Embrace risk, shape the future

We start this year's report by looking at IPO & M&A activity, even though these liquidity events are typically associated with the latter stages of the startup and investment lifecycle.

Liquidity events - or exits - are critical to the effective functioning of the European tech flywheel - the virtuous cycle that powers the ecosystem. These serve not only as a means to unlock the realisation and redistribution of capital gains, but also as catalysts for the systematic recycling of talent and expertise into a new generation of companies.

Following the peak of the market in Q4 2021, six consecutive quarters of subdued exit activity followed. The IPO landscape, in particular, was notably quiet - though not entirely dormant.

The third quarter of 2023 saw a notable uptick in liquidity events. Before ARM's gigantic $55B IPO this year to test a 're-opening' of the IPO window, Europe had already witnessed two other billion-dollar tech public offerings this year, including the $2.6B listing of German cloud infrastructure provider IONOS Group and the ill-fated $1B IPO of UK fintech CAB Payments.

In contrast, the M&A market has displayed higher consistent levels of activity, although the volume and value of deals are still far from the peaks of 2020 and 2021.

As we'll explore throughout the report, the big shifts in the exit landscape, both in the pathway to liquidity and in the form of a reset of the valuation environment, have led to knock-on consequences for founders, talent, VCs, LPs and beyond.

Not surprisingly, the highly visible impact of the market reset is mirrored in the short-term performance of venture capital. One-year VC returns are now well into negative territory in both Europe and the US, as a consequence of increased down rounds, write-offs, and markdowns reflecting in the data.

This undoubtedly makes for painful, if not unexpected reading for investors. In VC, however, what matters is the long-term perspective, given that returns take 10 years or more to be realised. In this regard, European VCs have consistently outperformed over two decades, at least matching or, in most cases, beating benchmarks from US VCs, European buyout, and public equities.

As highlighted in the 'First Look' midyear update to the State of European Tech, a consequence of a very different exit landscape has been a huge decrease in - and in some cases a complete withdrawal from - activity by so-called 'crossover investors.' The retreat of these funds that actively invest across both the public and private markets has been a major factor in the slowdown of late-stage and large-round investment activity.

In 2022, the volume of new investment activity had already started to slow dramatically, especially during the second half of the year. This year, investment activity has effectively ground to a halt, with just four new investments announced publicly so far. Interestingly, this slowdown is visible across both large rounds of more than $100M and smaller rounds.

In Europe, shifting global capital flows have led to less investment from US investors in both early and late-stage funding rounds.

Despite the drop in investment stages, US investor participation in European funding rounds is still higher than historical norms. Many long-term US investors continue to be actively involved in the region.

As a consequence of reduced US investor activity, the role of European investors has taken on even greater prominence in the past year, underscoring the significance of building a consistent and dedicated source of European capital across all stages, and especially at later stages. At the Growth stages, for example, the share of total capital invested by US investors has fallen from a peak of 39% in 2021 to just 25% in 2023. The declining share is also evident among Asian investors, whose share of total capital invested has declined from 11% in 2021 to 7% in 2023.

This shifting mix of geographic sources are less of an issue at the earlier stage, since European startups primarily attract initial rounds from domestic or pan-regional investors within the European ecosystem. In fact, investors in Europe, including both domestic and cross-border players, contribute to approximately 80% of the total capital invested in European tech companies during early stage funding rounds, a share that has stayed broadly consistent over the past five years.

The number of unique investors actively deploying into European tech companies has risen consistently over the past decade, unsurprisingly spiking during the peak period of 2021 and the first half of 2022. This period was characterised by a significant ramp in the number of investors from outside the region deploying into Europe, growing especially quickly from North America.

While the full-year numbers for 2023 will end up higher than the year-to-date numbers shown in the chart, the reset in the market has seen the number of active investors retreat, driven by a significantly reduced level of participation from non-European investors.

But despite the slowdown in 2023, and even without taking into account full-year numbers, the base of active investors is still more than double the level of just a decade ago.

This commitment to embrace the perceived risk of investing through market cycles is a critical foundation to ensure the European tech ecosystem continues to benefit from a significant and stable base of local investors.

Despite the backdrop of almost two years of challenging macro conditions, as well as the persistent noise from negative events such as down rounds, write-offs, and reduced investment volumes, sentiment on the future prospects of the European tech ecosystem has stabilised. In fact, only 23% of respondents are less optimistic than they were a year ago, while nearly two times the number of respondents expressed optimism (45%).

