European Venture Capital: A Rembrandt in the attic?

Do European venture capital funds perform better than their U.S. rivals? German VC fund, Earlybird Venture Capital, just published an analysis that claims European venture capital has been producing higher exit multiples than U.S. venture capital in the last two years.

The exit multiple measures how much a fund earns when it sells its equity in a company in comparison to its original investment, e.g. 10 times as much.

“A lot has been written at a more emotional level about European venture capital. We wanted to bring it back to a more data-centred approach.” Jason Whitmire, a partner at Earlybird and one of the authors of the report, told VentureBeat. Based on recent performance, he says, “the whole industry is a ‘Rembrandt in the attic’”.

Earlybird’s analysis is based on data from a combination of sources. The Dow Jones VentureSource database covers about 80 percent of venture capital deals in Europe. Thomson Reuters provided fund data, although only 15 percent of European funds were tracked as opposed to more than twice that figure in the U.S. Other statistics came from the EVCA and NVCA venture capital associations. The authors did not segment the deals into technology and life sciences but believe that life sciences represented less than 30% of deals covered.

So what does the data say? The authors calculate that $15 billion was generated by venture capital-based liquidity events in Europe in the past two years compared with $30 billion in the U.S, even though total European VC funding is only about one fifth that of the U.S.

In exits over $100 million from 2005 through the first quarter of 2011, the average exit multiple in Europe was 7.2 times the amount invested while in the U.S it was 4.5 times the amount invested. However, exit valuations in this range were 25 percent smaller in Europe. Whitmire gave the concrete example of the German online mortgage lender InterHyp which Earlybird exited at just under $1 billion, a 54-fold return on investment. To put this in context Skype’s investors made about 40 times their original investment.

It’s clear that there is a big capital gap in Europe; many great companies, not enough funding. For investors, this keeps entry valuations low and quality and capital efficiency high. EarlyBird’s analysis implies that European firms are much more capital efficient than their U.S. rivals. Early stage valuations are 1.5 to 2.5 times higher for U.S. startups than their European equivalents and follow-up investments are considerably lower. Exits in the same order of magnitude only require half as much VC capital in Europe as in the U.S.

The report also highlights (on slide 20) a massive increase in the number of repeat entrepreneurs funded by European VCs. This could be because there are more of them, because repeat entrepreneurs are seen as a safer bet or a combination of both.

So if European venture funds are doing so well why do we hear so little about it? According to the other author, Earlybird managing partner Hendrik Brandis, it’s because “professional marketing is not in the DNA of Europeans.” U.S. VC funds have internal PR departments. Their European equivalents don’t.

In spite of this lack of visibility, Whitmire contends that “we are increasingly seeing U.S. VCs coming into Europe because they see more headroom”. Bradis told me that the current crop of investments won’t exit for 2-3 years, so their performance is still somewhat “hidden”. That means it will remain difficult for entrepreneurs to get funding during that period. He predicts that very good returns after that will result in a flood of new capital into Europe.

Fred Destin, a Partner at Atlas Venture, recently wrote an impassioned article on how European venture capital needs a revolution. One of his main complaints was that most European VCs simply don’t understand tech entrepreneurs or their technologies. Destin described European venture capital as “very average, sometimes downright ugly and only sporadically brilliant.”

So is the European VC industry a Rembrandt in the attic or knock-off Van Gogh? Time, and the data, will tell.

Image: “The Money Changer” by Rembrandt van Rijn

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