My Private Equity elective coursework was one of the most enjoyable so far. Traditional approaches to venture capital by GPs in Europe and the USA. I have a lot of interest in venture capital and private equity so it was really fun to research the European and US investment returns data in more detail.
US Venture Funds have outperformed European Venture Firms by a large margin when looking at both capital weighted average and upper quartile returns (Fraser-Sampson, 2010). Some argue that this outperformance is due to market and labour conditions, however most experts agree that the US approach to venture capital (VC) has largely driven these superior returns.
The traditional US approach is characterised by a home run mentality, investing in early stage companies and using entrepreneurial experience to add value to portfolio companies. In contrast the Europeans adopt a risk-adverse mentality, invest in later stage companies, often lack start-up/ entrepreneurial experience, operate in a fragmented market and have no stockmarket equivalent of the Nasdaq.
However in recent years, newer European funds have started modelling themselves on the successful US firms; investing in earlier stage companies and adopting a home run mentality (huge exits such as Skype, Betfair, MySQL). These success stories have created a new breed of entrepreneur who now has the ability to add value to portfolio companies. There are other changes as well, VC in Europe is also maturing with more fund managers managing repeat funds, relative undervaluation of Europe companies, coupled with better capital efficiency means that Europe may outperform over the next few years. The US could also be a victim of its own success with large amounts of capital flooding the market, driving up valuations and increasing the number of inexperienced US Venture Firms.
This leads us to ask the question of how relevant are historical returns comparisons if the markets have changes post-credit crunch and European funds are adopting the US model.
European VC firms seem to be closing the performance gap, but whether upper quartile returns in US and Europe narrow still remains to be seen.
Investment is about risk-reward trade offs, and the risk-reward profile of venture capital is not uniform across all sub-categories. Generally speaking, the earlier the stage, the riskier the investment, but the greater the potential payoff in case of success. As US VC adopts a more early stage approach there is a higher probability of extreme (positive and negative) returns. By comparing Europe VC to the US, a naïve conclusion might be that European venture performance would have been better had investment been undertaken in greater volumes, with more of a focus on early stage, and more of a technical focus. However, correlation does not indicate causality (Kelly, 2011).
Ultimately US and European capital and labour markets are very different so trying to compare VC firms on either side of the Atlantic is very difficult.
The report covers:
- Executive summary
- US and European venture performance
- Traditional approaches to venture capital
- US approach
- European approach
- Are the traditional approaches still valid?
- Younger European VC funds develop a more early stage focus
- Europe wakes up to value add
- Home run mentality crosses the Atlantic
- European VC maturity catches up
- Recent comparative returns
- Is the US a victim of its own success?
- European post-IPO outperformance
- How valid are historical returns?
- Are European returns as bad as they seem?
- Comparing like with like
- Shifting leaders in technology
- As technology matures diversity becomes more important