1. Insights of the week

European VC deal value will break new records in 2022

European deal value is on track to significantly exceed $100B (€90B) in 2021, a new annual record. If that wasn't enough, analysts expect this number will be blown away in 2022 as more outsize dealmaking continues. Pitchbook predicts a colossal €175B of European investment over the next year, stating: "The COVID-19 pandemic has accelerated capital flows into tech-based VC-backed companies, and we feel further investment will be conducted to seek out heightened long-term returns amid high inflation, low interest rates, and an uncertain period for wider global financial markets." To underpin this prediction, capital under management for European VCs has more than doubled from 2016 ($59B) to 2020 ($111B), while dry powder, which refers to the amount of available capital available for future deployment, has now reached a new high from a record base of $47B in 2020.

This capital must now find a home. If current trends continue, most will be shovelled into growth-stage businesses. Founders at the beginning of their journeys will not share equally in this bounty. As we have witnessed in 2021, deal value is expected to be almost 3x that of 2020, but deal volume will see only a very modest increase. As we reported in our 9th December note, whilst the number of rounds at growth stage and beyond have increased, those of $5M or less – a proxy for pre-seed and seed level deals – will barely be any bigger than that of 2020, after already trending downwards for the past 5 years. There is not due to a lack of investment opportunities. Europe has a strong flow of new startups seeking institutional capital. In fact, Europe accounts for 33% of all capital invested globally in rounds of up to $5M, compared to 35% for the United States. But the money here is spread more thinly and round sizes are smaller. This is a key factor in European graduation rates to Series A and beyond continuing to lag well behind the US. The funnel at each funding stage narrows faster in Europe.

Even so, it is hard to dispute the claim that the European VC ecosystem is maturing. Europe now possesses a wide variety of unicorns in different sectors and geographies, and these companies will likely drive up deal value figures to new heights with enormous late-stage rounds. Competition for the hottest deals will continue to push up valuations across the board and average deal sizes will continue to soar, as more and more startups reach $B valuations in record time. In the more established venture ecosystems of UK & Ireland, France & Benelux, and DACH regions, some argue that valuations are becoming disconnected from reality. If this persists, it may push investors to seek out value in emerging territories, such as the Nordics. This region has an established ecosystem with experienced networks, skilled talent, and cutting-edge startups all looking to emulate the stunning success of Klarna. 2021 has been nothing short of a feeding frenzy for investors chasing after the big European growth stories. There is no sign of any let up - yet.

International investors will boost European investment in 2022

It is widely expected that both international and non-traditional investors will continue to target fast-growing European assets looking to scale globally. Cross-border flows of capital have been increasing, especially from the United States. US investors now participate in 1 in 5 deals across Europe. Meanwhile, in the UK the share of funding from domestic investors has halved over the past 5 years. In a recent survey, a large share of founders across Europe - in some cases the majority of founders - from Pre-seed to Series A said they now place less importance on physical proximity to investors compared to 12 months ago. Whilst the majority of investment for very early stage deals across Europe is still domestic, this flips as deal sizes exceed $10M. Once above this threshold the number of unique investors that are active has more than doubled in the past 5 years. Below this threshold the number has marginally declined since 2017.

VC deal value with non-traditional investor participation, especially Corporate VC (CVC), was among several annual records that were broken during 2021. As startups have become able to quickly challenge large corporations for market share, the need to incorporate emerging technologies and increase the breadth of product offerings has made startup investment a necessary strategy for corporates alongside internal R&D programs. As a result, new CVC investors are coming not only from high-tech industries but from legacy industries threatened by disruption. Emerging tech investments are a valuable way for corporates to iterate their products and develop new offerings while still leading in market share. Recent US market data confirmed this increasing appetite: of the 1,400-plus CVCs that have made an investment in the US this year, 769 of those had not made a VC investment in the five years prior to 2021.

