Europe Venture Capital Report 2019 — The Scale-Up Gap

By 2019 the diagnosis of European venture capital was clear enough to state precisely, and precision matters because the interventions that follow from a vague diagnosis are wrong.

Europe founds and seeds companies at a rate broadly comparable to its economic weight. Talent is strong, costs are competitive, the ecosystem density described in the 2017 report has developed, and early-stage capital is adequate.

Europe funds companies to scale at a rate well below its economic weight. The shortfall is concentrated at the rounds where a company moves from proven product to market leadership — the large Series B, C and D financings that fund international expansion, substantial hiring and category dominance.

The distinction matters because it rules out most of the explanations usually offered. If Europe lacked ambition, or entrepreneurial culture, or technical talent, the shortfall would appear at formation. It does not. Companies get founded and reach Series A. The failure is specifically at the point where large cheques are required, which points at the supply of large cheques rather than at anything about the companies.

And the supply of large cheques is determined by limited partner capital. A growth fund needs institutions willing to commit hundreds of millions. Where those institutions are structurally under-allocated to the asset class, the funds do not exist, and no amount of entrepreneurial quality changes that.

One of the causes is specific and fixable, which distinguishes this from the diffuse cultural explanations: insurance capital rules assign high capital charges to unlisted equity, making the allocation expensive in regulatory capital terms regardless of its return. That is a rule, and rules can change.

Where exactly the gap sits

Locating the gap precisely is the report's core contribution, because a mislocated diagnosis produces misdirected policy.

At pre-seed and seed: Europe is broadly competitive. Cheque sizes are smaller than in the US, which partly reflects lower costs, and the number of companies funded relative to population and GDP is in a reasonable range. Angel activity has grown with the recycling loop described in the 2017 report.

At Series A: Still reasonable. A European company with genuine traction can generally raise a Series A from a European fund on acceptable terms. Round sizes are smaller than US equivalents, which again partly reflects cost differences and partly reflects less capital chasing the stage.

At Series B and beyond: The gap opens sharply. Round sizes diverge from US equivalents by more than cost differences explain, the number of European funds capable of leading a large round is small, and US investors account for a disproportionate share of the rounds that do happen.

At the largest growth rounds: Europe has very few domestic sources. A company requiring a nine-figure round has a short list of European options and a much longer list of American ones.

The shape of this — competitive early, divergent late — is diagnostic. It is precisely what a capital supply constraint at large cheque sizes produces, and it is precisely what a talent, culture or opportunity constraint would not produce, since those would bind at formation.

If the problem were the companies, it would show at the start. It shows at the point where the cheques get large, which means the problem is the cheques.

Why the funds do not exist

The chain from institutional allocation to available growth capital is worth setting out link by link, because each is a potential intervention point.

A growth fund requires large limited partners. A fund deploying hundred-million-euro cheques needs to be a multi-billion-euro fund, which requires institutional commitments in the hundreds of millions each.

Which institutions can write those cheques? Pension funds, insurers, sovereign funds and large endowments. In Europe:

• Pension assets are unevenly distributed and structurally smaller relative to GDP than in markets with fully funded systems. Where retirement provision is largely state pay-as-you-go, the pool does not exist.
• Insurers hold large assets and face regulatory capital charges on unlisted equity that make the allocation expensive in capital terms. This is discussed in detail below.
• Sovereign funds exist in Europe but are concentrated in a small number of countries, and their mandates vary.
• Endowments are small relative to the US, where university endowments are a major source of venture LP capital.

So the LP base is thin. Which means European growth funds are few and small. Which means European growth rounds are led by US investors or do not happen.

And the feedback runs the wrong way. As the 2015 report describes, the absence of large domestic growth funds means no European growth track records exist, which makes raising a first European growth fund harder — a manager cannot point to a record in a strategy that has not been possible to run.

This is the equilibrium, and its self-reinforcing character is why a decade of ecosystem improvement did not break it.

The regulatory capital cause

Among the diffuse cultural explanations usually offered, one cause is specific, identifiable and fixable, which makes it worth isolating.

How insurance capital rules work. A regulated insurer must hold capital against the risks in its asset portfolio. The required amount depends on the asset's assessed riskiness under the regulatory framework.

How the framework treats unlisted equity. Equity generally attracts a high capital charge. Unlisted equity historically attracted a higher one, on the reasoning that it is less liquid and harder to value.

Why that changes the allocation decision. An insurer assessing an investment considers the return and the capital it must hold against it. A high capital charge means the same expected return is achieved on a larger capital base, which lowers the return on regulatory capital — the measure that actually governs an insurer's allocation.

The consequence is that the allocation can be unattractive on a regulatory-capital basis even when it is attractive on an economic basis. The insurer is not making a judgement about venture capital's merits; it is responding to a rule.

This is a genuinely different kind of cause from "European institutions are more conservative", which is unfalsifiable and unactionable. A capital charge is a number in a regulation. It can be changed, and the effect of changing it is predictable.