Looking across respondent types, the state of industry sentiment is broadly aligned across all stakeholder groups. On the investor side, responses from angels, VCs and LPs all showed remarkably similar perspectives. While on the tech company side, founders and C-level executives showed slightly less positive sentiment overall in comparison to their department heads and employees.

In the public markets, one story of 2023 has been the stabilising and recovering of multiples. While the highs of 2021 remain distant peaks, the median enterprise value to next-12-months (NTM) revenue - after sinking below average through most of 2022 - rebounded back above this line early this year, only to dip just below it in October 2023. The multiple for companies trading in the top quartile, meanwhile, is still hovering below the long-term, 10-year average.

It is this recovery in multiples, coupled with reduced volatility, that helped to lay some of the necessary groundwork for an initial reopening of the IPO window in late-2023. More significantly, it will continue to be crucial, along with confidence in strong post-listing performance, in setting the stage for an even stronger increase in IPO activity in 2024.

Reflecting the multiple compression of the public markets, valuations in the private sphere are also returning to normalised pricing levels, once again framing 2021 as an exceptional year.

Valuations across stages in Europe are now hovering around 5- and 10-year long-term averages. The notable stage exception is Seed, where despite a levelling off of median Seed pre-money valuations in 2023, there has not yet been a correction to long-term pricing averages in the same way that has been evident at every stage from Series A and later.

This shift back toward longer-term averages in Europe mirrors what is happening in the US. Notably, however, median valuations in Europe continue to be 30-60% lower than in the US across all stages.

One of the 'north star' metrics for the European tech ecosystem is its total value, as measured by the combined equity value of all tech companies headquartered in the region, across both public and private markets.

For context, after a peak of $3T in 2021, 2022 saw a reduction of total ecosystem value equivalent to around $400B. The rallying of the public markets this year, however, has helped this number bounce back to the $3T mark.

This rebound in ecosystem value has also been supported by the continual influx of new companies starting and raising private capital for the first time, as well as the fact that, despite a large increase in the number of down rounds, the overwhelming majority of follow-on capital deployed into the ecosystem has been through flat rounds or up rounds.

Total capital invested into the European tech ecosystem in 2023 is on track to reach around $45B, more starkly highlighting the impact on capital flows as a result of the shift in the broader macro landscape. This will be down more than half (55%) from the record year of 2021, when investment volumes surpassed the threshold of $100B for the first time.

This also represents a steep drop-off of 45% from 2022's total of $82B. The decline is not surprising given the dual effect of many later-stage companies delaying fundraising, as well as materially slower deployment pacing by investors, which have both served to drive the large decline in the prevalence of outsized, late-stage investment rounds - the biggest factor in the lower amounts of capital invested.

While the decline from the peak in 2021 is large, it's worth highlighting that 2023 is on track to be the third-largest year on record by total capital invested, and is on track to come in at four times the volume seen 10 years ago in 2014. In fact, the resetting of investment levels appears to reflect a correction to the long-term upwards trajectory, following two outlier years of overheated activity.

The decrease in investment since 2021 is mainly due to a slowdown at the growth stages. However, after a sharp drop right after the peak, there has been a stable total investment volume for the past five quarters.

There are two important things to note. First, early stage investment has stayed stable despite the turbulence in investment volume since 2021, reflecting the vibrancy of Europe's early stage startup scene. Second, if we exclude the overheated 18-month period from Q1 2021 to Q2 2022, we get a clearer view of the trajectory of consistent, long-term growth in investment in the European tech ecosystem.

The combination of the withdrawal of crossover investors and the general slowdown in late-stage investment activity is unsurprisingly reflected in a huge decline in the number of so-called mega-rounds, meaning round sizes of $100M or more. In the peak of 2021, there were almost 200 rounds of this magnitude, including more than 50 rounds greater than $250M.

While this number declined slightly in 2022 to 163 rounds of $100M or more (of which 38 were greater than $250M), the first nine months of 2023 saw a far more significant decrease. In the first nine months of 2023, there have been 36 rounds of $100M or more, of which only seven have been sized in excess of $250M.

Predictably, a reduction in late-stage funding round volume and a major reset in the valuation environment has led to a huge drop in the number of companies surpassing the billion-dollar valuation milestone for the first time in 2023.

2023 is on track to see the lowest number of new $B+ companies emerge from Europe in the last decade, with just seven as of the publication deadline at the end of October 2023. This is, of course, in stark contrast to 2021's record-breaking total when 107 new companies hit a billion-dollar valuation.

