All eyes on venture as corporates and PE swoop in

European venture has had the wind firmly in its sails in recent months, not least on the investment side: aggregate value for early-stage deals in Europe in 2018 amounted to €3.34bn, more than double the value registered in 2014, according to Unquote Data. Although the space has not seen an increase in the number of deals over the past five years, the average ticket size rose considerably, from €3.1m per investment in 2014 to €9.9m last year.

The volume of European funds raised in that segment also increased sharply after 2010 and hit a four-year high last year, reflecting the growing appetite of investors for the strategy. No doubt fuelled by the success stories of Sweden's Spotify, the UK's Farfetch and the Netherlands' Adyen, European venture seems to have shed much of the stigma of the lean years.

The venture space is now increasingly attracting international backing. Up to 17% of investments in 2018 saw the backing of an investor based outside Europe, while the average during the period 2013-2017 was 7.4%, according to Unquote Data. But more importantly, venture is increasingly permeating the broader investment ecosystem: corporates are looking at backing VCs and buying startups, while private equity firms are no longer averse to dipping in by creating their own venture arms.

Being a professional investing in VC requires a specific set of skills, which are different from the ones of M&A professionals at corporates" – Matthieu Baret, Idinvest

Going corporate
Europe's corporate players are well aware of the opportunities newer competitors might yield, as well as the threat they might pose. As is the case in the US, innovation often happens outside the R&D arms of large groups, so unless they develop some sort of link with startups, they are likely to miss out on innovation.

In the past decade, corporates from all sectors have set up their own venture investment arm. Alliance Ventures (managed by Renault-Nissan-Mitsubishi), Total Energy Ventures, Unilever Ventures, Airbus Ventures and ING Ventures are among the growing number of big names trying their hand at early-stage investing, along with a number of their US counterparts.

However, VCs are keen to point out that, while popular, the strategy is not without drawbacks. Matthieu Baret, managing partner at Idinvest, highlights that it is usually very costly, and startups are often wary of being backed by a corporate, in case no strategic alignment is in place. "Being a professional investing in VC requires a specific set of skills, which are different from the ones of M&A professionals at corporates. They face the challenge of having to attract the right type of venture professionals to manage the investments," he says.

A number of corporates have found that directly backing VCs can be an attractive alternative. Of the 52 final closes of Europe-based venture VCs in 2018 recorded by Unquote Data, 36.5% had received backing from at least one corporate. Baret says corporate backing of VCs had only just established itself when utilities giant EDF backed Idinvest's Electranova fund in 2012. Today, French groups Total, Danone and Vinci Energies, Germany-based Henkel and Zeiss, Hungary-based MOL Group, US-based Johnson & Johnson and Pfizer, and Japan-based Toyobo are some of the many corporates regularly acting as LPs in venture funds.

Friends with benefits
The relationship between a corporate acting as a LP and a VC is, in most cases, a win-win situation, according to Baret: "Corporates are exposed to what's going on in the market and the VC can get some advice from its corporate LPs, to a certain extent, when having to manage portfolio companies and source deals."

Partech's investor relations team has equally found the relationship to be fruitful. Principal Nico Valenti Gatto explains that the firm has developed a closer partnership with corporates over the past eight years. "They represent a minority of our LPs, with a view of either becoming clients or partners of our startups," he says, before adding that the relationship can go further; in some cases corporates even act as co-investors, although Partech would always remain the leading investor.

The backing of large corporates can be a particular boon for debut venture funds, which are often sector-specific. Out of last year's 17 first-time-fund final closes, seven had received backing from corporates, according to Unquote Data.

It is a trial-and-error process and we are seeing European corporates becoming more and more experienced in the matter" – Stéphane Valorge, Clipperton Finance

For example, Finland-headquartered VC NordicNinja, which launched in 2019, attracted commitments from three large Japanese tech corporates, Panasonic, Honda and Omron, in addition to the Japan Bank for International Cooperation. The VC will use its corporate connections to help Nordic and Baltic scale-up-stage companies enter Japan and other Asian markets. Asked to what extent these investors can influence a VC's daily business, NordicNinja investment director Claes Mikko Nilsen underlines that "the investment decisions are made independently from our corporate LPs. Moreover, sharing the right amount of information about NordicNinja's portfolio businesses with LPs is fundamental for us: the startups must not be suffocated in any way by the corporates."

More generally, while welcoming corporate support, VC professionals agree that a little usually goes a long way. "It would be a problem to have many corporates that are competing with each other investing in our funds," says Baret. "Furthermore, the partnership with corporates requires some of the VC's workforce to dedicate a significant amount of time to the relationship, while other types of LP require less work on our side." Add to that the fact that corporates tend not to recommit to multiple generations of funds – viewing the backing of a fund as an ad-hoc case, rather than a long-term strategy – the consensus is that such backers are likely to remain a minority within the LP base of well-established VCs.

