14/09/2016

VentureCapital2020:UKvsUSMedium

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Beacon Capital
We are a venture capital firm for entrepreneurs of outstanding ability. Formerly AngelLab
May 13 6 min read

Venture Capital 2020: UK vsUS

This is based on data analysis we did at Beacon Capital (see acknowledgements at

the end of this post) and it was rst presented by Chris Mairs, CBE, FREng, and
Beacon Capital Venture Partner, in his keynote speech at our event London Tech
Venture Capital: An Asset Class for Global Investors, on November 18th 2015.
There has been no shortage in recent months of inspirational (and
aspirational) articles about the London venture capital and startup ecosystem
(Local Globes post serving as a good example) pointing to the robust
economic growth, world leading universities and favourable investor tax
regimes to paint a picture of a thriving venture capital ecosystem and a land of
opportunities for startups, VCs, and more importantly Limited Partners (LPs)
those who ultimately invest in VC funds which in turn invest in startups.
And yet, arguing that the London startup ecosystem is booming does not seem
to have attracted signicantly more LP investment. London venture capital
(let alone the rest of the UK or Europe) as an asset class has no, or only tiny,
LP allocations.
The issue is that LPs (understandably) look at historical mean performance of
Venture Capital investments in dierent geographies and conclude that this is
better in the US than elsewhere. But perhaps that is a simplistic view and it
may make more sense to consider the spread of performance within a
portfolio as well as the mean.
The more pertinent question therefore is whether the relative performance of
the two ecosystems, the US and European/UK, are likely to converge and, if
yes, how soon might this happen.
Relative Historic Performance of US and Europe
To try and shed some light on this question, we analysed two datasets of
startups in the US and Europe that received one or more investments between
2003 and 2010.

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The US dataset of nearly 6700 deals is much larger than the European dataset,
which contains a little over a 1000 deals, but both sets are large enough to tell
us something. The data is far from perfect and weve had to make various
assumptions where data was missing. We only considered companies that
have actually had a liquidity event i.e. got acquired, had an IPO or went
bust. For each investment we calculated the multiple return on the investment
and then considered the dataset as a whole. The model is quite basic and we
plan to rene this over the coming weeks but allows for some interesting
observations.

NB: The X axis refers to the year the rst investment was made. We did not
include investments after 2010 because only very few have exited (due to the
short time period) and hence this makes the analysis unreliable.
Looking at the chart on top, we can see that the US multiples (blue line) are
indeed on average better than the EU (red line). However, it is very striking
that the US standard deviations on the bottom chart, i.e. a measure of the
spread of the returns within the dataset, are consistently higher.
What about the future?
We then applied a polynomial regression to the data to predict how the
averages and standard deviations might look in the future. This is a

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notoriously unreliable business and of course does not take account of black
swans or other unexpected global events. But so long as the relationship
between macro conditions in Europe and the US follows the trends that
existed over the past few years then this may tell us something about the
relative performance of the two markets looking forward.

Although the US mean is still ahead, the EU is converging on the US and the
EU standard deviation remains much tighter than the US. In other words, we
are approaching the same level of returns but with much more predictability if
we have a sensible sized portfolio.
Predicted Portfolio Performances in the US vs Europe
We then used the Central Limit Theorem to predict the performance of a
portfolio containing 10 randomly selected investments per year based on
these mean and spread predictions.

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The red shaded area shows the performance of an EU portfolio within 99%
condence limits, and the larger blue shaded area shows the same for a US
portfolio. The dark blue and dark red lines are the mean performance.
What we see is that although the EU mean performance is a bit lower, the red
area falls entirely within the blue area. In other words, it is always more likely
that the EU portfolio will be closer to its mean than a US portfolio, making the
downside risk lower in the EU.
So one might ask is this anything more than lies, damn lies and
statistics?
Well, the sanity check comes in the form of the increasing number of posts
and articles arguing that the London ecosystem is becoming stronger and able
to compete on a global scale but also from our very own experience having
been actively involved in the local ecosystem for some time now.
A Golden Age for UK Tech Investment
Thinking about the US data for a moment, there is a very small number of
mega unicorns like Uber and Whatsapp that signicantly skew the data. Only
the privileged few get to invest in these super outliers and it would be
nonsense to build a strategy around nding the next Uber.
Coming back to the UK, a combination of the strengthening economy,
presence of world class universities, the attractive investment tax regime and
belief in the London ecosystem amongst investors has led to a signicant
increase in the private capital available to startups. This comes at a time when
hands-on investors have spent many years working with entrepreneurs to

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build businesses eciently in a capital constrained market. Their experience

in the ecient use of capital and the fact that we have not yet suered the
early stage valuation ination which has happened in the US is very
signicant. The return on an investment is the dierence between the exit
valuation and the entry valuation, diluted by the additional capital that
the business sucks up in its journey. So buying into a capital-ecient
business at an attractive early valuation is a great step towards good
returns.
What does that mean for LPs?
The reality is that there is a small number of tier 1 VCs in the US who
consistently get access to the best deals with consequent portfolio
performance consistently towards the upper end of the blue shaded area. In a
future post we will segregate the US data and we expect to see that after only
excluding a very few top performing investments the mean drops
signicantly. If you are an LP with access to one of the top performing funds,
then good luck and ll your boots! Unfortunately, these funds are almost
always oversubscribed and access is tough. So, if you are not in that privileged
elite then you should certainly consider the UK, where standard deviations
are lower, there is more space for new LPs in well managed funds and the
mean performance may well exceed all but the very best US funds.
All prudent LPs do of course take account of more than the headline numbers
and should not get seduced by Unicorn valuations. Interestingly recent
adjustments in publicly traded stocks including Twitter and LinkedIn [1] have
shaken some investors general appetite for the Venture Capital class.
However, we believe that these adjustments simply reinforce our view that
markets with a smaller standard deviation, and hence less volatility, make
more sense, so perhaps now more than ever before is the time for progressive
LPs to refocus their investments towards the UK market.
A big thank you to the two INSEAD MBA students, Gautam Nangia and GillesAime Harerimana who worked painstakingly for two weeks to get the data from
various sources (Preqin, Thomson Reuters, etc) and Vasos Dramaliotis, now a
graduate engineer, who performed the analysis.
[1] http://www.marketwatch.com/story/linkedin-loses-nearly-a-twitter-inmarket-cap-2016-02-05
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Originally published at Beacon Capital.

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