European Accelerators as Series A Engines

A relative analysis on the shape & size of Series A rounds for ‘accelerated’ startups

I was intrigued by the numbers recently released by Mattermark on accelerators share of the US Series A market (tl;dr c. 10% of all Series A are raised by graduates of the top 3 accelerators, Y Combinator, Techstars and 500 Startups), so I did some digging to see what the situation is like over here in Europe.

The headline is that in 2016 18% of all European Series A rounds were raised by startups that at one point went through an accelerator or incubator programme.

This table has many more interesting numbers in it, which I will dissect below.

Source: Crunchbase

A few takeouts from the data:
  • 10x more rounds. The number of Series A rounds raised by accelerator graduates has increased more than 10-fold since 2012, from 6 to 61, while the rest of the A market ‘only’ grew by 2.8x over the same period;
  • Bigger share of the volume pie. Series A rounds raised by accelerator graduates have taken a larger and larger share, trebling from 6% of all A rounds in 2012 to 18% in 2016. This year we can be pretty confident that at least 1 out of 5 Series A are of this type. Series A investors better show up at those demo days!;
  • Bigger share of the dollar pie. Accelerator graduates have raised $456m worth of Series A rounds over the past 5 years, representing c. 8% of the total Series A capital raised over the same period, although that was 14% in 2016 and only 3% in 2012. So the pace of capital deployment is accelerating, literally;
  • Smaller A rounds. The average Series A round size raised by accelerator graduates is consistently lower than that of non-graduates, with the average discount being c. 28% over the last 5 years ($3.6m vs $5.0m). It would be fascinating to have the data on how pre-money valuations (and thus dilution) compare between graduates and non-graduates. I would speculate that this discount can be attributed to either: a) adverse selection (i.e. the more confident, experienced and networked founders do not need an accelerator and/or are able to raise more capital); or b) once ‘accelerated’ a startups has less funding needs, having invested previous capital more wisely and achieved more with it;
  • Less pre-A capital. The average amount of pre-Series A capital raised by accelerator graduates is 22% lower than that of their counterparts ($1.1m vs $1.4m). In other words, graduates get to a Series A more capital efficiently, ‘wasting’ less capital, or perhaps it is adverse selection at work again;
  • More pre-A rounds. The average number of pre-Series A rounds for ‘accelerated’ startups is more than double the number of rounds than their counterparts require to get to a Series A event (1.5 vs 0.7). i.e. graduates needs an extra round to get to a Series A (which I guess is glaringly obvious if the acceleration is considered as a round per se);
  • The A-crunch is real. Across the board it is very clear that the Series A bar has consistently risen, with the average amount of capital needed before getting to the A having increased 7x from $0.4m over 0.34 rounds in 2012, to $2.6m over 1.03 round in 2016.

While one can easily get stuck in it, it is always interesting to draw some comparisons to what is happening in the US, where in 2016 21% of all Series A rounds were accelerator graduates (so not too far from the 18% in Europe).

Source: Crunchbase

Other then the most obvious observation, such as that Series A rounds are generally larger in the US (just shy of 50% larger, whether or not the startup has been through an accelerator), it is interesting to note that:

  • It appears hard to unlock a US Series A with less than $3m in pre-Series A funding, regardless of accelerators involvement;
  • In Europe a Series A can happen with a lot less pre-Series A funding, particularly going though an accelerator which gets you there on about half the capital ($1.5m vs $3.1m) and fewer rounds (1.8 vs 2.3);
  • The accelerator Series A ‘discount’ applies in similar fashion across the pond, with average size of Series A rounds 37% higher for non-accelerated startups in both US and Europe.

So overall, with various caveats, it seems clear that accelerators and incubators in Europe can be a very strong engine of Series A creation, just like they have been in the US.


2016: The Year European Venture Capital Changed Gear

68 tech VC funds raised €8.4B in a record year for Europe.

Despite the unprecedented macro and political uncertainty that has characterised 2016, this has undoubtedly been a very prolific year for European tech VC funding.

I compiled a list of new tech-focused funds publicly announced this year and, with a couple of weeks to go, the headlines are hot: close to €8.4B of capital was raised by 68 European funds, at an average fund size of €127m (I’ve ignored clean/bio/med-tech funds for simplicity).

screenshot.png

Note: numbers in this table exclude two funds that were announced, but whose size was not disclosed.

