2Q23 – European Venture & Growth Market Review – Is DPI the new IRR?
Executive Summary
We break down our 2Q23 review into four short sections: i) public market performance, ii) European fundraising, iii) deal round-up, and iv) fund flows in the private markets. Section 1 & 2 – Public & private markets: The macro environment saw some signs of dislocation with public and private market performance in 2Q23. At quarter-end, real yields had approached +2% (highest level since 2009); the 2s-10s spread (-100bps) had reached its deepest inversion since the 1980s; and credit conditions had deteriorated. Yet, European deal value (>$25m) in the venture & growth market improved sequentially ($6.8bn; +25% QoQ; -61% YoY). Public markets were also mildly positive, with the exception of the Nasdaq which was up >10%, largely due to the concentration in AI-focused large-cap technology stocks. Section 3 – Deal round-up: European fundraising remained centred around a few core themes, including Generative AI and Life Sciences. Notable deals in the quarter included: Mistral AI, Builder AI, Getir, GetYourGuide, ITM, Beacon Thereuptics, Distalmotion, Patient21, Odoo, Quantexa, Terrapay, Volt & Nomupay. We provide a full 2Q23 deal round-up in section 3 of the review. Section 4 – Fund flows: In the final section, we assess the velocity of capital in the venture & growth market, breaking down the liquidity cycle into three stages: i) GP fundraising, ii) capital deployment, iii) exits/returns. Until strategic M&A and IPO markets pick up, overall exits and market liquidity looks set to be challenged, leading Bain to recently suggest ‘DPI has become the new IRR.’
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Section 1 – Public Market Performance
Despite the deterioration in the backdrop for risk assets, headline private and public market performance was mostly resilient in the second quarter. Financing conditions tightened as real yields approached +2% (10y UST less 10y breakeven rates) – their highest level since 2009. The 2s-10s spread reached (-100bps) by quarter-end – the deepest inversion since the 1980s. Credit conditions deteriorated following challenges in the banking industry.
Following double-digit returns in 1Q23, public equities traded range-bound in 2Q. European equities were flat, but US equity markets outperformed in the period. The US rally was largely driven by concentration in large-cap technology stocks which likely benefitted from the expanding opportunity set within Generative AI. Equal-weighted returns were more in-line with Europe. The US valuation premium vs. Europe has reached the widest levels in history – approaching 40%. While the European outperformance since September 2022 has now been fully eroded.
The narrow US performance is demonstrated by the Nasdaq, which returned +13% in 2Q23 (>30% YTD) pre-dominantly driven by MFST, AAPL, AMZN, NVDA, GOOGL, TSLA, META – which collectively contribute around 50% of the NDX 100. Returns from the S&P 500 and the DJIA were comparatively more modest, and in-line with our VC-backed index which traded +3% in 2Q23.
Figure 1: Selected asset class performance data in 2Q23
Source: Lazard VGB Insights, FactSet. Note: VC-backed companies includes 877 publicly listed companies that previously received venture funding
Section 2 –European Fundraising
At the headline level, deal activity in Europe stabilized in 2Q23 (deals >US$25m) – and was broadly aligned with the prior two quarters. European deal value of US$6.8bn was down 61% YoY. Strength in DeepTech (>+300% YoY) and Healthcare (+16% YoY) partially offset the persistent slowdown in Enterprise Software and Fintech – both sectors which saw funding down by 80% compared to 2Q22. InfraTech and Consumer deal value fell by over 60% YoY.
Figure 2: Capital raised in Europe by sector since 1Q22
Source: Lazard VGB Insights, Pitchbook Data, Inc.
Across our six sectors of focus, Healthcare and InfraTech contributed over 50% of funding collectively in 2Q23, compared to only around 35% throughout 2022. Conversely, contributions from Fintech and Enterprise Software were half compared to the prior year, delivering just one-quarter of overall funding in 2Q23. Consumer remained at 10%, while DeepTech was increased to 6% from only 3% in the prior year.
Figure 3: Capital raised by sector in 2Q23
Source: Lazard VGB Insights, Pitchbook Data, Inc.
Life Sciences - the leading vertical in 2Q23
In VGB Insights, we break down our six sectors by verticals. For deals >US$25m, the below chart provides a view of the year-on-year performance across each vertical (relative to 2Q22). The cluster of bubbles in the bottom left of the chart demonstrates low volume and a decline in deal value compared to the same quarter in 2022.
Breaking down the strength in Healthcare, Life Sciences drove over 20% of overall funding. This was in large part down to a combination of oncology and gene therapy (see deal round-up). Robotics also notably drove 100% annualized growth within the MedTech vertical. Other areas which saw a positive year-on-year performance included Next-Gen Computing which captures the buoyant activity in Generative AI, and Industrial/Real Assets which includes a range of real estate and vertical farming applications.
