All Aboard the Trans-Europe Express! Episode 2: The Historical Perspective

Understanding the current state of European tech through the three significant waves of activity in the ecosystem

Welcome back! If you missed last week’s introductory post, I suggest reading it here. I want to give a big thanks to those who shared, commented, and/or supported my comeback article. I appreciate you <3

In this week’s installment, we will look at some key historical narratives that largely define the evolutionary arc of the European ecosystem. I go chronologically, sketching out how the cycles have built on top of each other to form the current state of development. Let’s dive right in!

The First Wave: 1985-2001

Sadly, I don’t think Eric Newcomer got the chance to read what is likely the definitive paper on the European ecosystem from ~1985 to 2004, the year of its publication. Written by a pair of academics and Bessemer Partner Felda Hardymon, who has been with the firm for 40(!!!) years and helped finance Staples, the American office supplies retailer, this HBS case details the 2001 establishment of Accel Partners’ London office. Mr. Newcomer, rightfully so, calls them “European venture capital royalty”, but there is an important history that precedes the California firm’s anchoring down in the British capital.


American Kevin Comolli established Accel’s presence in Europe in 2000-2001


The paper traces the history of the modern technology startup ecosystem in Europe to the mid 1980s. Akin to today, the tech company financing environment was at record levels of froth, especially in the United States. European financial institutions saw this enthusiasm as an opportunity to finance new companies who could then become customers of their business-banking products (mortgages, lines of credit, advisory, etc.). This was not a positive development. Hardymon et al. quote an expert, who recalled:


“The industry was staffed in completely the wrong way…with bankers and accountants. They were fine in terms of structuring the deals, but lacked the expertise to assess trends and technologies and add value.”


Bankers, rather than technologists trained to anticipate the future by seeing the present clearly, executing risky investments into fledgling companies led to bad outcomes, unsurprisingly. Returns were weak and the venture capital industry was soon “annihilated”. Crucially, many investors today hail from financial and advisory backgrounds at a proportion far higher than that in the United States because of historical precedent, LP risk appetite, and social capital signaling.

The annihilation of 1987 saw European LPs allocate their capital to other asset classes, European firms close their doors, and American funds pull out of the continent. Conditions wouldn’t improve for a decade. In European English, venture capital and private equity became synonyms. Late-stage equity investments in private companies were better described as buyouts involving complex financial engineering.

The late 90s, of course a frothy time in California as well, saw a resurgence of early-stage tech investment in Europe. While the proportion of institutional capital invested in the PE/VC asset class was only half of that in the United States, European VC AUM grew 2.5x between 1997 and 2000.

In this resurgence, European investors continued to have predominantly financial backgrounds but there was recognition of the importance of operational expertise. Several technology companies reached successful exits, minting some founders and employees with financial, operational, and social capital. The social capital aspect should not be overlooked, especially in the European context. The authors note that entrepreneurship gained some social cache at this time. Finally, regulation started to become a bit more normalized across markets, leading to tech companies becoming more attractive employers.

American players re-entered the market at this time. As with the previous instance, the reasons for their arrival were to avoid intense competition back home, diversify their portfolios via geographic arbitrage and find deals on the cheap, as salaries (especially for engineers) were far lower in Europe. Some funds brought their people over from California, often to London, while others sought to hire investors from existing European firms. A third model emerged, in which established VCs from America would collaborate with financial institutions in Europe. The paper gives the example of Benchmark Capital and JP Morgan (I guess this is what ended up creating Balderton?). The partnership approach mitigated the Americans’ problem of lacking a local network while providing enough space for US funds’ to flex their superior branding, relationships, and capital to win deals for the most promising European ventures. US-based limited partners were largely supportive of Cali funds’ European vehicles, though some declined to take part in these fund raises, citing a lack of personnel experience in Europe and an over-indexing on telecommunications in the European ecosystem.

While many funds were raised (and deployed) between 1997 and 2000, market conditions brought an end to this period of exuberance. Starting in 2001, firms had lots of difficulty raising second funds and enthusiasm for the European market waned. Another European winter had begun.

American capital allocators did not stop looking at foreign markets in the ‘winter’ between 2001-2007. They looked further eastward, at China, which was experiencing its tremendous growth years that culminated with the Beijing Olympics. Enormous firms like Alibaba, Tencent, Baidu and JD were all founded in the late 90s and experienced wild growth in this period. General Atlantic famously invested in Alibaba in 2009, though there are many other examples of American enthusiasm for The Middle Kingdom.   

