3Q23 – European Venture & Growth Market Review
Executive Summary
The bull case for venture & growth returns we often hear from investors is based on two main factors. First, we may be approaching a ‘once in a cycle’ collision of attractive valuations, rapid growth in disruptive technologies, and the withdrawal of marginal capital allocators. Second, capital recycling is improving through: nascent signs of an IPO window opening, increased strategic participation, and a maturing secondary market. More negatively, default rates have remained low, and companies who have reduced burn may not necessarily have found a long-term path to sustainable profit.
The 3Q23 European funding data suggests we are trading through a period of stablization, with a few signs of greenshoots. In this report, we split our quarterly review of the European venture & growth market into four sections: i) public markets, ii) private funding, iii) deal round-up (>$25m), and iv) we revisit the venture & growth capital cycle in the last section
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Section One – Public Market Review
Headline inflation has fallen across developed economies throughout 2023, and public equity markets have subsequently rebounded. The third quarter however, represented the first negative print of the year. Most major indices parred gains, trading down between 0% and (5%) – the FTSE 100 was the exception (+1%), pre-dominantly benefitting from rising energy prices. The IPO market showed signs of life with three highly antcipated US listings in September in Instacart, Arm Holdings and Klaviyo. An extended IPO window could be an important lead indicator for funding activity, especially at the later-stage where deal flow has been most subdued.
On a macro level, inflation continued to fall in 3Q and the labor market remained robust. This backdrop has supported expectations for a soft economic landing, which is now the base case for Ron Temple, Lazard’s Market Strategist. Longer-dated yields rose aggresively into quarter-end, with curve bear steepening pressuring both bond and equity valuations, particularly longer duration assets. In 3Q23, the MSCI Growth index under-performed MSCI Value by 200bps, for the first time in 2023. The Nasdaq and our proprietary VC-backed index – useful proxies for venture valuations – saw a 4% decline in the quarter. This was broadly in-line with major European indices. The USD strengthened against Sterling and the Euro.
Looking ahead, Lazard Strategists expect disinflation to continue through year-end, with the pace being a critical determinant of monetary policy. The follow-on impacts are likely to be felt across venture & growth markets.
Figure 1: Selected asset class performance data in 3Q23
Source: Factset (as of 30-Sept-23) Note: VC-backed companies includes 877 publicly listed companies that previously received venture funding
Section Two –European Venture & Growth Funding
Overall fundraising activity in Europe saw a slight uptick in 3Q23 (deals >US$25m) to US$8.2bn, 22% higher sequentially but down 23% YoY. Deal value was buoyed by two large InfraTech deals (Verkor and H2 Green Steel) which accounted for almost one-third of capital raised. DeepTech recorded another strong quarter - growing 350% YoY and 110% QoQ – but Healthcare retrenched as Life Sciences funding fell. FinTech and Enterprise Software continue to struggle, with both sectors down 80% YoY.
Figure 2: Capital raised in Europe by sector since 1Q22
Source: Lazard VGB Insights, Pitchbook Data, Inc.
Across our six sectors of focus, the ‘Harder Technology’ sectors of InfraTech, DeepTech and Healthcare accounted for a combined 74% of funds raised, more than twice their share in 3Q22. By contrast, FinTech and Enterprise Software was responsible for less than a quarter of funding in 3Q23, compared to 56% one year ago. Consumer accounted for the remaining 12%, interestingly in-line with 3Q22.
Figure 3: Capital raised by sector in 3Q23
Source: Lazard VGB Insights, Pitchbook Data, Inc.
Energy Transition leads European fundraising
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 3Q22). 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.
Digging into the strong performance from InfraTech, it was the Energy Transition vertical that accounted for 45% of overall funding in the quarter (and >90% of total InfraTech funding). This was driven by the mega-rounds from H2 Green Steel and Verkor (see deal round-up).
Life Sciences continued to dominate the Healthcare sector as it has done throughout 2023, with large deals in the UK contributing to outperformance. Other notable performers were the Products/FoodBev vertical within the Consumer sector, and the Internet vertical which recorded a strong YoY performance but a small contribution in absolute terms.
Within DeepTech, the Next-Gen Computing vertical showed strong YoY performance from continued activity in Generative AI. The 'Other' vertical (which captures DefenceTech and semiconductors) accounted for 7% of 3Q23 funding - this appears in the bottom left of our chart as it recorded no funding in 3Q22.
Figure 4: Capital raised in Europe by vertical in 3Q23
Source: Lazard VGB Insights, Pitchbook Data, Inc.
Nordics see spike in activity, with Germany sequentially quieter
The UK, France and Germany have dominated the European market recently, accounting for two-thirds of funds raised since the start of 2022. However, in 3Q23 the Nordics saw an unusually large share of funding at 24%, as H2 Green Steel and Northvolt boosted the region. The UK and France maintained their strong performance accounting for half of capital raised. Germany struggled and recorded an 11% share, its lowest performance since 1Q22.
