Venture Industry report for the second quarter 2016 by PitchBook

Post-Brexit, Investors And Entrepreneurs Must Make Decisions

Introduction

It’s difficult to unpack the consequences of the United Kingdom’s exit from the European Union, namely because such an event has never happened before. Frustratingly for forecasters, the timeline is protracted enough that many issues remain clouded, but when it comes to what venture capitalists and startups consider most important, there are several key areas that are likely to adversely affect venture financing and indeed entrepreneurial activity in the UK. In no particular order, the first is talent, whether tech or otherwise—with the right of workers’ free movement now in question, companies will have a harder time managing cross-border workforces. The second is regulation of VC fund managers, as they could cease to qualify for the current “passport” regime whereby UK managers can market and distribute funds throughout the entire EU. Third, when it comes to matters of trade, duties on the export or import of products and services may be entailed, encouraging relocation of offices. Last but not least, additional registration of trademarks and other forms of intellectual property could incur extra costs upfront, while any benefits generated by the new Unitary Patent system—scheduled to be launched in 2017—UK startups will miss out on.

Will this litany of issues compel startups and investors to relocate or look elsewhere, thus proving the UK’s loss yet the continent’s gain as a whole? That remains to be seen, although a short-term crunch in VC deal flow in the UK is to be expected, at the least. The reality is that nobody is quite sure exactly what current regulatory schema will remain in place and what will change for startups and investors in the UK. For now, an additional hazy layer of risk has clouded investors’ forecasts, testing even VCs’ tolerance of the unknown. Thus, as VC financings continue at subdued levels outside the UK, there doubtless will be some companies that elect to relocate, while investment firms make necessary preparations to adapt. But the long and short of it is that since nobody knows what will happen, it only remains for investors and founders to decide if they wish to trade the unknown for the known by, say, moving to or sourcing more in Berlin, or whether they should continue in a holding pattern until things become clearer.

Garrett James Black

Senior Analyst

Capital continues to flow as activity slides

Overview

The midyear statistics for European venture capital illustrate the ongoing effects of considerable dry powder combined with heightened uncertainty around economic growth prospects. The World Bank forecasts 1.2% real GDP growth for Europe and Central Asia, as of June 2016; better than what was seen in 2015, but still quite low. VCs plus nontraditional investors still have plenty of money to dispense, yet as competition in certain sectors remains intense and multiple economies troubled, forecasting sure paths to profitability becomes ever-more difficult. At the earlier stages, funds with government ties and angel syndicates may bolster financings by count, but there remains a significant lack of institutional capital sources to help startups transition to scale. A small population of noted fund managers are still raising pools of considerable size to fulfill that need, while top-tier firms from abroad with the know-how and resources still source across the continent, but that hurdle is still in place. Efforts to surmount that barrier through legislation and/or formation of regulatory frameworks rendering investment in fledgling companies more attractive continue, but by and large remain unrealized. Thus, overall activity is set to stay low, while total VC invested could prove somewhat more resilient, as a smaller cadre of proven businesses still fundraise.

Venture Industry, Brexit

Venture Industry, Brexit

Brexit fallout

Rounds by region & sector

On a regional basis, the impact of Brexit is already becoming clear. VC is already a high-risk, highreward field; any untoward ratcheting up of uncertainty will inevitably lead to fewer investments in a given timeframe. Consequently, the UK & Ireland saw completed financings in 2Q fall to a level unseen since the middle of 2011 as the vote loomed ominously. Proportionally, that region’s share of overall VC activity declined to the lowest level in five years. The DACH and Nordic regions actually saw their deal tallies rise between 1Q and 2Q. For all the talk of Brexit inducing VCs to shift focus to the mainland, as such regions still enjoy all the advantages of inclusion within the European Union, it will take some time for the true ramifications of Brexit to unspool. Anecdotally, startups have looked to relocate to Berlin, but for now, any mass exodus has yet to be realized. But in the meantime, at the very least, other regions’ activity won’t be interrupted, so their relative shares will rise.

Venture Industry, Brexit

Venture Industry, Brexit

Spotlight: DACH

Overview of DACH VC activity

Venture activity in the DACH (GSA) region registered a slight surge between the first and second quarters of 2016, but overall still remains off pace relative to the past three years. The decline has been most pronounced at early stages, as is evidenced by the precipitous drop in first financings of domestic startups. That trend in particular, however, has been ongoing for some time. Despite the activity of government-sponsored investment programs, as well as entities such as IBB or High-Tech Gründerfonds, there simply aren’t many smaller VC funds active domestically and/or they have difficulty coaxing commitments from typical classes of LPs such as pension funds. Investors ranging from super angels to family offices wish to gain exposure to the asset class given unattractive prospects in other investment opportunities, but in many cases it’s more compelling for such investors to invest directly or via angel syndicates rather than entrust their capital with a general partner, especially when it comes to earlystage investing. That is particularly the case for corporations; eventually some may set up a separate entity for such investing, like SAP Ventures. Accordingly, as such firms either enter the market or continue investing, early-stage activity won’t plummet but rather looks more set to plateau, at the least. That difficult hurdle of significant institutional capital remains in place, yet as corporate venture arms continue to be established or remain active, certain companies will be able to rake in all the capital they need.

Venture Industry, Brexit

Venture Industry, Brexit

Investors are still pursuing relatively safer investments, funding maturer companies that warrant significant sums. Proportionally, financings at the upper end of the size range still account for a considerable portion of all 1H activity, more so than in any other prior year. Companies such as Number26, with its $40 million Series B funding, will still attract considerable investment from outside and local investors. Those types of rounds will simply be fewer and farther between. However long it takes to materialize, another positive factor is the relative attraction of the Berlin-Vienna startup scene, given the impact of Brexit. Berlin was already one of the more active entrepreneurial centers on the continent,

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