Neglected sectors are getting in the focus of investors

Every month the Go4Venture Advisers’ European Venture & Growth Equity Market Monthly Bulletin provides a summary of corporate finance activity among emerging European TMT companies. In the recent bulletin the team reflects on the year past and the trends for 2014.

To capture simply what is going on in European venture, all the action is at the large and early-stage ends of the market (the former driven by growth equity and internet momentum investments; the latter by tax incentives and business angels), with anything in the middle (Series B/C) suffering from a fairly battered venture industry just starting to recover.

In a way, this move to the extremes reflects the growing confidence of European investors, which are increasingly adopting Silicon Valley style investing, i.e. less focus on managing the downside (worrying about the probability of success), and more emphasis on the size of the upside. Of course, they are egged on by US investors, which are becoming increasingly involved with European companies as illustrated by two (out of six) of the Large HTI transactions featured in our November Bulletin (Spotify and Scanadu).

As mentioned before, there is definitely a hint of a bubble forming, driven by excess liquidity. So, back to 1998 or 1999? Perhaps not quite:

• This time, the underlying web infrastructure is here. In fact, we are about to become an always-on broadband wireless society, which is probably as profound a change as when we moved from dial-up to ADSL.
• We do get businesses which scale at the speed of light with solid network effects (even if such positions are not easy to hold for long – see MySpace, Friends Reunited, etc.)

Regardless of the underlying merits of this new investment cycle, we know where the movie ends, and as soon as the excess liquidity is sucked out of the economy (starting c.2015) and overheated battles among taxi apps, restaurant booking apps, furniture-to-order, holiday rentals, smartphone card payments, etc. claim their first victims, investors will start beating a retreat.

That's why the Go4Venture team start to see hints of caution, with venture funds moving away from B2C’s breathtaking valuations to spend time on more mundane B2B plays, and US investors arbitraging price by increasing their exposure to the cheaper European venture market.

Investors are even returning to neglected, but perhaps more defensible, sectors such as medtech, software or even drug development and semiconductors. This is part of a quiet revolution happening before our eyes: a further division of labour by which corporates are increasingly outsourcing much of their R&D to startups, creating all manner of new investments and acquisition opportunities for venture companies. As TechCrunch rightly put it, “as software eats the world, non-tech corporations are eating startups”.

What this means is that venture success will be increasingly found outside the ‘hot’ sectors jealously guarded by Tier 1 venture investors and, on the contrary, in verticals occupied by large corporates.