 

screenshot.png

Amount raised and number of venture funds announced in European tech (by quarter)

A few take-outs from the data:

1. Growth! Since I’ve only been tracking new funds this year, I haven’t got a direct comparable for 2015. Luckily Atomico came to the rescue with their freshly released State of European Tech 2016 report, with data on new tech funds provided by Invest Europe (EVCA) up to 2015. After applying some adjustments to my data to make it as like-for-like as possible (e.g. they exclude Russia and Israel, they do not include all “growth” funds nor all corporate venture funds), in the most conservative scenario where I completely ignore corporate venture funds and growth funds, it looks like 2016 will be up at least 33% in terms of capital raised (well on pace with last year’s growth) and 10% in number of funds (reverting a trend that saw number of funds closed drop by 20% in ‘15), making ‘16 a record year as far as recent memory is concerned. And that is by excluding some funds that undoubtedly do ‘venture’ such as Idinvest Growth (backers of Onfido, Happn, Zenly), Nokia Growth (Clue, Drivy) and Santander InnoVentures (PayKey, Elliptic) which Invest Europe might actually have included. So the actual growth could be much higher.

Within the year, H2 appears markedly down compared to H1. One could infer that the Brexit referendum and US election had an impact on fundraising activity in the second part of the year. In reality Q1 & Q2 appear to be two exceptional quarters with the mega funds (>€250m) like Index Ventures, Nokia Growth Partners, Rocket, Accel London, EQT Ventures and Partech Ventures Growth together raising €2.6b in capital in the first half of the year. Excluding mega funds, H2 was only about 17% down in value compared to H1, and interestingly was up 46% in the sub-€100m category.

Fresh new funds raised by VCs is typically a strong leading indicator of the direction of the industry, as funds have to deploy capital within a specified period of time (3–4 years for first cheques). So, in a year in that will see capital invested at levels roughly on par with 2015, this is a great sign of things to come for European startups.

2. More late stage capital. Capital was raised at all levels and for all venture stages, not just at the small early end as it’s often conventional wisdom with European VC. The mega funds in particular raised €3.5b combined. These are the funds that can write €20m+ cheques at Series B-C-D and support companies until larger exit, a segment of the market in which Europe has historically lagged the US.

It’s great to see more capital becoming available at that level, to help European champions scale, with the welcome appearance of EQT Ventures as a 1st time fund in that category (and the largest raised in ’16 at €566m).

3. New breed of GPs. While the mega funds continue to raise larger funds, a new generation of 1st time funds is clearly emerging. 44% of the new funds announced were 1st time funds (30), representing 30% of the capital (€2.5b), with the average first time fund being €65m (excluding EQT Ventures mega fund, which would skew the numbers). This is a very important category as 1st time funds tend to come to market with innovative strategies and models (e.g. Entrepreneur First) , often tailored to their local market (e.g. Kibo, Daphni) or to the previous experiences of the GPs (e.g. BlueYard, EQT Ventures), new ideas and perspectives, filling gaps overlooked by established funds. Shai Goldman’s spreadsheet on sub-$200m US funds reports ‘only’ 25 1st time funds raised in the US this year. In that size category Europe has 27 already and, if one assumes that most if not all 1st time funds are in the sub-$200m category (maybe an incorrect assumption for the US), then Europe is likely to have produced more 1st time funds than the US this year, which would be remarkable.

I’ve written at length about 1st time funds and what they entail here, it’s great to finally see LPs embracing this category in Europe too. It’s also great to see successful entrepreneurs, executives and investors recycling their wealth and experience back into the ecosystem.

4. More specialisation. More funds are being raised to go after a specific opportunity or strategy: from Seraphim and OHB space-tech funds, to Entrepreneur First follow-on fund for deep-tech startups, to Anterra’s agri-tech fund, to Partech Growth fund, to Kibo and K Fund Spain-focused funds, to Barcamper in Italy, Daphni in France and Karma in Estonia. Stage, sector and country specialists are emerging, led by specialist managers with relevant experience.

