Big Picture

The Democratisation of Venture Capital

Private wealth across Europe is at an all-time high; yet European venture capital firms still line up for the same few managers of pension and insurance funds, relying on their goodwill. If we aim to significantly increase the amount of venture capital raised in Europe, we have to lower the barriers to entry for affluent private investors and raise awareness about the benefits of venture capital in order to access the substantial amounts of private wealth that sits unused.

It is no secret that national economies benefit from private equity investments in general and venture capital investments in particular. An increase in VC investments of 0.001% of GDP is statistically associated with an increase in real GDP growth of 0.30 percentage points. Early-stage investments have an even bigger impact of 0.96 percentage points . Yet, venture capital remains scarce for promising startups in Europe. For comparison, in the first three quarters of 2014, preliminary figures by the EVCA indicate that European VC firms were able to raise an amount of €1.67bn, while their American counterparts raised €23.8bn over the same period - 14 times as much and that even though the economic output of the European Union and the United States is roughly the same. Therefore, it comes as no surprise that European governments seek for ways to increase VC investments in young companies. However, instead of holding out for state subsidies, tax reliefs, and regulatory reforms, venture capital firms should live up to their name and venture to new grounds.

The root of the problem lies with the limited amount of capital in circulation within the venture capital ecosystem. Nearly all VC funds raise their capital – apart from a handful of very high-net-worth individuals – from a narrow circle of institutional investors (their limited partners), such as endowment, pension, and insurance funds, whose total managed assets and willingness to allocate those assets to venture capital remain relatively constant. Therefore, when a new VC firm enters the market, it simply gets in line to wring money from the same institutional investors that other funds have already been targeting. Therefore, the amount of venture capital available to startups will usually remain the same, whereas only the competition between VC firms will increase.

If we aim to close the sizeable gap to the American ecosystem, venture capitalists will have to branch out. They will have to demonstrate the same kind of entrepreneurial spirit that they demand from the founders and CEOs of their investments and venture into uncharted territories. For many – particularly newer – VC funds, it is sensible to move away from traditional limited partnerships in favour of new, more dynamic structures in order to enable investments from more numerous, smaller private investors. Europe is one of the wealthiest regions in the world and, in fact, European private wealth has hit new record highs at a total sum of €56 trillion . Private wealth is distributed unequally among the population. The top 10 percent owns more than half of the total private wealth, which indicates that an amount of about €28 trillion is in the hands of European individuals with more than €200.000 in capital to invest, who would be able and potentially willing to allocate a share of their capital to VC firms – if they only knew about the possibility and be able to find the right structures that allowed them to do so.

The time has come to lower the barriers of entry for affluent private investors, to democratise venture capital, particularly since interests rates are lower than ever and even penalty interests for private investors are not unheard of. The high activity of business angels and the growing interest in crowdfunding platforms demonstrate an ongoing desire to participate in the success stories of technology companies; yet most individuals lack the eagerness, time, and especially knowledge to separate the wheat from the chaff themselves when it comes to truly promising startups. VC firms can offer those individuals an excellent alternative to invest in a carefully selected, diversified portfolio. They only need to adapt more flexible structures, e.g. open-ended corporate structures, so-called evergreen funds and/or listed versions to provide liquidity and improved transparency.

Apart from major advantages like independence from the whims of single investors and much higher flexibility to act, a broader structure nevertheless requires adaptation to the new circumstances. Firstly, it is essential to establish cost-efficient, lean processes that can handle a greater amount of smaller investments in an unbureaucratic way. Secondly and most importantly, raising awareness about the opportunities that venture capital provides is a central task, which has to be mutually tackled by the entire ecosystem. It should be our collective goal to establish venture capital in the eyes of all kinds of private investors as a go-to asset class that provides, aside from attractive returns, an overall advancement of European productivity and innovativeness, increased independence from the data superiority of the U.S., and simply a great opportunity to participate in exciting tech projects. If we were able to activate only 0.01% of European private wealth, we would more than triple the current amounts of venture capital raised.

We at German Startups Group have also been embracing smaller private investors since our outset. Two and a half years ago, we decided to build a VC firm with an entrepreneurially minded and open-ended corporate structure instead of an institutionally backed close-ended fund and have been promoting the benefits of venture capital both directly to smaller (aka semi-professional) private investors as well as to the press. We would love to see more VC firms follow this example.

Nikolas Samios
Managing Director & Chief Investment Officer at German Startups Group, Berlin
Twitter: @BerlinVC