Henrik Grim, MD of Europe at Capchase, discusses the financing challenges facing Europe’s startup ecosystem
On the surface, all seems well in the world of European startup funding. There’s more cash available to founders than ever before, with significant new pools of capital pouring in from large funds, both local as well as American ones. Investments are setting new records for both funding amounts and valuations.
Time to access, financing amount and deal terms, have historically been the key elements in the funding equation. Founders will typically explore one of three options; VC money, traditional debt financing, or bootstrapping. Unfortunately these don’t always add up to good options for founders. Here’s why:
Looking beneath the surface of Europe’s funding model reveals a crack, there’s a disconnect between the range of financing options available and how founders are using them. It’s time for a new tool to increase the options open to founders, which, when combined with VC money, can supercharge startup growth in Europe.
Many startups don’t realise that funding options are tools for them to deploy when needed, and end up stuck between options that don’t quite fit the gap they’re trying to plug, and are not flexible enough to realize these are not mutually exclusive options.
The right tool, at the right time
Growing a business requires a founder to make a hundred decisions a day, but when to take investment and on what terms is one of the most significant you’ll make.
In general, as the VC market has become more competitive through a significant influx of capital and new players, we’ve seen an increasing founder friendliness and improved terms from VCs in Europe.
However, it’s not the only option out there. It might be too slow for a business that needed cash yesterday to develop new products for example. Or businesses on a slower growth trajectory.
With increasing risk appetite among investors, founders can find themselves in a tricky place if they take VC money at the wrong time. For example if you’re not confident in delivering outpaced returns, or you have a smaller addressable market that will take longer to crack.
If you think you could be the next big thing, VC funding is great. If that’s not you, then founders are at risk of setting themselves up for a backlash, if they’re not able to grow into their high valuations before their next funding event.
Given that the majority of the capital available comes from investors seeking very large outcomes, we see a skewed distribution of capital allocation as well as a pressure on entrepreneurs to take unreasonable risks with a “go big or go home” mentality. Fast-growing companies in large, eye-catching industries (e.g. food delivery startups) can get overcapitalized quickly, while more complex or slower growing but profitable businesses get very little or nothing at all.
On the other hand, traditional financial institutions are struggling to value startups who come to them for financing, and often offer unattractive terms to founders. Combined with the length of time it takes to secure funding via this route, traditional financing routes can inhibit a startup’s growth.
SaaS financing – a case in point
The software as a service market is a focal point for these pressures. Customer contracts that pay back over long periods of time combined with significant, upfront technology investment yields a need for significant financing into product, go-to-market and operations.
Further, building a business is time consuming – the last thing you want is having to spend months pitching and negotiating, before getting term sheets that require 2 weeks of legal work to decipher. Here is where historical solutions have fallen short. There are some innovations in the market, with players moving increasingly quickly, but lenders are often still stuck in manual processes that last for months.
The missing link – quick, flexible, and non-dilutive financing
Revenue-based financing provides a new alternative, allowing founders to get access to flexible sources of capital within days, without giving up ownership of their company, and while being able to choose the associated level of risk for themselves.
What the market is missing is a more flexible financing option, that allows founders to take the right and preferred level of risk, while scaling their business with care. There is further generally a greater need for non-dilutive financing options, allowing founders to maintain control and ownership of their businesses.
Europe needs more financing options to unleash its innovation potential
Europe is home to some of tech’s biggest success stories and future unicorns – the continent is bubbling with innovation, but the financing scene is still behind our US peers. VC funding is a fantastic option for many startups, traditional financing for others, but there is still a lot of innovation to come.
If we look at the US, a core difference between the two ecosystems is the extent to which founders use non-dilutive financing to grow their business. In Europe, ~5% of capital raised in 2020 (<$100m rounds) was through venture debt (vs 95% equity). However, in the US, ~16-20% of capital raised in 2020 was venture debt. Given the total US early stage funding market is 3x larger than the European one, the venture debt market is ~8-10x larger in US vs Europe.
When a company is on the verge of high growth, it needs access to financing quickly so that it can invest and grow. Revenue-based financing is creating a new way of startup funding, which is quickly accessible and more flexible than what the market has offered to date. It allows founders to get improved access to capital, without giving up ownership of their company, and while being able to choose the associated level of risk for themselves.