The Second Wave: 2007-2015

Rocket Internet was founded in Berlin in 2007 by three lunatics who happen to also be brothers. Their strategy was simple: build B2C companies whose business models’ had been proven in other markets and, crucially, sell them off to unlucky acquirers. They themselves did this in the frothy late 90s, when they copied eBay for the German market and sold it in ~100 days. Rocket built dozens of companies in Europe but also across the world, from Sao Paulo to Singapore. Prominent Rocket companies include Zalando (Berlin’s largest startup employer by some distance), Hello Fresh and Home24. There is no secret sauce nor technological innovation here. Rocket Internet sought to use increased internet penetration in Europe and other emerging markets to build companies that sold physical goods online to consumers. Sometimes, they tried to build businesses not built around delivering stuff to people. Examples include Pinspire and Paymill, clones of Pinterest and Stripe respectively. In the end, regardless of what you think about what they did, it is irrefutable that they were hugely successful in their execution. Without Rocket, Europe would not be where it is today.

Within emerging ecosystems, where best practices governing optimal behavior of capital markets are not yet fully developed, conglomerates have been observed as a common phenomenon. Research on this topic looks, among other things, at corporate governance in the context of conglomerates. In immature markets, conglomerates form because capital holders can expect internal diversification (i.e. finance and operate businesses within the same organization) to triumph over financial diversification (i.e. equity investments in other organizations). This is particularly potent when a region’s financial markets and institutions are “substandard”. In the absence of robust capital markets, conglomerates, like Rocket Internet, are able to bridge the gap and provide financing, without onerous transaction costs, for business opportunities. This can be expected to be effective until transaction/monitoring costs converge between internal and financial diversification. Convergence occurs because conglomerates become bloated (see General Electric, for instance) while successful ventures attract the attention of asset allocators who wish to juice returns. This hastily put-together graph may help to visualize this phenomenon:

In the case of emerging startup ecosystems and Rocket Internet, the “substandard” aspect is not related to ineffectual governmental enforcement of contracts, chaotic accounting standards, or anything like that. Rather, the deficit refers to poor information flow, which is a common trait of developing ecosystems. Essentially, when ecosystems are nascent and best practices are not widely adopted and understood, a firm’s cost of transacting with capital markets swells. In the face of such steep transaction costs, aggregating resources under one roof gains in attractiveness. If local capital markets are inefficient--recall that European investors were (and still are) disproportionately financiers rather than technologists--size can function as a significant advantage when it means increased exposure to international financial markets.

Academic research on the topic of conglomerates and capital markets includes the subject of tunneling. It is described as inter-conglomerate dealing that occurs at the expense of external shareholders. Say Zalando makes a large loan at a tiny interest rate to a less financially robust Rocket sibling. Or, perhaps more perversely, HelloFresh executives exclusively using Nestpick for business trip accommodation AND paying far above market rates. Researchers make quite clear that they see this kind of strategy as malign and fraudulent but, in the context of building fast-growing technology firms in immature markets, such an approach seems prudent and synergistic. It is powerful to utilize a highly aligned system of globally-applicable operating models and centralize key functions like IT. More so, Rocket can credit its success to building an internal capital market where the conglomerate can play both market maker and ‘rule-breaker’. This is a brilliant method to overcome the challenge of servicing high-growth, tech-enabled business opportunities in a region where capital markets have not developed at the same rate as technological or business model innovation.      

In a 2014 Economist article, Oliver Samwer was prompted to respond to allegations that Rocket Internet did not pursue original ideas in its company building (it most certainly did not). He emphasized the importance of implementation and operational excellence in his retort, quipping, “A bridge is a bridge wherever you are. We are a construction company.”

And indeed, the business successes of die Gebrüder Samwer are not what make their contribution to this story of Europe’s startup ecosystem so significant. Rather, it is that they helped build a bridge for the next generation by endowing leaders with money, operational know-how and useful relationships. Rocket Internet is often seen as a school for German founders and I think that’s pretty apt. While ‘the administrators’ of the school had some pretty crazy ideas about best practices, it ended up producing exceptional graduates. 