This is fantastic news for European founders who can finally find the best-fit capital for their business or sector, while increasing their chances of success with the right support.

5. Democratisation. It’s clearly not just about the UK and Germany anymore. While this math is bit simplistic, as most funds can also invest outside of their home country, non-UK and non-German HQ’d funds accounted for c. 60% of all capital raised, with Sweden and France crossing the billion euro mark, Netherland, Finland and Israel each solidly in the €400–500m range and Southern-European countries like Italy, Spain and Portugal emerging with €200–250m in capital raised in each. Even Estonia and Bulgaria are coming up with their local VC funds.

This was the main theme that emerged from Atomico’s recent report published at Slush ‘16: capital is following companies from an increasingly diverse range of geographies and hubs across Europe. Great news for founders outside of the traditional tech hotbeds.

6. Government support. To the best of my knowledge, at least 26 out of 68 funds (38% by number and 45% by value) announced in 2016 had a national or European governmental institution as a LP, with the European Investment Fund (EIF) alone present in 20 funds (I believe in line with 2015). The recent announcements of a €1.6B pan-European EU-sponsored fund-of-fund programme and of a £400m top-up to the British Business Bank suggest there is more of that to come in the near future. This continues to be the reality of the fragmented European venture capital market. The bet remains that over time, as the industry continues to grow and mature, generating large and larger exits, attractive returns will eventually flow and attract private institutional capital from the likes of pension funds and insurance companies to the asset class.

This is already starting to happen at an accelerating pace, which is a great sign, with the recent news of Legal & General committing to Accelerated Digital Ventures, AP4 (Swedish national pension fund) investing in EQT Ventures, and Italian insurance group Generali in Earlybird Venture Capital most recent fund. It’s also worth noting that, out of my list, 40 funds raising a total of €4.6B do not have any government agency as LP, including 20 1st time funds, showing signs of European funds being able to stand on their own two feet.

Now onto more and bigger exits, please! If every fund manager is targeting to return 3x to their LPs, this vintage will need to return >€25b. That’s easily somewhere in the €100–200b worth of exits from the portfolio companies of these 68 funds over the next 5–10 years. While it certainly feels like a big endeavour, considering the pace of exits is now in the order of magnitude of €10b/year, the European tech industry has never been stronger and better positioned.

Onto an even greater 2017!


On First-Time VC Fund Performance

I recently tweeted two charts from a Preqin report on Venture Capital. Since that tweet got a lot of interest (relative to the amount of interest my tweets generally get) ranging from celebratory to cynic, I thought I would dissect it further.

The top chart (Fig. 1) shows the performance of first-time funds and non-first time funds compared to the venture industry as a whole, by vintage year (2006 through to 2013), measured by the median net IRR as of September 2016. The bottom chart (Fig. 2) plots the performance (again measured by net IRR) of first-time funds vs non-first time funds from all vintages from 2003 to 2013 relative to the standard deviation of that performance (standard deviation in statistics is a measure of the dispersion of a data set around its mean, and applied to the financial world is a common proxy for risk). I can infer the size of the bubble represents the size of the population for each bucket.
Since the measure of performance is net IRR, this is all to be read with a LP hat on.

The point I was trying to convey in the tweet is that while first-time funds do outperform non-first time funds on an absolute basis (over that period), the outperformance is (in part or entirely?) a function of first-time funds being riskier than non-first-time funds, as measured by the standard deviation of their returns. In crude terms and as a way of example, a first-time fund is more likely to return <1x than a non-first time fund, but equally more likely to return >5x, while the returns from a non-first time funds are less disperse and more concentrated around the mean of the distribution. That is, the distribution of returns from first-time funds are more “fat-tailed“.

The relationship between risk and expected return should ring bells to anyone who has taken portfolio management class at school and recalls what the efficient frontier is: investors only accept higher risk if it is compensated by higher returns, or in other words there is no ‘free lunch’ in an efficient capital market i.e. the only way to earn an extra unit of return is by taking an extra unit of risk, and therefore assets are priced accordingly by the market.

So why are first-time funds riskier?

