Rising levels of dry powder in private equity and venture capital firms make it inevitable that investment in Europe’s booming tech market will continue through 2022 – but in a sellers’ market founders will be choosy about the kind of capital they accept.
Among numerous investment-hungry firms, private equity giant Permira closed its growth fund in late December at $4bn, way over the target of $2.5bn, and more than twice the size of its predecessor growth fund. The fund has already jumped into the high-tech market, forming partnerships with AllTrails, the digital outdoors guide, Carta, the electronic equity management platform, data management specialist mParticle, and Sysdig, the cloud security specialist that created Falco.
Similarly, in November, General Atlantic closed its sixth flagship growth fund at $7.8bn, also smashing its target of $5bn, after new and existing capital partners piled into the fund. It’s a measure of the attraction of high tech that participants included family offices, endowments, foundations and institutional investors around the world.
Once again, the UK is certain to be at the heart of what has all the appearance of a long-running success story. According to research by Leadership Dynamics, Drax’s data partner, there were 545 investments made by 371 UK investors in 2020/21. And during this period, 246 UK businesses exited their value. 78% of these companies were in consumer products and services (B2C), business products and services (B2B), and information technology. The momentum looks likely to continue with a record number of cash-rich UK-based private equity funds on the hunt for companies with potential.
As competition for plum start-ups heats up, deals are getting bigger. “A series A round three years ago would easily be a seed round today,” explains Chris Grew, partner in the technology division of law firm Orrick that specialises in high-growth tech. And as restrictions on overseas investments in and out of Europe are eased, the most likely prospect is for even bigger deals on both sides of the Atlantic, as leading European funds return the complement and chase opportunities in the US. “We expect to see more of this activity in 2022 and beyond,” predicts Grew.[1]
Market dynamism
The dynamics of the private equity and venture capital markets are changing, with investment seen more as a partnership. As the latest research shows, there will be a greater focus on growth equity as opposed to the typical leveraged deals. Indeed, several traditional private equity funds already run thriving growth-oriented divisions. As a result, investments are being measured differently. For instance, accounting rate of return – essentially, how an asset performs relative to the purchase price – is seen as more important than EBITDA which has long dominated.
Going forward, investors of all stripes – venture capital and private equity – are under pressure to support socially-led tech companies. Citing the $31bn allocated to purpose-driven tech companies in Europe in the last five years, Miika Huttunen the chief executive of Helsinki-based Slush that links start-ups and investors, calls for more of the same: “We need to understand the difference between change and progress. Change is inevitable and erratic. Progress is deliberate and disciplined.”
Right on cue, research by Orrick finds that, while fintech investment rose by 159% and shows no sign of stopping in Europe this year, “planet-positive investments are dominating the fast-growing, purpose-driven space.” In short, there’s every reason why there will be more deals like the $2.75bn that Northvolt raised in June to help in its mission of building the world’s greenest batteries.
And the boot will probably be on the founder’s foot. In a seller’s market, venture funds will have to convince companies that they can add long-term value through deep knowledge of an increasingly specialised sector. Indeed, it’s already called hyper-specialisation and it’s happening on both sides of the Atlantic.
Towards hyper-specialisation
“European venture capital [will] have to become more competitive in their value propositions and agile in their approach as competition with established US venture capital has now become the norm,” points out Silicon Valley Bank. The lender predicts “greater inflows of capital from multiple destinations, especially with late-stage investors willing to pay a premium to participate in pre-exit rounds.”[3]
Source: McKinsey & Co
We can also expect a furious round of exits. “Rapid investment and big exits are now the norm,” points out Grew. Last year exits by European tech companies alone posted a combined value of $275bn, among them the direct listing for $11bn of fintech group Wise and the sale of Wolt, the Finnish food group, to the US firm DoorDash for $8.1bn.
The current year has a lot to live up to. In 2021, the total equity value of European tech companies in public and private markets exceeded $3 trillion for the first time. Having taken 24 months to double from $1 trillion to $2 trillion, the market added the third trillion in just eight months of last year. At the end of the year there were $321 billion unicorn companies in Europe, nearly a third of which only emerged in 2021 as they capitalised on the pandemic-triggered charge for online services.
Another reason for the continuing momentum of high-tech is the rapid growth of talent. “People from one generation of companies are moving onto become the next generation, whether it’s as founders, builder or investors,” explains Tom Wehmeier, head of insights at Atomico. He calls it the “flywheel effect.”
One of the game-changing issues is when – or if – Europe’s conservative pension funds join the party. Currently, they invest around 0.02% of their combined $3 trillion in tech. “There’s prudent financial management, and then there’s overly conservative tunnel vision,” argued Wehmeier in an article for The Times late last year.[4]
Looking further ahead, Blackrock chief executive and chairman Larry Fink foresees a fundamental transformation in this exciting market. “It is my belief that the next thousand unicorns won’t be a search engine [or a] media company. They’ll be businesses developing green hydrogen, green agriculture, green steel and green cement.”[5]
In our next technology-focused piece, released in February, we will touch on the dynamics of building a tech unicorn, where valuations are going, and which emerging technologies will be driving these valuations.
Patrick Jones
Director – Technology and Technology - Enabled
pj@draxexecutive.com
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