This was first published in the Pitchbook Q3 2020 European Venture Report on 29 October 2020.
What is your general view on the European VC scene, as we enter the last stretch of 2020?
Despite unprecedented turbulence and challenges stemming from COVID-19, the European VC scene has remained remarkably strong and resilient. Millions of jobs have been lost. Economies have entered recessions. Economic sentiment has plunged. Yet deal value has remained high across the continent, nearing 2019’s record in part because of swelling deal sizes and thriving tech-heavy businesses.
This year has seen multiple “winners” and “losers” crowned. Sectors that lend themselves to life alongside COVID-19, including software, healthcare, biotech, and pharma, have flourished, whilst sectors such as energy, tourism, and high street retail have struggled. As millions try to minimise the impacts of COVID-19 by adapting to their “newly changed lives,” activity in cybersecurity, remote working, and online social activities has endured. Less capital-intensive opportunities to scale up and expand into new territories remain for those unencumbered by brick and mortar.
Localised lockdowns and constantly changing quarantine rules have considerably disrupted economies and plans, and they’ll likely increase in quantity and severity. No longer can investors meet founders in person, view their offices, experience the physical energy of a start-up, or engage in the virtual due diligence unmatched by any screen. This is undoubtedly going to create significant uncertainty around investments and could deter investment altogether.
The race for a vaccine is also going to affect the landscape. Many start-ups, operators, and investors are trying to identify and prepare for a vaccine and its restoration of normal daily life. Market confidence will likely rebound following the vaccine’s announcement once all parties can plan next steps—albeit tentatively.
It is hard to predict what the rest of 2020 will hold. The financial crash in 2008 bred some of the largest and most innovative companies in the world today. Current figures show that the European VC market is performing well, and Europe’s software “engine room” will, if anything, continue to benefit from COVID-19’s far-reaching implications. A second wave could bring the same challenges the European VC scene has so far fought off. However, governments’ emergency stimulus measures are now winding up, taking us even further into unchartered territory where anything could happen.
Deal-making conditions were irrevocably altered by the pandemic. What surprised you the most about those effects? Conversely, what were the most difficult hurdles that you saw businesses and your colleagues surmount?
Early in the pandemic, priorities shifted markedly towards existing portfolio companies and away from new deals as investors were understandably reluctant to commit capital without physically seeing the target businesses in action. Since then, we have been pleasantly surprised by how well and quickly investors, target companies, advisers, and intermediaries have adapted to remote deal-making.
The anticipated torrent of distressed deals has not, as of yet, materialised. Government support measures seem to have, so far, helped many businesses in the worst-affected sectors avoid distressed investment territory. The vast majority of deals that we have done during the pandemic have been on full valuations.
Our recently published Restart Capital report showcased the survey responses of 500 SMEs and 100 investors and, based on the results and inevitable withdrawal or scaling back of government support, we expect an increased focus on distressed deals. Our report identified that SMEs see the depth of the precipice being approached as worse than we had pictured. However, this survey has also shown that private investors’ robust health and appetite for distressed investment also exceeded our expectations.
Which of these changes do you anticipate will sustain or subside?
The move to remote negotiations, due diligence, signings, and completions will persist. The technology is here, and the pandemic has forced more people than ever to adjust. It seems unlikely that we, as a law firm, will continue to host physical all-party meetings and signings to the same extent. Investors will undoubtedly want to return to visiting target businesses in person. Technology has not yet replaced the understanding that comes with in-person meetings, but in the interim, it has proven adaptable to the “new normal” of deal-making.
From a regulatory perspective, what is least known but very critical to start-ups across the European venture space?
Countries such as the UK have traditionally believed they should welcome nondomestic investment and treat it no differently than investment sourced domestically. However, politicians have recently asked authorities around the world to act on concerns that non-domestic actors are too easily snapping up companies and assets of “national” importance. COVID-19 has undoubtedly accelerated these changes. As financial markets have dropped, governments are moving fast to prevent undervalued companies from becoming targets for opportunistic takeovers by nondomestic actors.
This shift of approach has led to various regulatory initiatives targeted at increasing scrutiny of corporate deals in specific parts of the economy, most notably the technology sector. In the UK, the government has recently introduced protective measures that significantly lower the threshold at which the Business Secretary can intervene in transactions involving non-domestic investment in artificial technology, cryptographic authentication technology, or advanced materials.
Further reforms are currently under consideration as part of the forthcoming National Security and Investment Bill. Taken together, the current direction of travel means that investors and investee companies will need to account for any potential non-domestic investment concerns upfront to mitigate risks of delays and, in the worst-case scenario, deal failure. It would be well to consider these challenges at the outset rather than be surprised later in the process.
Are there any items of note related to Brexit to discuss?
After a lengthy period of uncertainty over the precise consequences of Brexit, some details are now beginning to fall into place. For the numerous UK citizens that reside in EU Member States, it seems many may face significant inconvenience in retaining access to UK bank accounts, especially if they retain property or other assets in the UK where a local sterling bank account will be an essential part of their planning. Various institutions have announced that they will begin closing accounts held by residents in EU countries. This follows from the fact that passporting rights, which allow UK banks to provide services in other EU Member States, will expire at the end of 2020.
The British press has naturally focused on the plight of UK citizens living in Europe. But there may be wider implications. For example, if it is unlawful for a British bank to provide services to a British citizen resident in France, then it must equally be unlawful for that bank to provide services to a French citizen in France. The approach to closure of the accounts could therefore severely restrict the ability of UK banks to offer financial services to persons and companies based in the remainder of the EU.
There is also some scope for legal argument around rationale for the closure process. For example, it may be argued that a British bank does not provide a banking service in France in the above example. Whilst the customer may be resident in France, the banking service itself is provided in the UK, where the bank branch is based, cheques and credits are collected, and payments are made. On that basis, it may be said that laws in France and other EU Member States should not prevent their nationals from merely holding an account with a UK bank. However, there appears to be limited appetite for pursuing that type of legal challenge.
In the final analysis, banks have the right to terminate their relationship with current account customers, subject to a period of advance notice. There would seem to be no basis for customers to challenge the bank’s closure decision, because it has been made against the background of a changed regulatory environment. The absence of any tangible deal between the UK and the EU over the financial services sector will therefore leave many British expatriates searching for alternative banking arrangements. Wider implications could also mean UK investment firms may face difficulty providing portfolio management services for EU-based customers, and there may be more consequences to come.
Graham Spitz has over 20 years of experience advising PE and VC funds, including early- and late stage investment. He acted as lead adviser to Zouk Capital, Index Ventures, 83North, Creandum, and Northzone on the sale of their entire interest in iZettle to PayPal Holdings. Graham is a member of the leadership committee of the American Bar Association Private Equity and Venture Capital Group and the Fladgate Israel desk.
Jamie Hamilton specialises in all stages of the PE investment cycle, from early-stage venture through growth and development capital to buyouts and other M&A. He represents start-ups and institutional, corporate, and private investors throughout that cycle, with a focus on late seed and Series A stages. His sectors of interest include agritech, medtech, fintech, clean energy, travel, and sports.