In last year's report we first introduced the concept of de-horned unicorns, $B+ companies whose valuation has dropped below this milestone since first hitting it. In 2022, we mapped 58 dehorned unicorns. This year, that number has reduced slightly, with 50, meaning some companies have seen their valuation lifted back up above the billion-dollar level in 2023. For clarity, when referring to $B+ companies, we have in mind tech companies that command that valuation today.

Unsurprisingly, capital investment volumes are also being shaped by changes in round sizes, and not just the absolute count of rounds taking place. At the later stage, following a reduction in the latter half of 2022, there are now observable signs of stabilisation in round size over the course of the past four quarters. As a consequence, round sizes are back in line with the longer-term, 5-10 year averages for the growth stages.

The trend at the earlier stages, however, is somewhat different. At Seed and Series A, median round sizes have also seen a period of stabilisation following rapid increases during 2020 and 2021, but remain elevated at levels significantly above 5-10 year averages.

For growth stage founders in particular, this inevitably translates to having to achieve more with less capital for an extended period of time, despite the ongoing inflationary pressures on wages that are keeping talent costs elevated.

The same trends are playing out across the ocean, where US Seed stage companies raise significantly larger rounds - roughly twice as large as their European counterparts. This delta starts narrowing as companies mature, disappearing by Series C.

Even in the face of challenges in the capital markets and concerning indicators such as layoffs that may impact the perceived attractiveness of joining the industry, European tech has not seen an exodus of talent. In fact, new positions are constantly being created, and talent from outside tech continues to look past any perceived risk to place significant bets on the European tech sector.

Although there has been a levelling off in the rate of increase of net new joiners into the tech industry over the past three quarters, and a very small overall decline in total headcount in Q3 2023, it's remarkable that in just five short years, European tech has expanded its workforce from slightly over one million employees to more than 2.3 million today.

Europe is a net beneficiary of talent flows, attracting new starters from across the globe. That means we’re gaining more international talent than we’re losing.

Notably, more talent is moving from the US to work in European tech than European talent is moving to join the US tech scene, illustrating the pull European companies now have. In fact, Europe is a net gainer of talent from every single region apart from Australia.

The impact of the market reset is also visible in the effects on entrepreneurship and the rate of new company formation by founders. Globally, the rate at which founders are starting new tech companies has receded by approximately 30% from its peak in 2020. This decline is reflected in the data for new tech founders in both Europe and the US.

While the decrease in companies being founded might appear concerning at first glance, there is a case to be made that this reflects a return to 'healthier' conditions.

Those who are taking the leap into entrepreneurship today face a higher bar to raise money, attract talent, and win customers. This changes the perceived risk of starting a company and, as a consequence, means that only the most committed and resilient founders are prepared to embark upon the entrepreneurial journey.

Subsequently, it is not surprising to see the share of repeat founders remaining stable, while almost all the decline is accounted for by fewer first-time founders.

What will, however, be surprising to most is the fact that the annual volume of founders starting new tech startups in Europe exceeds the US, and has done so consistently for every one of the past five years.

It’s one thing to have great talent, but are they working on the hardest problems?

Here, we look at the flow of talent into and within the tech industry, broken down by theme. This helps us to quantify talent flows and identify the sectors drawing in top talent, whether they are completely new to the tech industry or moving jobs within it.

Sustainability and health take the #1 and #2 spots, clearly reflecting the powerful magnetic effect of purpose-led companies in attracting talent.

It is not just talent that is being drawn to the hardest problems - capital is flowing in the same direction too. Here, we look at investment volumes are broken out by sector. Remarkably, the Carbon & Energy sector, which encompasses climate tech, accounts for 27% of all capital invested in European tech in 2023, more than doubling its share of investment since 2021.

Carbon & Energy has soundly overtaken Finance & Insurance and Software as the single largest sector by capital raised. This not only represents a dramatic increase in the scale of capital invested behind the green transition, but also a clear slowdown in fintech investment volumes since the peak of the market.

There has been no shortage of perspectives on Europe's position in the AI race. Amidst the noise, it is easy to overlook the fact that the AI theme has actually hit a stride in Europe in recent years, with European AI companies consistently securing mega-rounds of $100M or more. In fact, this year will come close to matching the record set in 2021, despite the huge headwind of a steep drop in overall investment levels in Europe in 2023.

