The year 2022 was a hallmark one for startup capital in Europe, as both founders and investors saw significant shifts. To set the scene, funding across all stages dropped a whopping $14B—down 38% from the $38 billion peak of VC funding in 2021. 

Early-stage companies are in a particular pickle, with demand outstripping supply. Wages have increased and larger, more well-established businesses can naturally pay these rates more easily than younger businesses with tighter pockets. This has resulted in the startup job openings dropping significantly, with consumer-focused startups seeing a decline of 58% from the beginning of this year.

This lack of job openings has added uncertainty for investors, leading them to ask why these cuts are being made. Investors have also had to navigate complex macroeconomics, with the euro falling below the USD for the first time in 20 years—making it so their money has less endurance in ventures. 

In total, this is igniting both investors and founders to double down on efficiency, with investors being much more cautious with where they invest, and startups required to accept lower valuations (of up to 50%) and adopt a cost-effective mentality with the funding they are given. 

Although the VC future seems to be bleak, in actuality it is simply recalibrating. During this transition period, each side can use the moment to not only come up with strategies to survive the instability but devise a more resilient and long-term game plan moving forward. Let’s take a look at what both founders and investors can do to understand the caveats that will characterize Europe’s VC Landscape in 2022.

Not All Doom and Gloom: How Investors Can Navigate The Current VC Terrain

Despite concerns for European VC flows, a new report from The VentureCity shows that, in comparison to the US and Latin America, Europe has been performing well in investment. VC in the region as a whole may have shrunk by 20% quarter-over-quarter in 2022, but Europe has still generated $24.9B in volume across 2,266 deals.

Image Credit: Unsplash.com, Jason Goodman

So the good news for VC investors is that European startups are still generating significant value, with many declines only occurring because the previous year was a record–breaker by a long shot. In actuality, what we’re currently seeing is a natural slowdown following years of unprecedented growth, because the number of deals and money being poured into startups in 2021 wasn’t sustainable. Fear-mongering has occurred in many ways because this phenomenon was also compounded by the market slowdown. 

On the bright side, startup valuations in Europe did not get out of hand as much as they did in the US, making EU startups more strapped for stability and a more sound investment through rocky terrain. Further, most of the investments made in Europe to date have been in early-stage startups (Series A and prior), which means that their capital needs are much lower than late-stage companies. This makes for smaller buy-in tickets for investors and also makes startups in the EU region less vulnerable to slashed capital. 

Investors can keep faith by remembering that previous investments still hold the potential for value growth. Some of the most successful companies are built during challenging market conditions, so investors should pay attention to their existing portfolio to help meet the needs of growing companies that may be navigating the downturn for the first time. VCs that double down on financial backing and operational support for current investments could make powerful moves towards ensuring that the companies in their holster are equipped with what they need to weather the turbulent times.

Founders Can Still Get Their Golden Ticket

Unlike other locations, Europe’s startup ecosystem has kept a healthy level of positivity despite a challenging capital atmosphere. Three-quarters of Europe’s founders are still extremely optimistic about the development of their local ecosystem, while 57% say they still prefer the EU over the US as a starting location for their business. 

Although founders are optimistic, the new standard of due diligence and efficiency to get on investors’ radars is undoubtedly higher considering the current set of factors. 

Rising inflation has unquestionably impacted how companies’ customers view the value of a product, so it’s important for startups to reevaluate their product’s current stickiness. If profit margins are low, the core of the issue is most likely with the product. Exposure to new clients and strategic marketing are important, but building a product that people genuinely want to use is the key aspect in keeping customers despite a waning market. It’s no secret that loyal customers are a green light for investors.

It’s also vital for startups and founders to keep an open channel of communication with their customers. Through surveys, in-app touchpoints, or meeting with people, businesses can scope customers’ satisfaction with their products. Collecting this type of data will also help to paint a roadmap of the future ahead in the terms of continued use, as well as provide any benchmarks of feedback that show a collective need for improvement. This data is priceless when it comes to a rollercoaster market.  

Image Credit: Unsplash.com, Annie Spratt

It’s also worth noting that because VC firms typically wait two to three years before raising new funds, there is dry powder capital available in the market right now. According to TheVentureCity, there’s as much as $40B+ of dry powder currently from fund “vintages” dating back to 2020. Investors may be more cautious with deals but that doesn’t mean that they don’t have the capital to back the right opportunities when they arise. So checking these due diligence boxes will prove to investors that your startup is worth the risk.

Finally, founders should be keeping an open channel of communication with their investors as well. Many investors have owned their own businesses, which means they are a touchpoint of resources, advice, connections, and knowledge on how to get the most bang for your buck. Understanding what capital might be available from existing supporters is one thing, but there is also value outside of the monetary kind in tapping into investors’ wealth of knowledge on how to remain visible in the current market.

Innovation for Improvement

One of the most significant roadblocks for the EU is tech layoffs. These have been rampant across the region, which might be a short-sighted solution for startups scraping for funding but could be problematic down the road once market conditions settle. One step forward and two steps back, this hasty reaction to the market could put the business landscape right back where it started—grappling with a severe tech talent shortage. 

Thankfully hope is in sight with the recently released Innovation Agenda, which aims to help the EU’s growing tech companies tackle a range of long-standing issues, supported by a $47billion private capital fund committed to bolstering deeptech. Efforts from this initiative will help to link up innovation ecosystems, help companies understand how to retain talent and access finance, improve existing policies and data-driven approaches, and amend fragmented and risky regulatory frameworks. 

Thankfully, the Innovation Agenda also aims to generate concrete definitions for startups and deeptech by 2023. The European Innovation Scoreboard, a tool that compares innovation performance in EU countries and their neighbors, will help to create an understandable playing field for the EU’s business macro ecosystem—helping to incorporate tech innovation benchmarks. While these shifts will help transform the business landscape for the better, VCs should still be looking to provide startup teams with the advice they need to protect themselves for a tumultuous year in tech and how to access top-tier talent once it’s available.

Europe has matured into a key part of the global venture market. More VCs from every corner of the map have come to recognize that they must stay engaged in the region to ensure their opportunity with up-and-coming talent and investments. VC potential in Europe is still intact and can be even more promising when one keeps some of these guideposts in mind—helping all players in the game look to the horizon with hope.

Disclosure: This article mentions a client of an Espacio portfolio company.

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