Figure 5: Capital raised by country in 3Q23 and 3Q22
Source: Lazard VGB Insights, Pitchbook Data, Inc.
InfraTech drives funding in France, with strong contribution from DeepTech
Splitting the sectoral data on a country level, the UK saw a relatively stable split YoY - albeit with a larger contribution from Healthcare as UK Life Sciences businesses continue to be active. France saw an outsized contribution from InfraTech (61%), coming entirely from the US$907m Verkor deal.
Figure 6: Capital raised by sector in Europe’s top 3 markets
Source: Lazard VGB Insights, Pitchbook Data, Inc.
Larger rounds tick up again as activity <US$50m continues to decline
The share of larger rounds (>US$50m) has continued to increase in throughout the year, now making up 85% of total capital raised. There are two drivers in 3Q23. Large InfraTech deals had a disproportionate impact on deal value, and capital raised in smaller rounds (US$25-50m) declined on both a YoY and QoQ basis.
Figure 7: Capital raised by size of round since 1Q22
Source: Lazard VGB Insights, Pitchbook Data, Inc.
Section Three – Deal Round-up
Energy Transition producers raise mega-rounds
EV battery producer Verkor raised a US$907m series C round led by Macquarie, in the largest equity financing ever by a French start-up. Funds will be used for the construction of Verkor’s first gigafactory in Dunkirk, with strong government support in the form of US$630m in debt financing from the European Investment Bank, and $680m in subsidies from the French state. H2 Green Steel raised US$1.6bn to finance the world’s first large-scale green steel plant, using green hydrogen in place of coal to help decarbonise industry. The round was led by Altor Equity Partners, GIC, Hy24 and Just Climate
Asset-light Energy Transition plays still attract funding
Whilst most investment within energy transition has accrued to asset-heavy producers in 2023, there were notable raises in the software space too. PVcase raised US$100m for its solar design software which improves performance and reduces costs for solar developers. Sylvera raised US$57m in a round led by Balderton Capital to expand its forestry carbon credit ratings into the US market. Also in the voluntary carbon market space, Isometric raised a $25m seed round for its carbon credit registry platform. Isometric will issue credits after projects have been verified by an independent 3rd party. Finally in the carbon accounting space, PlanA raised $27m from Lightspeed to grow its decarbonisation software across France, UK and Scandinavia.
AI proliferates across Europe
Generative AI recorded another strong quarter, with activity seen across the value chain. At the foundational layer, Aleph Alpha raised US$109m from strategic investors SAP, Intel and Nvidia as it continues to develop its LLMs. Poolside raised a US$126m seed round and simultaneously relocated from the US to Paris, as France’s €500m initiative to attract AI firms begins to pay dividends. Poolside is co-founded by former Github CTO Jason Warner and is developing a foundational AI model to create software code.
At the application layer, Helsing raised a US$226m series B round led by General Catalyst, as it continues to develop software-based capabilities for defence. Finally at the infrastructure layer, DeepSet raised US$30m led by Balderton Capital. The company’s DeepSet Cloud platform helps AI teams deploy LLMs and their applications within an organization.
Large consumer rounds defy macro concerns
Butternut Box raised the largest Consumer round in 3Q23, with US$355m (inc. both primary & secondary) to be used to continue to scale the premium dog-food subscription service. Founded by two former Goldman Sachs employees, Butternut Box is now the largest fresh dog food brand in Europe. In Germany, EGYM – fitness hardware and software - raised US$225m from Affinity Partners. The business generated US$130m of revenue in 2022 and expects to grow its topline 100% in 2023.
Life Sciences investment driven by strength in UK
The United Kingdom is responsible for 64% of funding in Life Sciences in 3Q23, roughly twice the UK’s share of overall investment in the quarter. The largest round in the quarter was the $227m raised by Apollo Therapeutics, which has developed a diversified pipeline of over 20 programs, sourcing its assets from its academic partners. This model sits in contrast to many Life Sciences fundraises, which tend to have fewer molecules focused on fewer therapy areas. One such example is Ellipses Pharma, which raised $139m to develop its 6 candidates for oncology therapies.
Banking/Lending leads the way in FinTech
The Banking/Lending vertical accounted for roughly half of all funding in FinTech in 3Q23, with activity spread across larger (>US$50m) and smaller deals. Perenna raised $52m to launch its long-term (20 - 30 yr) fixed-rate mortgages in the UK, addressing the housing affordability crisis amid the rise in interest rates. The round was led by Silverstripe and comes on the back of Perenna securing an unrestricted banking licence in the UK in September. There were two smaller deals within embedded finance, with Banking-as-a-Service platforms Solaris ($41m from internal investors) and Swan ($40m series B led by Lakestar) both raising in the quarter.
Figure 8: Selected fundraising rounds in 3Q23
Source: Lazard VGB Insights, Pitchbook Data, Inc.