The general lesson for reading structural problems: when a market outcome is attributed to culture, it is worth checking whether a rule produces the same outcome. Rules are frequently the actual cause and are always the more tractable one. The Japan Investment Report 2019 makes the same argument about a different structural gap — the mechanism looked cultural and was substantially structural, and the catalyst that eventually moved it was a rule change.

What early sale costs

The most common European outcome for a successful company — sale at Series B or C rather than independent scaling — has consequences beyond the individual transaction.

The direct cost. A company sold at a growth-stage valuation captures a fraction of the value it would have created at scale. The remainder accrues to the acquirer, which is frequently non-European.

The recycling loop cost, per the 2017 report's framework, is the larger one:

• Smaller proceeds pools. An earlier exit at a lower valuation produces less wealth to recycle into the next generation of companies.
• Fewer people who have scaled. The operators who make an ecosystem valuable are those who have taken a company from a hundred people to a thousand. An ecosystem whose companies sell at two hundred people does not produce them.
• No large-company gravity. A large independent technology company anchors an ecosystem — it trains people, spins out founders, acquires local startups and attracts talent to the region. A company acquired and absorbed does none of that.

The compounding is the point. Each early sale reduces the ecosystem's capacity to produce the next generation of scale-ups, which produces more early sales. This is why the cost of the growth-stage gap is not the sum of individual transactions but a persistent reduction in the ecosystem's ceiling.

The counterargument deserves weight. An early sale is frequently the right decision for the founders and investors involved, given the options actually available. Criticising the decision is not the point — the decision is rational given the constraint. The point is that the constraint is producing a systematically worse aggregate outcome than the individual decisions suggest, which is a structural problem rather than a behavioural one.

US capital as a partial solution

US investors filling European growth rounds is frequently presented as a solution. It is a partial one with a specific directional cost.

What it genuinely provides:

• Capital at the scale required, which is the binding constraint.
• Experience of scaling, which European growth investors by definition have less of.
• Access to US customers, talent and follow-on capital, which matters for companies whose largest market is the US.
• Credibility with subsequent investors and acquirers.

What it costs, and the costs are structural rather than a criticism of the investors:

• Pressure toward US centre of gravity. An investor whose network, board meetings and comparable companies are American will reasonably encourage a company to build US presence — often correctly, and with the effect of shifting where the company's value accrues.
• The exit is more likely to be American. A US-backed company is more likely to list in the US or sell to a US acquirer, which moves the proceeds and the subsequent recycling out of Europe.
• The European growth track record still does not form. If European growth rounds are led by American investors, European growth managers still cannot build a record, so the equilibrium persists.
• Availability is conditional. US capital's participation in European rounds depends on US conditions. When those tighten, as the 2023 report describes, it withdraws — and the domestic capacity that would have substituted still does not exist.

That last point is the most important and was demonstrated four years later. A market whose growth capital is imported has outsourced its most important funding stage to conditions it does not control. It is a solution to the transaction and not to the problem.

What an allocator could act on

Locate a market's constraint by where the divergence appears. A shortfall at formation implies talent, culture or opportunity. A shortfall specifically at large cheque sizes implies capital supply. The shape of the stage-by-stage comparison is the diagnostic, and it is available free from Atomico and Invest Europe data.

Trace the LP chain before accepting a fund-level explanation. Funds do not exist without institutions willing to commit to them. A market with too few growth funds has too few large limited partners, and the reasons for that are the actual causes.

Check for a rule before accepting a cultural explanation. Regulatory capital treatment of unlisted equity is a specific, quantifiable cause of European insurer under-allocation. Where a market outcome is attributed to conservatism, it is worth checking whether a rule produces the same outcome — rules are more often the cause and always the more tractable one.

Model the early-exit scenario explicitly for European growth companies. The realistic option set is a US-led round, an early sale, or slower revenue-funded growth. Each has a different return profile, and assuming the US-equivalent path overstates the expected outcome.

Treat imported growth capital as conditional. Its availability depends on conditions in its home market, not in the destination market. A model assuming continued access is assuming something outside anyone's control, as 2023 demonstrated.

Watch insurer and pension allocation to unlisted equity as the leading indicator. It is the variable that would signal the equilibrium genuinely changing, it moves slowly enough to be an early signal, and it is disclosed.

What 2019 established for Europe

• The gap was located precisely at growth stage, ruling out talent, culture and opportunity explanations that would bind at formation.
• Limited partner capital was identified as the binding constraint, not the number of funds — funds are downstream of institutions.
• Regulatory capital treatment was isolated as a specific, fixable cause, distinguishing it from diffuse cultural accounts.
• Early sale was shown to compound, impairing the recycling loop and lowering the ecosystem's ceiling rather than merely costing one transaction.
• Imported growth capital was shown to be conditional, solving the transaction while leaving the structure and the dependency intact.