Activity within the Energy Transition was interestingly much more subdued, with only $540 million of funding in the quarter (down 81% YoY). 75% of this funding was attributable to Northvolt’s latest raise.
Figure 4: Capital raised in Europe by vertical in 2Q23
Source: Lazard VGB Insights, Pitchbook Data, Inc.
France and the Benelux grow share of funding versus the prior year
The UK, France and Germany continued to dominate the European funding market, accounting for two-thirds of total funds raised. France saw an uptick in the quarter, driven by larger deals in InfraTech (DriveCo, Ynsect) and DeepTech (Mistral AI and SiPearl). The Benelux region also doubled its share YoY to 10% due to larger rounds from Odoo and TerraPay, while Germany, Spain and the Nordics saw lower quarterly contributions compared to the prior year.
Figure 5: Capital raised by country in 2Q23 and 2Q22
Source: Lazard VGB Insights, Pitchbook Data, Inc.
InfraTech and Healthcare drive majority of funding in France & Germany
Looking a level deeper, FinTech funding remained weaker in the UK, accounting for just 15% of UK funding in the quarter (vs. 50% in 2Q22). As a result, the UK saw a more even spread across sectors in 2Q23. Germany and France were more concentrated in terms of sector allocation, with InfraTech and Healthcare accounting for 65% in France and 83% in Germany respectively.
Figure 6: Capital raised by sector in Europe’s top 3 markets
Source: Lazard VGB Insights, Pitchbook Data, Inc.
Larger rounds continue to recover as activity <US$50m remains subdued
Share of rounds >US$50m continued to recover in 2Q23, accounting for 77% of the total capital raised. However, value from larger rounds remained 60% lower YoY - smaller rounds (between US$25m-US$50m) similarly fell by 64% YoY.
Figure 7: Capital raised by size of round since 1Q22
Source: Lazard VGB Insights, Pitchbook Data, Inc.
Section 3 – Deal Round-up
AI generates deal flow into Europe
Generative AI’s potential to boost productivity and accelerate innovation appeared to drive a few notable fundraises in the quarter. At the foundational level, Paris-based Mistral AI raised US$113m seed round in June with a stated view to building, training and launching its first text-based models in 2024. The company was set up by ex-Meta & Google researchers, with the round led by Lightspeed. Within vector databases, Weaviate raised US$50m series B led by Index Ventures with a plan to accelerate development of its core AI infrastructure which aims to help users to store, manage and search unstructured data.
UK-based Builder AI raised a US$250m series D round led by QIA - the largest round related to AI in the quarter. The platform aims to customize and simplify software development.
Signs of consolidation within Consumer
Later-stage consumer deals saw some notable activity, with Getir – the rapid food delivery platform – raising US$475 million in April led by Mubadala. The US$6.5bn valuation was at half the level of March 2022, with the capital raised largely used to support industry consolidation. Getir acquired Gorillas in May, with an acquisition of Flink also mooted. GetYourGuide – the online booking marketplace - also raised US$194 million (US$85 million of equity) in June – as consumers appear to continue to favor travel and experiences post-covid.
Healthcare brings life to fundraising market
We identify three main themes running through capital raising from healthcare companies in 2Q23: oncology, gene therapy and robotics. ITM – a radiopharmaceutical biotech company – raised US$277 million in June led by Temasek, in the largest Life Sciences deal of the quarter. The firm intends to use the proceeds to reach commercial and manufacturing readiness while in the final stages of phase III development.
Other healthcare deals saw notable fundraises from Beacon Therapeutics (US$119m series A in June) in gene therapy, and Distalmotion within robotics, who raised US$150m in April. Digital Health was more subdued – with Patient21 the only notable deal, raising US$110m in May led by Pitango.
Several best-in-class software firms tap equity markets
Within business productivity tools, Odoo raised US$162m from General Atlantic in June - the firm aims to enable developers to create inter-operable applications focused on SME business functions and has now reached over 50k paid customers. Quantexa – a decision intelligence platform focused on risk & compliance - raised a US$129m round led by GIC in April. The proceeds are earmarked to benefit global growth and help strengthen core product capabilities.
Cross-border payments deals fund global expansion
Within payments, transactions looked to be mainly dedicated to simplifying access to cross-border payment networks – though the payments vertical still remains well below 2022 funding levels. TerraPay – which builds payments infrastructure to enable cross-border transactions - raised US$100m at series B in April led by IFC, with a view to funding expansion into Latam and MENA.
Volt similarly raised a US$60m series B looking to support expansion into APAC and the Americas. The company’s open payments gateway facilitates real-time account-to-account transactions. Lastly, NomuPay raised US$54m from Finach Capital to continue their geographical expansion in Southeast Asia. The company aims to unify the fragmentation of cross-border payment networks.