Section Four – Private Markets Capital Cycle
In the last section, we breakdown the venture & growth markets into three constituent parts:
- Capital raising (at the fund level)
- Company funding activity
- Exits (IPO, strategic and secondary)
Figure 9: Venture & growth capital cycle
Source: Lazard VGB Insights
Capital raising
In theory, the 500bps increase in the risk-free rate should result in negative fund flows for venture & growth markets. And the data largely concurs with this view, with Preqin’s European quarterly data showing capital raising volumes (at the fund level) have retrenched to pre-covid levels. The average fund size has however remained elevated through 2023 - there are likely two drivers:
- Larger funds (with usually stronger and longer track records) are taking advantage of being able to raise capital through the equity cycle.
- LPs see an opportunity for outsized returns over the next few years in European venture & growth - the regulatory backdrop is also supportive of this thesis.
Figure 10: Venture capital raising by funds – average size & volume (Europe)
Source: Preqin, Lazard VGB Insights
At the aggregate level, European fund capital raising fell to $4bn in 3Q23. This remains materially higher than pre-2020 levels, but around half of the peak seen through the heights of 2021.
Figure 11: Venture capital raised – quarterly (Europe)
Source: Preqin, Lazard VGB Insights
Company Funding
We have dissected the company funding environment in detail within sections 2 & 3 above. In this segment we focus top-down, and assess net business formations in Europe, followed by the valuation environment.
According to ECB data, bankruptcies in 1H23 were at their highest level since 1H15, reaching over 200k (+26% YoY). Tightening financial conditions and a more selective funding environment has likely driven the rise in delinquencies.
Figure 12: European bankruptcies – quarterly
Source: ECB
However, the bankruptcy data only tells half of the story. When we aggregate with new business formations - a proxy for innovation in Europe – we can see net formation has stabilized well ahead of pre-covid levels. That is, new business registrations continue to more than offset the recent rise in bankruptcies in Europe, with the supply of early-stage opportunities remaining healthy.
Figure 13: European net company formation – quarterly
Source: ECB
In the valuation section, we cite two inter-related factors: down rounds and multiples. According to Pitchbook, ~11% of VC deals so far this year have been ‘down-rounds’, up from ~7% in 2022. For context, the rate of down rounds following the 2000 dotcom bubble reached ~58%, and ~36% following the global financial crisis in 2008. While there is likely upside risk to the current 11%, the rate of down-rounds is unlikely to reach the depths of prior crises, in our view. There are a few reasons why.
- The time between equity funding rounds has extended as companies have adapted their strategic and operational initiatives.
- Availability of alternative capital sources has improved – notably private credit, and venture debt.
- Business fundamentals have evolved. To put things simply, a company growing at 50% and raising equity capital 24 months after the prior round will avoid the ‘down-round’ if the firm avoids more than 56% in multiple compression.
- Application of deal structuring correlates with higher pre-money valuations. That is, firms and investors can negotiate valuation offsets by including liquidation preferences within term sheets.
The valuation back-drop has seen greater stabilization this year, after significant pressure throughout 2022. For example, aggregate EV/forward sales multiples for the Nasdaq 100 fell by around 30% last year (from >5x to ~4x). In 2023, multiples have improved by around 20% - that is, despite the continued rise in the UST 10y yield to almost 5%. The chart below shows the recent divergence between these two variables.
Figure 14: Nasdaq 100 EV/FY+1 sales vs. UST 10yr (Inverse)
Source: Factset
In private markets, we continue to see a notable dispersion between multiples ascribed to higher quality assets within given verticals, and other sector participants. In short, we believe there are three types of assets able to raise at relatively more attractive valuations in this market:
· Long-duration verticals which includes areas such as Energy Transition, Life Sciences and DeepTech
· Profitable growth companies who have proven unit economics
· Top quartile companies (as mentioned above)
The valuation dynamic continues to drive consolidation among many firms who raised capital in 2020/21, with venture debt and other sources of financing continuing to be notably prevalent.
Exit Potential
One of the encouraging trends in 3Q23 was the nascent re-opening of the IPO market, with two venture-backed firms, and another backed by a notable growth investor listing on the NYSE. The performance since has been mixed, with Klaviyo – marketing automation provider – trading the strongest. The possibility of an extended IPO window is likely to be positive for the later stage funding environment, with investors able to price assets within their given return thresholds.
Figure 15: Daily performance post-IPO
Source: Factset
A further sign of growing strategic participation in Europe was the acquisition of LeanIX – a market leader in Enterprise Architecture Management - by SAP, for a fee reportedly >$1.2bn. LeanIX raised an $80 million series D in July 2020, led by Goldman Sachs Growth Equity. The growing alignment of IPO optionality and strategic exits, with increased investor participation in secondary transactions, are the three key drivers for improving capital recycling in the European venture & growth market. Furthermore, improved DPI and LP liquidity is, in our view, likely to be supportive of capital raising by LPs and company fundraising in the coming quarters.
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