To compete with the U.S. and Chinese tech giants, European VCs must take a different path
By building portfolios themed around deep tech and committing to scientific breakthroughs, underdog investors can carve out a unique angle into tech’s next frontier.
In the middle of the summer, thanks in large part to the global COVID-19 pandemic, the S&P 500 plunged after data painted a worrying economic reality in the United States. But despite a looming recession, the five tech giants — Apple, Amazon, Alphabet, Facebook and Microsoft — have been able to expand their market shares and account for 20 percent of U.S. market capitalization.
The technology giants are leading the way back from the depths and underscoring their economic strength.
Unfortunately, we Europeans don’t have much in the way of global heavyweight technology firms in our markets such as the DAX and FTSE. There are no BATs or FAANGs here: acronyms for the Chinese and U.S. tech giants Baidu, Alibaba and Tencent; and Facebook, Apple, Amazon, Netflix and Google. These drove markets forward in the past decade and look set to continue to play an important role in market leadership also during COVID-19.
There is a huge split between American and European tech. Not one of the world’s 15 largest digital firms today is European, and the U.S. is forecast to spend 175 percent more on IT development than Western Europe between 2018 and 2022. Only 8 percent of businesses in European markets are classified as “leading innovators,” according to the European Investment Bank’s 2019 Report. In the U.S., this figure is twice as high.
For digital firms founded in the European Union, scaling up within national borders is easy enough. Capturing customers across the entire bloc, however, is a more difficult proposition. There are language barriers to overcome and different market considerations to steer. A U.S. startup can capture a significant chunk of the country’s 328 million potential customers with a relatively homogenous business strategy.
Another challenge for European startups lies in access to capital, which can be difficult to come by. E.U. startups are forced to focus on revenue and profits from the get-go, while American and Chinese companies can prioritize growth. The fragmentation that still exists between E.U. member states presents a barrier for businesses and investors to overcome, particularly when competition comes from the likes of the U.S. and China.
There is also the matter of culture: European entrepreneurs appear far more risk-averse than their counterparts elsewhere. The latter approach has allowed firms like Netflix, Uber and Alibaba to accrue mountains of debt in exchange for market share.
Below, I’ve laid out a few areas where European markets could do more to encourage entrepreneurship, because starting a business has changed drastically over the last 20 years — just not in the way that conventional wisdom would lead you to believe.
Forging strong relationships across science and tech
The first step is to define our own views about what breakthroughs science will enable in the near-term future. Some areas of focus might include: commercial applications of synthetic biology across the likes of agriculture, pharma and genomics or new materials. These are just a few places where scientific breakthroughs will shape our future, and I believe Europe has an intrinsic opportunity to bring these from the lab to the world.
Given the smaller ecosystem of venture capital in Europe, it is impressive to see how proactive and willing so many fellow investors have been to support Deep Tech’s objective of providing solutions based on substantial scientific advances and frontier engineering innovations.
Closer collaboration between institutions based in different E.U. states could be one important channel that ensures promising research proposals from outside our tech hubs of London, Paris and Berlin do not get overlooked. For all the talk about Europe’s innovation struggles, the continent has no lack of great ideas or, for that matter, startups. It is mostly during the process of scaling up that companies generally struggle. At this point, they often either seek acquisition by larger overseas firms, or they collapse. This creates the impression that home-grown success stories are hard to find.
Theme-based portfolios help investors navigate the tech landscape
As investors scan the financial market in the wake of COVID-19, there are a number of inescapable truths. Some trends have accelerated — like e-commerce, online working, the energy transition — while the slow decline of a number of long-established industries has notably sped up.
New technologies in fields such as artificial intelligence, virtual reality and biomedicine will be among the main drivers of economic growth and prosperity over the next decade, but they will only emerge in Europe with significant long-term R&D investment and a substantial shift in mindset.
We must accelerate our minds to take on the opportunity ahead of us. This means forging closer links between academia, corporations and government-backed organizations. But it also requires a rethinking of the venture-capital model. We must shift our metrics away from purely unit economics and valuation upticks and modify our funding reserve ratios in a way that truly allows the science to leap from the lab into the real world.
In creating a portfolio based on themes, investors could buy funds based on a series of individual genres such as artificial intelligence, biotechnology, robotics, energy transition and infrastructure. Europe is leading the way on climate change, renewable energy and low-carbon power, while Japan leads in miniaturization and automation. Elsewhere, the U.S. leads in healthcare and digitization, while China and India have created a range of new retail models that play to the theme of “evolving consumption.”
A thematic approach involves investing not in all technology companies or all renewable energy companies, but in areas that are reshaping society over the long term. It looks at digitalization, automation, aging and climate change. These each then divide into sub-themes: aging might include the role of healthcare — but also financial services, which should benefit from a greater need to save.
It is really important to keep in mind whether a theme will be around within the next decade. Investors should be looking for ideas and businesses that will stand the test of time. The important element is that these themes should grow and develop over the long term.
Venture capital is not an individual sport. We all know we will need to have fellow partners in the ecosystem with whom we can identify and jointly back some of the ambitious Deep Tech startups of the future. The trick will be bringing these entities together — across borders and disciplines — and forging lasting partnerships together.
