet on micro- and mid-cap European markets. Reason enough for having a problem with IPOs in general. Even if there were IPOs, the prospect of diversifying into young ventures vs. US alternatives doesn’t really cross anyones mind. But all in all, the micro- and mid-cap market does not exist. This puts pressure on valuations. If companies can not exit via the IPO way, they are prone to sell to companies only. With this competition gone, valuations are lower whoever you sell to.
- The buyers suck: Europeans don’t compete globally on the brand level. Many reasons. But with this, also the buyers don’t sell well either. With no secondary and IPO market that allows them to try, they get sold to companies that do not try to scale globally. If you do not sell and scale globally, you again lose opportunity and Exit valuations are lower.
The implied biases suck
- If you are a smart entrepreneur, and you know that you can’t do very well in the EU, you are heading for selling in the most attractive exit market. We explained why this will not be in the EU. So you either move to the US – getting a better valuation due to higher probability to role out globally and not sell to a “local” player and scaling globally – or you simply stay in an unattrative market and lose your “prime equity opportunity” tickmark. Or: more simply put, if you don’t move to the US and raise money and sell there, you are either mediocre or you thought you were not competitive enough to make it there. That all somehow gives you the stamp of “mediocre” or “uncompetitive”
Remedies or further issues?
- Secondary markets must improve: Easy to say. But this requires anothe consumer sentiment, different institutional regulation, different labour market policy and much more. That would drive some competition and improve valuations here.
- Europeans need to sell better: Maybe EMEA-China relations were traditionally better than US-China relations. But that is part of the past. With EMEA struggling since the crisis and the US going on new course with China, the biggest markets – US and China – are moving further away from the EMEA region. Unless we develop some global sales talent beyond what we have, we will not be competitive. Period.
And let us be very very honest. Nobody cares about the benefits from European reuglation – privacy or governance and shareholder value-specific -, so the regulation stands in the way rather than being a value proposition.
- EMEA political impact lowers: With financial crisis, economic development and the inability to form a union on foreign policy, EU and EMEA further declines in its power to leverage trade deals and foreign relations to place European companies.
- Suprisingly, welfare is an “educational play”: Scarcity in the US on tech education remains. It is the one weakness. With this scarcity and Educational inflation, the structural disadvantage in the US remains. But what is the true benefit here? India keeps on producing more engineers with sufficient education to keep the US competitive and Asia or China is no longer lagging in any sense. The HR output per 3-year generation on engineering and technology is steadily improving. The only thing that keeps things volatile and tilting against the US is immigration policy and inequality. While Europe has a shot at becoming more competitive here, the political agendas of national states and the inequality among the core and the core also increased by the language and cultural barrier and a rise of intolerance is keeping Europe back.
- Where is consumption going? The only big metric everyone is looking at is the per capita GDP and national GDP development. China GDP appears to be “under review”. The rural development is lagging. And income disparity within the urbanized and developed cores appear to drive the innovation motor, but also doesn’t yet promise a game changing development in consumer behaviour. So there is nothing yet said and done regarding global shifts in consumption patterns. India similar story, but looking a bit more dire. LatAm appears the most attractive on consumer development, but also is too frantic and unstable to really get a picture. So from this perspective, Europe should get over intolerance and disintegration problems. But no real indicator that this will happen too soon. Fears of disintegration are still too large.
The European USP?
- European countries are cheap as it gets R&D opportunities. The educational quality is better than high school rankings suggest.
- Europe clearly faces demographic structural problems, but they can be solved “fairly” easily by overcoming “simple” political issues.
- FinTech wants to disrupt the Financial System, but it can also play a role in solving the European secondary market problem
- The real issue for the VC world is that the R&D opportunity is hinting towards a “move sales to the US, but keep developing in EU” doctrine. But there could be an opportunity to build ecosystems that bridge the language, cultural and regulatory divide and make the EU a valid market with a sufficient SAM.
- With a sufficient SAM, and a developing secondary market, valuations could increase a bit and could lead to competitive salary levels, attracting the sales and value chain talent the region needs to build the “global sales and scale” opportunity.
- Finally, if this all plays out, regulation would play a key role to facilitate the import and global marketing of European products. This requires the mindset that current regulation is not a benefiting but hurting factor for European market. The big embezzlement and wonder being that labor markets sustain their benefits without slowing down the growth aspects of the region.
My personal opinion would be that Europe fails at most of this, failing on the political and – as bad is it sounds – military and foreign policy level. But nobody knows. the talent is here. Let’s see where it goes.