Europe’s Digital Startups are Closing the Gap with Tech Companies in the U.S.

The article below is from our BRIEFINGS newsletter of 31 March 2022

Europe’s tech entrepreneurs have arrived. The ecosystem of digital companies has grown twice as fast as in the U.S. during the past seven years, and funding in Europe’s private companies eclipsed $100 billion for the first time in 2021.

We spoke with Clif Marriott, co-head of the technology, media and telecom group in EMEA at Goldman Sachs, about the growth in European startups following our Disruptive Technology Symposium last week. The event hosted nearly quarter of the region’s 220 unicorns — a metric that highlights how much the sector has grown: Europe had fewer than 20 private tech companies backed by venture capital that were valued at $1 billion or more when the symposium first took place in 2016.

Marriott says one of the biggest topics of discussion at this year’s conference was the differential between valuations in public and private markets. While financing has slowed for now, he says Europe’s unicorns have raised immense amounts of capital that will eventually result in large, well-funded companies going public. 

The growth in European tech has been a major topic at Goldman Sachs events in recent weeks. What is your outlook for that sector?

In 2021, we executed more than $150 billion of M&A and financing transactions for tech and tech-enabled companies in Europe, which is an absolute record in terms of activity. This year, and especially the first half, we would expect to be much slower in terms of the activity levels and that’s really driven by volatility in the markets and lower overall valuations. That has slowed IPO activity to basically zero during the first half of this year.

That said, one of the key metrics, that $100 billion of capital that has gone into European companies in 2021, means two things. First, companies are getting bigger and they’re very well funded. Many of these private companies took capital last year when the market was really good. They’re using that capital to grow their business and to invest. So that’s a positive thing.

Secondly, that there are 220 unicorns means there are a ton of private, very large companies that will eventually list, transact, conduct M&A, conduct financing, go public, direct list — all kinds of interesting things.

From my standpoint, while the first half of 2022 will be definitely slower than 2021, I would expect that over the next two to five years we will see very, very strong activity from that collection of unicorns and the continued funding that goes into Europe.

Has the market turmoil impacted private markets differently than the way it impacted public markets? 

This is probably the biggest theme that came out of the conference and also some of the networking activities that we held. The dislocation between the private and public is definitely here. I had one very large tech investor who said he’s never in his career seen private and public valuations be so unlocked or separated.

I think there’s three things driving that. The public investors, and let’s say hedge funds in particular, but institutional investors generally have become much more negative around the impact of inflation, and therefore the impact on asset values that have a long duration — meaning the more the valuation of a company is dictated by its terminal value a long time out, the more that higher rates impede that valuation.

The second thing is that volatility has meant that there has been a lot of forced selling within technology, which means valuation levels have been impacted by that volatility.

The third thing is that private markets haven’t adjusted as much. Very few if any of the tech companies are seeing any impact to their business from inflation, nor from the geopolitical situation, yet, and a lot of them have raised capital in the last two years and they don’t see why their valuation should be impacted as much as the valuations have been impacted in the public markets.

This valuation differential will have to narrow one way or another. The bigger issue is really seen at the late stage, the companies that are raising one or two rounds before they go public, and therefore those valuations are much more driven by a time-value discount to what they could go public at in a couple of years. And if the effective IPO valuation is lower because multiples for their comps are lower, then that has an impact on their valuation.

We’ve seen a lot less impact on valuations in the seed, series A, series B rounds where those companies are really investing over a 10-year period and multiples up, multiples down, isn’t really going to drive an investment decision — it’s much more about the long-term market potential of these businesses. That part of the market hasn’t been impacted as much.

You’ve also seen some of the large, let’s say crossover institutions, mostly hedge funds, who have invested in very large private tech in the last two to three years, and they have moved down from doing crossover, late-stage pre-IPO investing to much more series A, series B, series C. So they’ve moved earlier in the stack, and therefore that market continues to be relatively healthy.

At what stage does Goldman begin working with European startups? 

We start interacting with companies well before they go public. It’s not just a Europe phenomenon but a global phenomenon — these tech companies are accessing private capital at higher volumes and for a longer period of time than ever before. Every year the average tech company raises more private capital and waits longer before going public.

We at Goldman can’t wait for the IPO request-for-proposal in order to start interacting with the company. We start interacting with them much earlier — two to three years, or even earlier, before they go public, we’re starting to interact with them from the advisory side of the business.

On the institutional side of the business, our core investing clients want to have access to these companies earlier rather than waiting for them to go public. So for us it’s synergistic to help or enable these large private companies, which 10 years ago probably would have gone public by now based on their size, but in this environment they can stay private and raise capital. We help those companies access capital and to meet and build relationships with large institutional investors who are investing more and more in private companies.

What else stood out to you during the conference?

There’s so much to talk about with respect to technology in Europe. We spent a lot time talking about the markets at the conference. Putting that aside, I would say there were three things that came out that were especially interesting.

First, the hiring environment for tech talent is still incredibly aggressive. And there was a lot of debate in various of the sessions but also in some of the networking activities around how employees at tech companies are mission focused. And that, even more than compensation in some cases, was a driver for employees to move to those companies. So mission culture is really, really important for hiring the best people.

The second thing was discussions about the creator economy, Web 3, and it touches crypto as well — these huge new industries that are being created involving influencers on YouTube, TikTok and Instagram. These influencers need software to help manage their careers, need software to market their businesses, need payments solutions, need a currency with which to transact globally — ie, can crypto be an interesting way to transact globally across borders, and that flows into not only the influencer community but also the multiverse or gaming community where there are whole economies online using different currencies or types of stores of value? All of those interesting things that are happening that are very new and not seen in the public markets.

And the last thing that came out was this change in mind set. European technology companies feel confident to raise capital, to invest that capital, become global, but in many cases to continue to base themselves in Europe and really go for the moon. That’s the most important thing that came out of the conference and the thing that excites me the most.