...most strange of all, right now the world's hottest tech stocks are traded not on Wall St but on Frankfurt's Neuer Markt... A stunted venture capital industry - that intricate network of entrepreneurs, investors and bankers which turns good ideas into growing companies so deftly in America... seems to be shaping up at last. Suddenly, Europe is awash in venture capital. -- The Economist
Venture capital has never quite caught on in Europe in the way it has in US. While the American market has a long history of turning new technologies into thriving businesses, as late as the mid-1990s its European counterpart had barely hit its infancy.
So the passage quoted above must have made a comforting read for investors. Perhaps a little too comforting, in fact - for the survey it's taken from was written in 1998. Within a couple of years, many investors had found themselves staring dumbly into the empty space where their promising internet company had been.
While it was the American side of the crash that received much of the world's attention, in some ways Europe that came off worse. Most venture capitalists are dependent on money raised from institutional investors such as pension funds. In the US, these investors took a hit, but most had seen enough market cycles to know that venture could also provide juicy returns. In Europe, though, many watched their first investment in the sector get swallowed - and, with little track record to boast about, many VC firms struggled to raise follow up funds. The result was all too predictable: according to the European Venture Capital Association (EVCA), funds raised by venture capital investors fell from €22 billion in 2000 to a mere €9 billion in 2002.
But bad timing is not the only reason that European venture has yet to reach the heights of its American equivalent. An American technology company benefits from having the world's largest economy on its doorstep and, in Silicon Valley, a ready-made cluster of investors and entrepreneurs to help it develop. As a result, a decent idea can quickly become a fast-growing company. What's more - at least until Sarbanes-Oxley threw a spanner in the works - venture capitalists had, in the NASDAQ, a thriving IPO market which provided a lucrative exit route.
Europe doesn't have any of these advantages. The smaller size of its countries means companies can only grow to a relatively small size in their home markets - and while the EU has spent two decades edging towards the creation of a single market, in practice business still faces a patchwork of languages and tax regimes. What's more, in the absence of a Europe-wide tech exchange, companies going to IPO have generally preferred to list on smaller national exchanges, where returns tended to be lower. Even the most visible step towards the single market - the launch of the euro as a single currency - is less of an advantage than it may appear. A hefty chunk of European venture is managed from and invested in the UK or Sweden, which remain outside the Euro, meaning that many companies that hope to grow internationally still face currency fluctuations.
The regulatory regimes in place in some EU countries can also make tough going for a VC's portfolio companies. Stringent labor laws can limit companies' flexibility to hire and fire staff - something vital for young, fast growing businesses - while high capital gains taxes can discourage investors from parking their money in equities.
Perhaps the biggest problem for new early-stage companies in Europe, though, is one of attitudes towards risk. Hugh Stewart, chief executive of Hampshire-based venture capital firm Strathdon, says that the conservatism of European customers can make it harder to persuade them to take a gamble on a new technology. "In the US, a customer will think, 'If I buy this product and it works I'll get promoted,'" he says. "In Europe they'll think, 'If I buy it and it fails I'll get the sack.'" The combination of all these factors means that European tech companies can find themselves overtaken by newer but faster growing American rivals.
Despite these problems, European venture capital finally seems to have left the doldrums of the post-crash years behind it. Investors are getting more confident, with venture capital firms raising more money in 2005 than in any year since 2001, and London's Alternative Investment Market (AIM) is emerging as a key IPO market for young companies from across Europe and beyond.
What's more, those in the market say that - in contrast to the boom years of the nineties when anyone with an internet connection and a dream seemed able to find VC backing -the shake out that followed the crash means that most of those left in the market have greater experience of building businesses, and take greater care over where they put their money. And for all the problems it caused, the nineties tech boom did create a class of European entrepreneurs who are now, older and - one hopes - wiser, ready to put their experience to work.
There has also been much talk among business leaders and policymakers about how to make Europe better suited to venture capital. One subject under discussion what could be done to encourage the creation of a European Silicon Valley, with the high tech cluster around Cambridge - 'Silicon Fen' - a likely contender. This summer also saw a string of articles on how to better commercialize academic research, following a report from the Higher Education Funding Council of England which noted that deals by universities to license their discoveries to industry increased almost 200 percent between 2002-3 and 2003-4.
There is still a long way to go if Europe's venture capitalists are to have any chance of building a high-tech industry to compete with the US - not to mention Japan or Korea. But policy makers and business leaders alike will be hoping they succeed. New and innovative businesses play a key role in improving productivity and boosting growth. "You need a steady flow of small innovative businesses, or you won't have the Vodafones or Intels of tomorrow," says Peter Lindthwaite, the chief executive of the British Venture Capital Association. "They don't just suddenly appear."
The author is a London-based journalist covering finance and public policy. He also blogs at Atlantic Rift and writes for the Sharpener.