In addition, other new categories of investor are also entering the European VC scene; so called 'crossover investors' (big global hedge funds and PE funds such as Tiger, Coatue, and BlackRock) are now active at all stages, even though their primary focus is growth. As a result of this increasing internationalisation of capital flows, investors of all persuasions now expect to see European startups thinking bigger right from the outset. This often means a vision to become a global category leader, instead of just a local or national champion. Founders must therefore be far more cognisant of global markets, global competition and global investment trends as they build their funding strategies, right from seed stage. Relationships with international investors and corporates that have a broad geographic footprint and are capable of making the right form of strategic investment in a startup will therefore increase in importance through 2022.

2022 startup planning: Founders must 'rethink'

Many VC analysts felt the COVID-19 pandemic would be a market-correcting black swan event. However, broadly speaking, it has been the opposite. In its wake we are seeing a great divide emerge - between those whose businesses have risen on the tide of unprecedented capital flows and those whose boats were not quite ready to go into the water. So dramatic have the changes been, that irrespective of whether a startup would consider themselves a winner or a loser over the past 18 months, there are uncharted waters ahead for all. Money is not the panacea for every problem. Those who successfully raised outsized rounds - the 'winners' - must rethink their growth plans. Whilst there have been numerous pandemic-driven success stories in areas such as online event tools and remote working solutions, the sustainability of rapid growth for fast-growing businesses remains an ever-present question facing VC-backed companies. The euphoria of having big new investors on the cap table will be short-lived if founders can't continue to drive an unerring course to global category leadership. Outsized rounds set expectations of outsized results.

For those who needed to raise external capital in 2021 but didn't make it, it's also time to rethink the proposition. Some startups have suddenly found themselves addressing weakened sectors (e.g. travel, entertainment) or employing out of vogue business models (e.g. no recurring revenue) or at a funding stage where the investment criteria have just shot up a notch (e.g. Series A). Whatever the reason, investment propositions that haven't yet been able to demonstrate a strong growth response to current market conditions will have been pushed into the "too difficult" tray by investors. For those that simply need a little more evidence and have a decent amount of cash contingency, this could just mean a manageable delay. But for many others, nothing short of a pivot will now do. The next challenge is that pivots are usually only funded by incumbent investors and, if they are tapped out, the options are usually very limited. A big scale down in costs will almost certainly be necessary so the business can live to fight another day.

For those who relied (successfully) on internal rounds through 2021, bridging to a time when the investment proposition would be ripe for new investors, they might end up being the real winners. They have bought time to rethink the positioning for the next round. They haven't made promises that they may not be able to keep. In particular, founders with seed stage businesses heading for Series A in 2022 will be carefully re-examining the key criteria they must hit as the bar was raised significantly in 2021. They may not have revealed their detailed plans to new investors yet but know they must paint an even more compelling picture of a bright, post-pandemic future. Standing out from an ever-growing crowd of hopefuls requires a truly bold and unique vision, a confident, well-evidenced plan, and an aura of building excitement. All the signs indicate that the wave of continued record investment will continue to surge forward in 2022, ready to propel the next flotilla of aspiring winners into the race.

2. Other pieces really worth reading this week: 

What’s Next: Trends in Innovation and Technology for 2022
A special insight into key tech trends by ACV, an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds. "The following year will be full of great challenges and opportunities for those who have the vision to capture them. Decentralization and deep technologies are converging in a new era of the internet, out of which unknown business models and new technologies will arise. We are on the verge of the birth of the next wave of companies that will lead the market in the following decade."

The forces working against innovation and how to overcome them
A thought-provoking article (and interview) for McKinsey featuring David Schonthal, professor of strategy, innovation, and entrepreneurship at Northwestern University’s Kellogg School of Management and former senior director of the design-thinking firm IDEO. "No matter how cool your idea is or how compelling your strategy is, unless you address this human element, unless you address some of these psychological barriers and forces, your innovation efforts will be stifled."

Glassdoor Workplace Trends for 2022
A revealing perspective for the UK, France and Germany by Lauren Thomas of Glassdoor's Economic Research Team. "Looking ahead, we believe 2022 will centre on navigating the new normal and employees’ elevated power in this tight labour market. Companies that succeed will be those who embrace the opportunities to rethink old ways of hiring, employee engagement and how business is done."

Happy reading!