What does the future hold for VC funding in Europe?

European firms secured US$4.9bn in venture capital funding in Q3, far behind the US with US$28bn. But the European market could soon rebound.

The European venture capital (VC) funding market has dropped by 14 per cent in Q3 2018 compare to the previous quarter and is still lagging far behind North America and Asia, according to the MoneyTree report published by PwC and CB Insights in early October.

The report, which highlights the latest trends in VC funding globally, shows that Europe completed 638 deals and raised a total of US$4.9bn in Q3 this year. In comparison, North America closed 1308 deals for a total of US$28bn, while Asia completed 1359 deals and raised US$19.bn.

“These figures are mainly the result of larger VC deals being closed,” says Thomas Ciccolella, US capital venture leader at PwC in San Francisco and one of the authors of the report. “Over the last couple of years, we have seen more and more companies gathering a lot of private capital at levels we didn’t see before, mainly due to the arrival of new types of investors into the space such as hedge funds.”

The arrival of hedge funds in the VC market is a worldwide phenomenon. But what really makes a difference between Europe and the rest of the world is the capacity of US and Asian local tech giants such as Google, Amazon or Alibaba to invest large amounts into local innovative startups through their investment arms.

“For years, Asia was at par with Europe in terms of VC funding,” says Thomas Ciccolella. “But Asia eventually became a bigger part of the pie towards the end of 2016 thanks to investments made by local tech giants. This has resulted in larger deals in the region and, depending on the quarter, Asia sometimes outpaces the US.”

Thus, among the five largest VC deals - above US$500 million - listed by PwC and CB Insights, three took place in Asia and two in North America.

But for Georg Metzger, principal economist at KfW Bank in Frankfurt, the MoneyTree findings for Q3 are no indication that the European VC funding market is falling.

“VC investment can dramatically vary in size,” he says. “We see everything from seed investments of a few hundred thousand euros to larger rounds of several hundred million at a later stage of funding. Depending on when these mega-deals take place during the year, the quarterly figures can fluctuate and, thus, do not reflect long-term trends.”

Q2 2018 saw a few important deals in Europe. In April, the UK-based fintech Revolut raised US$250m, while Freeline Therapeutics secured US$116m in June. Both were backed by large European VC funds.

As to know what the future holds for those investments and whether investors will be able to cash out, the answer may lie in recent exits. In April, Spotify launched an IPO valued at €24bn (US$28bn), while the Adyen IPO in June was valued at €7bn (US$8bn).

“Future large exits will further improve the eco-system and we will see more and more VC funding in Europe as investors know they can make a return on their investments,” says Georg Metzger.

For now, the funding gap with the US and Asia remains, though. To address this issue, the European Union together with the European Investment Fund launched a US$2.6bn Venture Capital Funds-of-Funds programme (VentureEU) in April this year in the hope to boost investment in innovative start-up and scale-up companies across Europe.

In parallel, the European Commission is also working on the Capital Markets Union plan, which includes a number of actions to reduce barriers to cross-border investments.

“The issue with Europe is that it lacks a single area like the Silicon Valley and due to the different legal and regulatory regimes in Europe, VC fund managers are still reluctant to do cross-border investments and invest outside their home country,” says Georg Metzger. “Creating some kind of harmonisation will certainly help Europe to reach the same critical mass as the US or Asia.”