Written by Rami Cassis
Take a quick glance at the world’s 10 biggest companies by market capitalisation and it is notable that none are from Europe. The table is dominated by the US and Chinese behemoths that have radically altered the way we live today – Apple, Amazon, Microsoft, Alphabet and Facebook.
The question is whether a European start up can ever emerge as a world giant. Europe has had its successes, for example Sweden’s Spotify, but they are outweighed considerably by the giants from the US and China. It’s also worth noting that technology is increasingly becoming weaponised and a means by which countries exert influence over others. Europe will need to behave very differently if it seeks to develop the scale achieved by its American and Chinese rivals.
For starters, and focusing on the US, businesses are typically sold at substantially higher multiples in than they are in Europe – by at least 20 to 30% on a like-for-like basis.
This valuation gap becomes even more pronounced with software businesses growing organically above 20 per cent a year or with a high level of recurring revenue.
One of the reasons for the disparity is that American investors tend to be more focused on growing market share and conviction on achieving the first mover advantage. In practice that means they are prepared to pay more for growth and are less concerned about immediate profit generation than their European counterparts.
Indeed, you only have to look at how long it took today’s biggest companies to make their first profit. It was nine years before Amazon first reported a profit, for instance, while it took Tesla a decade to declare its first profitable quarter.
Fundraising is difficult in Europe because it’s so fragmented. Notwithstanding issues around attitudes to risk, you find that investors – whether it’s debt or equity – are aligned to one or two single jurisdictions in Europe. It is something I recently discovered with a potential deal that I’m looking at. You have investors who say, “Well, I’m prepared to lend in Belgium and Holland, but I won’t do Germany,” others will say, “We don’t like France, but we like Belgium.” This is why the EU, as a concept, does not work well for mid-market firms that do not have the scale to say issue their own bonds. The EU needs much greater integration to create a truly single market in order for it to compete with the US and China. In that context, Brexit clearly does not help.
Culturally, I would also argue that US investors are more tolerant and welcoming of risk than many of their European counterparts. They are open to entrepreneurs whose early ventures have failed because they are better for it – these business owners have experienced failure at first hand and have learned from it. This attitude, in my experience, is mirrored by businesses themselves – those in the US appear to focus much more on sales and marketing than their European counterparts. They are more effervescent in the way they describe their businesses – although by the same token probably less precise. In Europe, the risk averse approach often filters through into the sales pitch for funds.
Scale is perhaps the major barrier Europe needs to overcome if its businesses are to become the next global behemoths. There is a difference in valuation and fund raising depending on scale – with the magical mark around $5m in profits but even below that there appears to be more opportunities and access to funding in the US than in Europe.
This issue is compounded by the fact that while the EU economy is almost on a par with the US in terms of size, the reality is that there is no single European economy – there are 27 individual economies. This just makes life harder for the mid-market in Europe to attract capital. If you have a business that makes €5m EBITDA but is split across four or five countries – and you’re trying to do a European deal – it’s more complex because corporation laws are different in each jurisdiction. Insolvency laws in the UK, for example, are more friendly than they are in say France where banks and lenders rank below employees, creditors and the state. Tax laws will also differ depending on the country.
Europe broadly maintains a somewhat socialist approach to money – it seeks to limit people’s compensation in its tax and fiscal policies, and this strangles entrepreneurship.
Unless Europe fundamentally changes this approach to money, and to risk, it will continue to stifle ambition. In short, access to funding, attitudes to risk and money and deeper single market integration all need to fundamentally change if Europe is to stand its ground both in terms of technology capability and mitigation of reliance on the US and China.