By Dan Gray
Recent coverage of private market data from Cambridge Associates has surprised many by revealing the extent to which European venture capital has outperformed American venture capital in recent history.
Over the past 20 years, 10 years and 5 years, Europe led in net annual returns by 0.31%, 1.92% and 6.24%, respectively.
Many in the venture world have responded with disbelief, expressed in three main sentiments:
First, aren’t European VCs painfully risk-averse?
Second, don’t American VCs have a lot more cash?
And finally, when did the U.S. lose its lead?
In fact, these points illustrate exactly how Europe has managed to capture the lead.
Risk aversion hurts founders, not VC returns
Venture capital in Europe has often (and fairly) been criticized for risk-averse behavior in an intrinsically high-risk asset class. Whether it’s extended due diligence or downward pressure on valuations, it hasn’t been as “founder-friendly” an environment as the U.S.
Unfortunately for founders, the performance of venture capital (measured by rate of return) does not correlate with the scale or pace of deployment. It is connected to the quality of the investments, which is where European investors have focused more of their energy.
While European investors haven’t been immune (see Virgin Hyperloop), examples are much harder to come by, which speaks to their greater caution.
More capital is good for founders, not VC performance
Dry powder is a controversial topic, but the difference in capital availability between the two regions is significant and relevant. Currently, the U.S. has about 2,361 venture firms with an estimated $271 billion under management. Europe has 199 firms with about $44 billion under management.
To put that in context, the U.S. has 55,079 startups, while Europe has 39,668. These counts are based on an analysis of Crunchbase data of active private companies funded since 2014. That means the U.S. has $4.9 million per startup and 23 startups per VC firm. In Europe, that’s just $1.1 million — and as many as 199 startups per firm.
Abundance doesn’t appear to drive better outcomes for venture capital. To understand why, a good case study is offered by the rise and fall of ZIRP-era VC.
Over the past decade, we’ve witnessed the influence of cheap capital on VC, with a drive toward pumping the price on consensus bets and dumping companies onto public markets. VCs became more like traders than investors, focused on riding trends and harvesting management fees.
This practice was sustained — at cost to fund performance, VC reputation and LPs’ returns — until the public market started rejecting inflated valuations and interest rates drove up the relative risk for LPs. Europe, not suffering from quite as much capital boat, has seen proportionally less corruption of the asset class.
VC stopped being data-curious
Despite the impressive status and reputation, U.S. venture capital hasn’t led on returns since the dotcom boom.
If you’ve followed the data published by Cambridge Associates you will have known of Europe’s lead since at least 2019. It was emphasized again in this year’s “State of European Tech” report from Atomico.
The sense of surprise about these findings is yet another hangover of ZIRP. The focus of venture capital has shifted so far toward relationships (logo hunting) and hype (momentum), there is little curiosity about the data that typically informs investments and benchmarks performance.
It’s an industry running on anecdotes, not evidence.
As we feel the ripples of that 2011-2022 strategy collapsing, with startups closing at a record rate and markdowns across the board, it is clear that much will have to change as sentiment swings back toward real performance.
Illustration: Dom Guzman
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