How Europe Can Ride the Tech Rollercoaster
The region is investing more money in young tech companies. Now it needs to scale them.
In 2021, Europe’s tech venture capital market boomed – it doubled in size from 2019. The next challenge will be to scale – a task that has eluded many of their forerunners. If Europe can become adept at scaling tech players it could produce world-beating businesses, possibly even attaining a trillion dollar valuation.
Just as Europe was getting better at creating tech start-ups, valuations in this sector have crashed back down towards earth.
In 2021, Europe’s tech venture capital market boomed – it doubled in size to €35 billion from 2019 (a pre-pandemic benchmark). In the first half of 2022, it reached a healthy €18 billion, despite the major correction in the tech sector, which has seen investors refocus on sustainable profitability, rather than growth at all costs.
For those European start-ups that survive the forthcoming shakeout, the next challenge will be to scale – a task that has eluded many of their forerunners. If Europe can become adept at scaling tech players it could produce world-beating businesses, possibly even attaining a trillion dollar valuation – as described in one of the four scenarios for how Deloitte envisions Europe’s tech sector could evolve by 2030.
Yet there is also a clear risk that the ongoing correction might prompt investors to shy away from tech, leaving the sector under-funded and heading for a more negative scenario, such as A tech desert or Greatness divided scenarios.
As digital technologies catalyse and underpin the transformation of everything from healthcare to energy and finance, a robust and diversified tech industry would put Europe’s economy in a stronger competitive position and lessen its reliance on other regions for key technologies. With the ongoing labor shortages and inflationary pressures, organizations across the economy are turning to tech to enable greater automation.
In 2021, there were 65 cities in Europe with at least one unicorn (a privately-held company valued at more than one billion dollars in their most recent funding round), indicating that valuable tech companies are being created across much of the continent. On the flip side, Europe doesn’t yet have a Silicon Valley-size cluster where there is a critical mass of expertise and experience in scaling tech companies.
“Europe is catching up, while still lying miles behind the US,” says Patrick Polak, managing partner at Newion Partners, an Amsterdam-based venture capital firm. “The biggest concern is the availability of experienced people that have scaled companies from 200 to 1,000 employees. In the US, there is a huge pool of experienced scaling professionals to hire for your maturing company and subsequently take the next step in the scaling process. While there is enough talent in Europe, we lack experience in scaling.”
Europe’s private equity sector acquires a taste for tech
Importantly, much of the funding is coming from Europe, which was the origin of about half of the early stage venture capital invested in the region’s tech sector in 2021 and the first half of 2022. European investors are also now becoming more active in tech-related late stage private equity (PE) deals, and mergers and acquisitions (M&A). Europe was the source of 53% of all the private equity capital that flowed into European technology companies in the first half of 2022 and 63% in 2021.
However, mainstream U.S. companies are more likely to buy tech firms than their European counterparts, resulting in a much more developed and bigger M&A market in the US. In 2021, there were 4,835 tech deals in the US worth an aggregate of €610 billion. The equivalent figures for Europe were 4,076 and €203 billion. When European tech start-ups are sold to US buyers this can mean that Europe loses talent and intellectual property created in the region.
As well as financial backing, US tech companies have access to a massive home market. By contrast, European tech companies lack a large homogenous domestic market with a single language, and freedom of movement of labor. Despite the best efforts of the EU to build a single market, there are still some political, cultural and economic challenges that can make it difficult for a young tech company to expand across Europe. “European start-ups tend to do better when there is a significant local component to their business model, for instance in industries with local regulatory requirements or more asset heavy business models,” contended Sebastiaan Vaessen, Group Head of Strategy at Prosus at the time of writing this article, citing DeliveryHero and Just Eat Takeaway as examples of such companies.
Is a virtuous circle now in motion?
Looking beyond the current cycle, if Europe can spawn and scale large numbers of start-ups, it could begin to benefit from a virtuous circle, similar in nature to that seen in Silicon Valley. As European tech founders build more expertise and experience, and sell their businesses for significant sums, they are likely to become serial entrepreneurs and start or invest in more new companies, further strengthening Europe’s tech ecosystem.
Although it still trails far behind its US counterpart, Europe’s private equity sector channelled 27% of its investments into tech in the first half of 2022, up from 15% in 2021. Over time, both private equity and mainstream businesses may become more comfortable with buying technology companies. As a result, the region’s tech industry should become better integrated into the overall economy and better aligned with EU’s strategic objectives. If the core intellectual property and decision-making remains in EU, then the region should be well placed to shape its future in key strategic sectors, such as energy, healthcare and finance.
There are other reasons for optimism in the long-term. Although Europe wasn’t at the forefront of the big tech innovation waves of the past few decades (such as that related to consumer internet platforms), it has the expertise to capitalise on the next one – the convergence of engineering and information technology is now driving a new industrial revolution. As the world’s largest producer and exporter of machinery (with a 36% share of the world market) , Europe has a strong track record in engineering.
“As Warren Buffet once said: “companies get the shareholders they deserve”, and this is never more true than it is today. European tech companies need to reflect on the lessons from history and become more demanding, and more convincing, in choosing their investors for local, regional and global ambitions,” says Mark Casey, Technology M&A partner at Deloitte.
Now, Europe’s business leaders and policymakers need to steer a course towards the Who Wants To Be A Trillionaire? scenario Deloitte believes is one of the four plausible outcomes for the European tech sector in 2030. To do that, Europe’s tech investors will need to grow beyond early stage investments, while its tech companies will need the ambition and willingness to super scale, rather than pursue an early exit and start over. Regulators can help by supporting the development of ecosystems, talent pools with the skills to scale and Europe-wide funds, rather than country-specific funds.
With technology leadership in key areas, Europe could yet spawn several super-scalers valued at over US$1 trillion, joining a club that today consists solely of US companies.