Returns for venture capital funds are down in both Europe and the US, leaving limited partners in a difficult position when considering where to make future commitments.
Many factors contribute to a fund’s success, and geography is one of them. Past performance doesn’t guarantee future results, but it can be a good indicator. So which delivers better returns: Europe or the US?
Based on a PitchBook analysis of the internal rate of return of 981 VC funds, US vehicles performed worse than their European counterparts over a one-year horizon. Europe recorded an IRR of -1.6% compared to -4.9%.
But over longer timeframes, US vehicles perform better by significant margins, particularly over a five-year horizon.
The US market’s ability to generate a higher IRR in the long run largely comes down to its size and maturity, as well as a deeper exit market.
The timing of exits is critical to a fund’s IRR. Earlier exits provide a quicker payoff, increasing the rate of return. As of Q2, the median time between a US-based startup’s first VC round and its exit stood at 5.1 years compared to 5.4 years in Europe, according to PitchBook data.
In the US, exits have been completed in a shorter timeframe, but they are historically much larger across all types. Over the past decade, the median exit multiple over the first VC valuation—the comparison between a company’s exit value to the company’s valuation during its first VC round—was higher in the US almost every year.
This changed, however, with the public volatility in 2022 that badly impacted tech stocks. The IPO market shut for the highly valued tech startups that have been much more common in the US. Europe’s median exit multiple overtook in both that year and 2023. This dynamic contributes to European VC’s better recent IRR figures.
For the short-term, in all four quarters of 2023, Europe’s rolling one-year horizon IRR came in above that of the US.
As previously mentioned, exit multiples helped increase the IRR for European VC funds—but so too have valuations.
Since 2022, valuations have come under pressure for many startups on both sides of the pond, but the US has felt the effects more heavily. For almost all stages, valuations fell further than in Europe.
The outperformance of European VC funds’ rolling one-year horizon IRR over US funds in 2023 can be closely linked to the disparity in how the downturn impacted valuations of VC-backed companies in the two regions. Since 2022, valuations have come under pressure on both sides of the pond but the US has been impacted more heavily. For almost all stages, valuations fell further than in Europe.
This is partly because the 2021 valuation peaks in Europe were less extreme than in the US and, as a result, price tags were more stable and markdowns weren’t as severe. Since the rolling one-year horizon IRR is a short-term measure, it is sensitive to valuation changes within the 2022 to 2023 period.
This trend, however, has since changed this year. Barring the pre-seed stage, US venture valuations for each stage are either on par or significantly higher than in Europe. For late-stage companies, as an example, the median price tag increased 43% in the US, while it fell 2.8% in Europe from 2023 to H1 2024.
Preliminary returns for Q1 2024 showed US VC funds sailing ahead of Europe—1.9% compared to -15.7%. A faster recovery in valuations, as well as a relatively well-performing exit market, are strengthening US IRR.
While horizon IRRs appear to support the overall outperformance of US VC funds, they can create an apples-to-oranges comparison by including both older and newer funds, distorting performance due to varying stages in their lifecycle. Vintage IRR, however, provides a clearer apples-to-apples view by comparing funds launched under similar market conditions and over their full investment horizon.
US VC funds with pre-financial crisis vintage years—the year a fund makes its first investment—significantly outperformed Europe.
At that point in time, the European VC market was a fraction of what it is today—€4.6 billion (about $5.12 billion) was invested in 2007 compared to €56.7 billion last year, PitchBook data shows. Although the same can be said of the US market, it was more than five times larger in terms of annual deal value compared to Europe.
Greater tech-sector growth and capital availability in the US led to a stronger market. But the two converged as IRR fell sharply when investors pulled back on riskier investments and valuations declined with the financial crisis.
For fund vintages from 2011, the two locations have broadly been in line with each other until 2016, when the median European IRR shot up ahead of the US. That year marked the start of a significant period of growth for Europe’s startup market, with deal value steadily increasing until 2021. The region’s unicorn herd ramped up significantly, too, and with lower valuations than in the US, European VCs were positioned to capture significant investment gains.
With vintages only going up to 2018, it will be interesting in the years to come to see how those who made their first investments in the VC bull years fared in a more bearish environment and if Europe continued to outperform.
There is another metric that is perhaps more important to LPs: distribution. The potential profitability of investments offers a more forward-looking evaluation of fund performance, but distributions—the actual cash returned to investors—provide a tangible and realized performance metric that is less influenced by subjective valuations.
Looking at PitchBook data from 2019 onward, the answer for which fund strategy distributed more to LPs is somewhat unclear.
During the bull years when investments were accelerated with the pandemic, the US came out on top likely due to the outsized valuations and blockbuster exits of the time—Europe saw similar trends, but both were comparatively smaller.
Since the downturn, the gap between distributions for European and US funds has narrowed but remains close, particularly in the 2023 quarters. With the exit market seemingly stronger in the US, distributions will likely be in their favor over Europe in the short term.
Looking ahead, the European VC ecosystem’s recent momentum suggests that its growing market will continue to drive strong returns but, as global VC markets recover, perhaps to a lesser extent than the US. Ultimately, the future performance of VC funds in both regions will depend on strategic foresight and responsiveness to the ever-changing global market.
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