As of the end of Q3 2023, European AI companies had raised 11 rounds of $100M or more, compared to 37 rounds by US AI companies over the same period. So far, however, European AI companies have not yet raised the type of billion-dollar or multi-billion-dollar rounds that have become crucial sources of firepower for the most important and fastest-growing US AI companies, like OpenAI or Anthropic. The multi-$100M+ rounds, however, are certainly beginning to appear in Europe.

The most remarkable subset within the AI space this year has undoubtedly been Generative AI.

Generative AI companies focus on developing and applying artificial intelligence technologies, particularly machine learning techniques, to generate new content, data, or media. This category features companies like Mistral AI and Aleph Alpha in Europe, alongside OpenAI (the makers of ChatGPT) and Inflection AI in the United States.

While Generative AI companies may represent a relatively small fraction of overall tech fundraising activity on an absolute count basis, they have swiftly had an outsized impact on workflows, regulatory discourse, and society at large.

What is also notable is that whilst generative AI companies have leapt into the public consciousness in 2023, they have been quietly being started and funded in greater numbers for many years, both in Europe and the US.

The fact that AI is flourishing under the radar in Europe should not be a surprise. Europe has a strong technical talent pool, owing its strength to world-class scientific and technical institutions and the depth of its engineering talent.

This strength extends into the field of AI. Over the past decade, Europe has not only witnessed a greater than 10x increase in the number of people working in AI roles, but also claims a larger resident population of highly-skilled AI professionals compared to the US.

Of course, many of these AI professionals are working in roles at US-headquartered technology companies that have built a large AI research presence in Europe, such as Alphabet or Meta. But as Mistral AI - a company founded by European former leading AI researchers at Meta and DeepMind - demonstrates, these European-based pools of AI talent have become an incredibly rich breeding ground for the founders and talent behind the next generation of European AI companies.

Europe is seeing more new tech startups being formed than any other region, supported by the strongest ever teams working on the most challenging and urgent problems. Europe has all the essential raw ingredients to become the next tech superpower. But for Europe to be able to shape the future of tech, the ecosystem needs to take further action to embrace the opportunity - and the risk that comes with it.

Europe's ability to fund and spur innovation has evolved considerably over the past decade. Nevertheless, a noticeable disparity with the US persists in terms of access to capital.

More European tech startups are formed each year, but over time, a growing gap emerges when it comes to their likelihood to secure external investment.

After five years, US tech startups are 40% more likely to have successfully secured venture capital funding. This is in spite of the fact that once companies secure an initial round of Seed investment, the probability of scaling to a billion-dollar valuation is the same in Europe as it is in the US.

This underlines the imperative for the European tech ecosystem to ensure that funding flows to European talent, giving them the firepower to compete globally and ensuring Europe can play a meaningful role in shaping the future.

A single success story can have an outsized impact on the tech ecosystem. This is exemplified by Skype, co-founded 20 years ago by the CEO of Atomico, Niklas Zennström.

Skype's workforce absorbed a culture of innovation and subsequently went on to start Europe's next generation of leading tech companies. In total, the first- and second-generation entrepreneurs to have emerged from the Skype alumni network have gone on to start more than 900 companies across 50 countries all around the world.

This alumni network has already produced additional billion-dollar companies and, today, Skype alumni companies employ more than 65,000 people worldwide.

It's astonishing to witness the ecosystem-level effect that a single game-changing company can have over time.

The Skype effect speaks to the catalytic impact of just one success story. 

Back in 2003, during the darkest days for the European technology industry following the dotcom crash, would anyone have predicted that the value of the ecosystem today would have increased by a factor of more than 45x to hit $3T? Would many have predicted that billion-dollar exits would start to be counted by the hundred? Surely not.

And yet, in just the past five years alone, there have been a remarkable 111 billion-dollar exits of European tech companies. This is a huge number, but it is also just the start. Europe’s never had a stronger pipeline of billion-dollar exit candidates.

This also underlines why it's so critical for the ecosystem to see a return to a healthy and functioning exit market, both in the form of entry to public markets, as well as through M&A.

The story of Skype is far from unique in Europe today. In fact, the European tech ecosystem has witnessed an industry-wide surge in the number of new companies launched by individuals that have spun out of Europe's billion-dollar companies. In doing so, they benefit significantly from the established knowledge and networks they take with them.

Remarkably, nearly 9,000 companies have been initiated by alumni of European exited unicorns that were founded during the 2000s. To put this into perspective, it is nearly a staggering 50% increase compared to the unicorns founded in the 1990s.

It is not difficult to imagine how this network effect will significantly influence Europe's path in the next ten years.