Why does Europe have a scale-up capital gap?

“Why does Europe have a scale-up capital gap,” asked the gentlemen sitting across from me.  I was attending the European Pension and Investment Summit in Montreux meeting with the leadership of some of Europe’s largest pension funds, on a mission to educate them why they should consider growing their allocations to growth capital.

“Well,” I said, “Europe has a scaleup capital gap because a lot of European pension funds like you allocate very little to growth and venture capital funds. In fact, European pension funds contribute only 0.01% of total pension fund assets to venture capital compared to US pension funds who invest nearly 2% of assets into venture capital.  In other words, US pension funds invest 200x more per capita into early and growth stage innovation than European pension funds.”

“Growth funds are, by definition, significantly larger than early-stage venture capital funds,” I continued. “So we need more institutional investors, like you, investing in them to grow the asset class.”

Over the last 15 years, the UK and Europe have done an incredible job building an early-stage angel investment and venture capital ecosystem.  I vividly remember sitting at breakfast at Number 10 Downing Street 12 years ago with other Founders, investors and members of the David Cameron administration talking about Europe’s early-stage funding gap – and how to change it.  Since then, Europe has fundamentally changed.  Europe now starts the same number of companies each year per capita as the US. London is considered the world’s second-most vibrant tech ecosystem behind Silicon Valley, which will be on full display next week during London Tech Week and Founders Forum, which includes many of the who's who of global tech. The UK’s Enterprise Investment Scheme, R&D tax credits and unicorns have stimulated an early-stage investment landscape in London that is arguably as good as any in the world. Europe’s government support, from France’s “Startup Nation” to Germany’s High Tech Grunderfunds, changes to tax policies and support for university spin-outs has spurred both startup formation and early-stage investment throughout the continent.  Public sector capital has played a huge role growing this. Many European governments now have a pool of public sector capital that invests significantly into venture capital funds and startups, including British Patient Capital in the UK, the European Investment Fund in Luxembourg, BpiFrance in France, KfW Capital in Germany, EIFO in Denmark, Tesi in Finland, PFR in Poland and more.

But now it’s time to turn our collective focus to filling Europe’s scale-up and growth capital gap - the “missing middle”. Despite the vibrant early-stage funding ecosystem in Europe, many successful early-stage companies still have limited options for their Series B and C funding rounds, and even fewer options from local investment firms, those founded, built and headquartered in Europe.  When you filter for growth funding options in Europe from firms with partners who have scaled a European tech company themselves before becoming an investor, the list is even shorter. Europe has 1/7th the per capital funding of the US.  Just 8% of European funds have partners with operating experience (and even fewer with European scale-up experience) vs. 60% of top tier funds in the US.  Put simply, Europe has a massive scale-up capital and expertise gap.

The good news is that nearly everyone seems to now recognise this.  At SuperVenture in Berlin last week, a marquee annual gathering of European tech, a lot of the dialogue from public and private sector LPs and GPs focused on “filling the growth capital gap”.  The UK recently announced a “scale-up policy sprint” with the goal of investing £5B of new scale-up capital.  The European Union is similarly encouraging institutional and public sector investors to grow their scale-up and growth investments. I was encouraged to hear from many in Berlin last week that this is a priority for the coming years.  If we can mirror our success growing early-stage capital, Europe will be well-positioned to accelerate unicorns, job creation and economic growth in coming years.

Just like it did growing the early-stage ecosystem, growing the scale-up and growth ecosystem will take many different people working together to grow capital and new funds. Firstly, we need LPs to back emerging growth funds, not just early-stage emerging managers. Growth and early-stage investing are fundamentally different skill sets, which means we need to unlock a generation of new growth funds, where many will be emerging managers.  By definition these growth funds will be larger and need institutional and pension investors across the public and private sector to fund them, often taking bets on new managers.  Secondly, we need banks to support more creative financing for GP commitments and capital call lines.  Since the numbers are bigger for growth funds, the barriers are higher for new funds to start.  Finally, we need the same level of government mobilization to stimulate scale-up and growth investing as we have in the early-stage.

At SSV, we are focusing exclusively on European growth-stage (Series B) investing, in order to help fill this missing middle in Europe’s funding landscape and help stimulate the next phase of the European tech ecosystem. With strong European companies and compelling valuations often now available at the growth stage, we see the opportunity to achieve strong returns for investors with comparably less risk than in the early-stage, while helping to grow more generational European unicorns.