  1. Size. To start with, first-time funds are likely to be smaller in size, just like a Seed round is smaller than a Series A round. Preqin data shows how first-time fund size targets have ranged between $100-170m for the past 10 years, compared to a range of $200-370m for non-first-time funds. Smaller funds tend to play more earlier stage where the attrition rate is higher, as is the dilution risk from not having enough funds to follow on in the winners, but also where the potential return from hitting the outliers is much higher (this is also referred to as convexity of returns, in that the downside is capped at 0x but the upside is, theoretically, limitless);
  2. Focus. As a first corollary to the smaller size, first-time funds tend to focus on a single region or on a single sector, thus not benefiting from a more diversified portfolio that would reduce the volatility of returns;
  3. Incentives. A second corollary to fund size is GP incentives: raising larger subsequent funds allows GPs to earn larger, and cumulative, fixed cash compensation regardless of fund performance. Management fees on first-time funds tend not to be substantial in absolute terms, particularly when netted off of GP commitments. So one could argue the attitude towards risk taking is higher in managers of first-time funds;
  4. Impatience. As sub-corollary to incentives, first-time funds main goal is to demonstrate enough proof points to allow them to raise a second fund; in doing so, they may be more tempted to accept quick early exits as validation, which might generate higher IRR (though lower multiple and less cash creation) compared to more patient non-first time fund managers;
  5. Experience.
    • First-time funds can be managed by first-time managers who don’t benefit from previous investment experience or come with a completely different background from existing funds. That can either make them more susceptible to making mistakes, but equally more receptive to ground breaking, yet dismissed, ideas in the absence of preconceived notions or powered by unique perspectives;
    • First-time funds can also be managed by experienced GPs who may have spun-off from more established funds; they may come with proprietary experience and networks, taking them away from non-first time funds, which coupled with a clean sheet may yield very different returns;
  6. Innovation. First-time funds are more likely to be exploring innovative strategies and funds models, which are yet unproved and could yield very different (read more dispersed) outcomes from those on non-first-time funds; such strategies can also be developed in response to markets, conditions and opportunities that non-first-time funds cannot adapt to (quickly enough), thus missing out on them;
  7. Brand. Lastly, a first-time fund, by its very nature, has no institutional heritage nor brand to leverage (though as mentioned above “spinoff GPs” in first-time funds do), which could potentially lead to a different quality of dealflow from non-first-time funds.

It would indeed be very interesting to have the same top chart, but showing returns adjusted for risk, to see if first-time funds do indeed generate true alpha (i.e. that portion of excess return that isn’t explained by extra risk) compared to the industry as a whole. It would equally be very interesting to split performance for first-time funds into first-time GPs vs first-time vehicles managed by spinoff GPs, and also first time fund performance by fund size or strategy.

While I don’t have that data at hand, and the preconceived notion in the industry is that success breeds even more success, I like to believe that first time funds have an increasingly good chance at capturing alpha in the industry. A recent Cambridge Associate report demonstrates how venture capital itself is undergoing disruption: returns are getting more democratised and are no longer exclusive property of the top 10 firms on Sand Hill road.

screenshot.png

As innovation and company creation happen literally everywhere, the next unicorn can be hiding where non-first-time funds aren’t closing looking. There is also a softer argument made by an investor who commented to my tweet, that first time fund managers work harder to to prove themselves. There may be some truth in there too!

While entirely anecdotal, the delta between performance of first-time and non-first-time funds in Fig. 1 of the Preqin report appears to be increasing over the period under consideration: is that because first-time funds are getting riskier or could there be some alpha in there?

The good news is that LPs are taking notes. According to Preqin, half of the c. 4,200 investors tracked by the platform and confirmed as actively investing in venture capital have either committed to first-time funds or are open to the idea. Also, according to Shai Goldman‘s spreadsheet that tracks <$200m venture funds closed since 2011, first-time funds continue to attract strong LP interest, with average fund size having increased from $54m in ’13 to $81m so far in ’16, showing more conviction. And notably 2016 is already higher than 2015 in both number and amount raised for first-time funds (though likely to end up down from the 2014 peak by 30-40% in numbers and 20-25% in dollars).

screenshot.png

screenshot.png


Specials thanks to Scott Sage, Simon Menashy, Stefano Bernardi and Julian Carter for reviewing early drafts of this post.