Rocket Internet hired many hundreds of ambitious and bright young Europeans who would have otherwise worked in finance, consulting or large corporations. They worked hard in difficult conditions, but in return, they received a chance to see the world and, most crucially, invaluable operational training. The innovation of taking the conglomerate model, often present in less mature ecosystems, and applying it to fast-growing technology firms was also significant. Rocket basically willed a robust-enough capital market into existence by reducing transaction costs associated with external financing events. At the same time, the aggregation of internal resources that Rocket is famous for allowed for extraordinary speed, flexibility, and repeatability which crystallized into a real competitive advantage that has proved to be highly influential and impactful. There can be little doubt that those who were initially launched into orbit by Rocket have drawn on observations around the most powerful mechanisms, systems, and processes as they build the current third wave. 

The Third Wave: 2015-Present

Of the investors in continental Europe with operational experience (there aren’t that many actually), a great deal of them cut their teeth at Rocket companies. The founding partners of Cherry Ventures (a firm Mr. Newcomer shouts out), one of the pre-eminent early-stage investment funds in the German-speaking world, were both blooded at Zalando, where they were executives. They then used their ‘winnings’ from that firm’s success to invest as an angel syndicate. After huge early successes seeding businesses like Amorelie, Quandoo and Flixbus (themselves all online commerce plays built by folks in the Rocket Internet orbit), they have raised several institutional funds and are leading the way among DACH-focused Seed stage funds presently.

Prominent pan-European investor Project A Ventures has an even stronger connection to Rocket (disclosure: I used to work there). The entire founding partnership, plus another ~15 people, famously absconded from Rocket in 2011 to found the investment firm. They initially sought to invest in what they knew: B2C commerce. But have subsequently shifted focus to B2B businesses, as the sector has matured in Europe. Third wave companies that Project A has backed include: Kry, Sennder and Dixa.

Admittedly, my main area of expertise is Germany but let’s pop up to the UK. Many know London for the consumer fintechs it has produced. TransferWise (now called Wise), Revolut, Monzo, and Starling (B2B) are the well-known names and have been founded in the last decade. The other big category the UK has shone in is ecommerce/marketplaces, with Deliveroo, Cazoo and GymShark leading the way.

In the Nordics, the big names are Klarna, Spotify and iZettle, companies that don’t really sell into large enterprises nor have high ACVs.

The situation in France is a bit different. Those who are familiar with both the Berlin and Paris scenes have (rightfully) observed that German companies excel at building robust operational models while the French, with their superior aesthetical sense, are more keen on building outstanding user experiences and pretty interfaces. But the divergence goes deeper.

Thanks to effective talent mafia dynamics, Parisian tech firms have bucked the trend and produced some stellar businesses that cater to enterprise customers. Exalead, founded during Y2K, functions as the starting point here. Alums of the search-specialist went on to found two of France’s strongest enterprise players: Dataiku and Algolia. While both of these companies were founded in France by French people and still concentrate their development teams in le pays des Gaulois, their HQs are in New York City and San Francisco, respectively. Ironically, two of the top software firms of German origin mirror this. Contentful, a Benchmark backed developer of headless CMS tools, and Rasa, a maker of conversational AI with a16z on their cap table, have their Chief Executives in SF while retaining developmental teams back in Deutschland. In all of these cases, these firms did a basic calculation and saw that the market opportunity in the United States was orders of magnitude greater.

Dataiku and Algolia do differ from Rasa and Contentful along a key dimension: seed investment participation from domestic funds. Berlin-based Point Nine is an investor in Contentful, though I would argue they are a global fund that happens to be based in Germany. Regarding Rasa, I noted this ten months ago:

Dataiku and Algolia had later growth rounds led by non-domestic funds but were both staked at seed by mature French fund Alven, along with other participants.

You may have begun to understand what I am hinting at with the examples I have chosen. Europe’s historical legacy has largely biased firms with a consumer focus over those building for enterprise. In next week’s installment, where I focus on the structural basis for Europe’s ecosystem, I will dive deeper into why I see things this way. I hope to see you there!

Thank you to Moritz for being such a strong sounding board. Thank you to Alexandre for filling me on some of the dynamics at play in France and to Twitter for connecting us. And thank you to Julian, Eric, and Fred, whose feedback on initial drafts has been key.