Figure 8: Selected fundraising rounds in 2Q23
Source: Lazard VGB Insights, Pitchbook Data, Inc.
Section 4 – Liquidity in Private Markets
Fund flows in the private markets
The build-up in unexited assets appears to have dramatically slowed the velocity of capital in the venture & growth market. In this section we explain the underlying dynamics and simplify fund flows into three main stages. 1. Fundraising: Capital raised at the fund level 2. Deployment: Cash deployed into target companies 3. Return/Exit: Liquidity event which can be one of three main options:
o Additional growth capital (step 2), o Exit to financial or strategic buyer, or o List on a public equity market.
Figure 9: Venture & growth capital cycle
Source: Lazard VGB Insights
1) Fundraising: Capital raised at the fund level has expectedly slowed in 2023. Returns of recent vintages have mostly disappointed, and the higher interest rate environment seems to have shifted LP allocations towards asset classes with less volatile risk-adjusted return expectations. Conversely, regulatory support and technological innovation continues to demand new capital. Dry powder also remains at historically elevated levels.
Analyzing the year-to-date European data, the run-rate for VC fund raising has fallen by around one-third in 2023, according to Pitchbook. But interestingly, the average new fund size is 40% higher suggesting LPs may have undertaken a flight-to-experience, with more established managers expected to source the highest quality deals. The 1H23 slowdown in fundraising may continue if the supply-demand imbalance between funds seeking additional capital, and the current availability of LP allocations persists.
Figure 10: European VC Fundraising Activity
Source: Pitchbook Data, Inc.
Regulatory tailwinds may help sustain fund raising over the mid-term. A recent example is in the UK where the government - recognizing the need to foster innovation and deep science - announced measures to encourage investment in private assets. The measures included: i) exclusion of performance fees from the charge cap of 75bps, and ii) 9 pension schemes committing to allocate 5% of AUM to unlisted equities by 2030.
2) Cash deployment: Sections 1 and 2 of our review provide a more detailed analysis of the cash deployed in the quarter. The overall message is the level of capital invested in Europe has shown signs of stability, now running at around US$6bn per quarter
On the supply-side, investors deployed capital towards verticals with potentially better terminal growth prospects – AI being a good example of this. Investors also seem to be continuing to target higher quality assets – see recent raises in Software. Moreover, investors who have slowed investment activity since early 2022 may also start to increase deployment as fund life cycles mature, and liquidity outcomes become clearer for portfolio assets.
On the demand-side, issuers have largely reset strategic objectives, cut cash burn and raised non-dilutive capital to reduce the need for equity capital. However, we are now over 12 months into the cyclical slowdown in venture funding, and we continue to expect demand to progressively pick-up into 2H23.
3) Exits: One key issue across private assets has been a lack of liquidity, with distributions to paid in capital (DPI) reaching historically low levels in venture & growth assets. Bain recently suggested ‘DPI has become the new IRR’, with LPs appearing to prefer liquidity over additional returns.
Recycling of capital has been challenged across both venture capital and private equity. The compression in the venture & growth market however has been more acute, where liquidity solutions are less established. Lower funding volumes, an immature secondary market, and a subdued IPO market has set a difficult backdrop – with strategic exit activity also depressed. Secondary opportunities have picked up however, as businesses look to re-capitalize and re-position their cap tables to support the next leg of growth.
IPO market: The IPO market remains a key catalyst for fund flows. And despite rising stock markets in 1H23, IPO volumes remain subdued. According to EY, 24 companies have listed on the main European market YTD – which is 75% and 30% below 2021 and 2022 on a run-rate basis. Looking ahead, market performance, economic growth, interest rates and geopolitics will all be important to future listing volumes.
Figure 11: European Main Market IPOs (to end of Jun-23)
Source: EY
At the company level, there are many later stage businesses in Europe who have adjusted their growth plans given the public markets are seen as less likely to underwrite losses. Companies have therefore re-mapped their strategic objectives and improved their financial profiles. Many of those who were expecting to list throughout 2022-23 are likely to seek to raise an additional pre-IPO round in the next 12-18 months, in our view.
Strategic exits: While the closure of the public markets is clearly important, the dominant route for exit pre-2020 was M&A rather than IPO. According to Pitchbook, acquisitions of VC-backed companies so far in 2023, remains well below pre-covid levels, likely also due to the persistent challenges in the macro environment. Even against the improving backdrop in 1H23, the bid-ask spread remains between corporates willingness to pay and sellers pricing expectations.
Figure 12: Acquisitions of VC-backed and formerly VC-backed companies in Europe
Source: Pitchbook Data, Inc., Lazard VGB Insights
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