M&A conundrums
Rather than nurturing startups from the beginning directly or via VC funds, some corporates may opt to make ad-hoc acquisitions to suit their goals. This has been a significant trend in the US tech space for some time, providing welcome exit routes to VCs, and European corporates are also getting in on the action. Discussing the pharma and medtech spaces specifically, LSP managing partner René Kuijten told Unquote at the start of the year that big corporates shifting from internal R&D to an acquisition-based model is a considerable development. VCs, he said, have specifically targeted startups that can then be absorbed by large corporates. Emmanuel Delaveau, a general partner at Partech, says: "We see a clear trend of senior execs more inclined towards those investments, looking at the long-term benefits of acquiring the know-how and technology of a startup, and approaching the acquisitions like a portfolio manager would do. If you regularly buy or invest in startups and maybe only a few of them end up being transformational successes for your business, then you have succeeded. You cannot just rely on a fluke."

Stéphane Valorge, managing partner at Clipperton Finance, says: "Corporates definitely face several obstacles when acquiring startups, and in some cases the transaction does not give the results hoped. However, it is a trial-and-error process and we are seeing European corporates becoming more and more experienced in the matter." It may still be some time before Europe catches up to the US in that regard, though. M&A teams of corporates still have a hard time grasping startup acquisitions and valuations that can be dilutive, with businesses not yet generating a profit, not to mention accepting that a number of the businesses they acquire will not be successful.

Furthermore, successfully integrating a startup is not easy: large groups and startups have very different corporate cultures and the management of the startups is often heavily relying on its founders for leadership.

Private equity looking in
Idinvest's Baret argues that European corporates will eventually need to overcome these difficulties to avoid being left behind, and their private equity backers might be able to help them. "Value creation in mid-market companies can be tough at times, especially when several LBOs have already taken place. Therefore, private equity firms are creating their own tech teams to support innovation within their portfolio companies and M&A strategies targeting startups," says Partech's Valenti Gatto.

But private equity players are not afraid to dip into the venture waters more directly, too. KKR's $711m Next Generation Technology Growth Fund, which invests both in the US and Europe, and EQT's €566m first venture fund, both held final closes in 2016. The following year, Spanish firm Arcano launched its first venture fund targeting a €200m close and aiming to back both US and European companies. Last year, France-based GPs BlackFin and Raise held closes for BlackFin Tech Fund 1 and Raise Venture, respectively. Additionally, Barcelona-based buyout firm Abac Capital launched Abac Nest to make seed investments in early-stage companies.

The drivers behind this willingness to step down a rung are numerous. Industry insiders across the board agree that the European market is now producing businesses that can scale up from small startups to so-called "unicorns" fairly quickly. Put simply, private equity does not want to be left out from the arbitrage possibilities the European market is currently offering. Moreover, some believe the current context of exacerbated competition for LP money, in which building multi-asset brands and a diversified strategy can be pivotal, can be a powerful incentive to venture into earlier-stage investments more formally.

Not surprisingly, dedicated VCs are keen to point out that the move can be risky. Partech's Gatto says most of the generic private equity firms do not have an immediate understanding of the venture world, and that investing in this area requires a high level of expertise. Perhaps this is why consolidation between venture and private equity firms might look attractive to some, a prominent example being the acquisition of a 70% stake in Idinvest by France-based private equity firm Eurazeo last year.

From our perspective, there is no upside from Brexit, especially on the talent front: the UK, and London in particular, have benefited enormously from being a magnet for talent from across Europe" – Frederic Court, Felix Capital

Growing pains
While the development of stronger partnerships between these players is a sign of the growing sophistication of the venture market, challenges still stand in the way. The fact that European startups still tend to move their headquarters to the US, or list there, once they achieve a certain size can be of particular concern. "As the European public equity market gets more educated about these companies, more will eventually go public in Europe, but there is still a lot of work to be done," says Felix Capital founder and managing partner Frederic Court. Last year's listing of Netherlands-based payment-processing platform Adyen on Amsterdam Euronext was a positive sign in that regard.

Another unknown is how Brexit might affect the entrepreneurial ecosystem of the UK, which has produced the greatest amount of unicorns in Europe. Court says that leaving the EU might end or limit freedom of movement, making it more difficult to attract talent from the continent. "From our perspective, there is no upside from Brexit, especially on the talent front: the UK, and London, in particular have benefited enormously from being a magnet for talent from across Europe and beyond," he says. Farfetch, Deliveroo, Revolut and TransferWise are among the successful UK startups launched by foreign founders.

Whether the European venture ecosystem can successfully navigate these challenges and, more crucially, continue to close the gap with its US counterpart when it comes to returns remains to be seen. But the growing interconnection between startups, VC funds, corporates and even traditional private equity firms shows that nobody wants to lose out on an industry that is coming of age.

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