Inflection Point: The Path To IPO
The past several years brought waves of international Crossover Investors to Europe, drawn by a thriving ecosystem of innovative startups and bold entrepreneurs. These firms, who invest in both private companies and post-IPO companies, turned the ecosystem upside down as they began writing 9-figure checks that sent valuations soaring, a boon for entrepreneurs and a shock for local investors.
However, the impact of Crossover Investors goes beyond simply writing big checks. If Europe wants to become an engine for creating world champions, the ecosystem must understand and leverage the ways Crossover Investing can accompany the best startups from early stages to post-IPO where historically the most value is created. For too long, the inability to guide the best startups through their public market journey has meant that Europe has been failing to capture the full financial potential of its innovation economy.
This may seem less urgent at the moment because the last 18 months have seen investments and valuations drop sharply, driven down by economic turbulence that has effectively closed IPO markets for the moment. But it’s important to recognize that even if funding has cooled, European founders continue to build companies that could become global players.
GP Bullhound recently noted that 34 new European unicorns were created between March 2022 and March 2023. The European ecosystem may have slowed, but it continues to grow compared to pre-pandemic norms as innovation and entrepreneurship remain resilient.
For these companies to become global powerhouses, they will need Crossover Investors to play a key role in helping Europe bridge the chasm between its private and public financial markets.
Defining Crossover Investors
Crossover Investors broadly fall into three categories:
- Hedge Funds: These fund managers allocate a portion of their assets in the opposite direction of their primary focus to offset (hedge) against potential losses. This method allows them to take bigger risks, and the liquidity requirements mean they’ve tended to focus on public markets. More recently, they have been taking excess capital and backing startups, attracted by the potential of large multiples on their investments.
- Private Equity: Venture capital and growth equity are the two types of PE most relevant to startups. The first traditionally has entered at the earlier stages, and the latter when the startup is scaling to a significant size. But to some extent, both have begun investing in public markets as well.
- Anchor/Cornerstone: These investors are the lynchpin for succeeding in the public markets. Cornerstone investors will validate the IPO price range while anchor investors will commit to placing an order at the IPO opening. Both are key roles in facilitating the passage of a company from private status to public markets.
Crossover Investors have become increasingly important to startup funding over the last 5 years, providing a powerful source of late-stage capital. These include marquee names like SoftBank which raised $100bn to create the SoftBank Vision Fund in 2017 and then proceeded to make massive investments between 2018 and 2019. Meanwhile, VC growth funds like Altimeter and Sequoia HF initiated public equities practices.
Seeing the impact
Revaia’s landmark study, “Inflection Point: The Path To IPO,” provides some key lessons and analysis, offering a strong overview for understanding Crossover Investing’s impact.
Until recently, the majority of Crossover Investors have been based in the U.S., making this largely an American phenomenon. As recently as 2021, 50% of Crossover Investors were located in the U.S. where they accounted for almost 50% of capital raised that year.
In contrast, by 2021 just 15% of Crossover Investors were based in Europe. Still, that European market share doubled in 2020, reflecting the rapid acceleration of Crossover Investing just about everywhere.
While this trend took longer to arrive in Europe, it was in full bloom by 2021 as Crossover hedge funds like Coatue and Tiger Global financed companies like Alan and Dataiku. In Europe, 26% of venture capital rounds in Europe were made by crossover funds compared to 13% five years earlier.
Beyond valuations and funding numbers, Tiger Global is emblematic of how a hedge fund also accelerates the speed of fundraising. At one point, Tiger Global was making more than one deal per day. It participated in 380 deals – 10% of the total globally – in 2021. With 200 employees managing $100bn of assets, rapid deployment was imperative to get the returns it sought.
Crossover Investors doubled their share of European VC funding between 2017 and 2021, participating in 4% of all deals but accounting for 13% of all money invested in European venture-backed startups.
Average funding rounds in Europe tripled between 2020 and 2021, closing a historic funding gap with US startups. Between 2017 and 2021, the average funding round in the US was $147m compared to $76m in Europe. By 2022, the average deal size in Europe reached $165m, topping the US for the first time.
Why it matters
The European startup conversation has long focused on catalyzing the emergence of a local venture capital industry. That’s an understandable goal for boosting an ecosystem that was badly lagging a decade ago.
And yet, much of the value creation in top-tier tech happens after the IPO. That’s a critical complement to building a more robust innovation economy.
Crossover Investing plays an important role beyond writing a check by aiding with this important shift in mindset. Currently, an IPO is still viewed as an “exit,” an endpoint to the journey for startups and investors. As a Crossover Investor, Revaia understands that an IPO or an acquisition is just a milestone, albeit an important one, to realize the full valuation of a startup.
This starts with instilling this long-term perspective in a startup while also assisting with the practical steps to get ready for an acquisition or IPO. That preparation includes the finance team, but it must permeate the whole organization.
In the case of a Crossover Investor such as Revaia, our value proposition to our portfolio companies is clear. We identify these companies early and then accompany them throughout their financing journey. This brings us closer to the company, which in turn allows us to be even more relevant in the analyses needed for them to succeed in an IPO.
This relationship gives us access to a lot of information which means we can dig deep, identify potential issues, and correct them before an IPO process starts. That includes advising them on non-financial issues like ESG and governance. To win the confidence of public market investors, governance is going to be one of the key elements on the road to the IPO. We also help add independent board members and set up best practices to meet financial and non-financial compliance.
Olivier Pailhes, the co-founder of Aircall, went through a similar process when Goldman Sachs invested. Here’s how he described it for our report: “When Goldman Sachs came in last year, things changed. They have a different way of looking at things. Of course, they look at the numbers, the metrics, and the growth potential, but they look a lot at compliance, the way the company is organized and structured.”
On a practical level, a Crossover Investor also makes these markets more fluid, whether the company is listed or unlisted. It’s not just about getting the IPO. The IPO has to be successful to continue to attract investors.
An IPO is not prepared overnight. As we know, it takes several months, even several years to prepare. One of the key roles of Crossover Investors is to assist in laying the groundwork for the IPO with parties like asset managers.
The IPO is also where the Anchor/Cornerstone investors can play a critical role. By investing close to the IPO, a cornerstone’s money is a sign of confidence to the market that the share price and valuation are reliable. Anchor investors build on that confidence by agreeing in principle to acquire shares at the opening price before orders are taken, another important signal to bolster trust and transparency around the public offering.
This latter category of Crossover Investors is an area that still needs much attention in Europe. Euronext, as part of its TechShare program, has launched some initiatives to strengthen this category. And the French state bank Bpifrance has stepped in to become a cornerstone and follow-on investor with €500m as well as creating a Cornerstone Investors Club to connect PE funds and institutional asset managers.
At Revaia, we have 15 companies in our portfolio, three of which have exceeded the €100m ARR mark: Algolia, Mews, and Aircall. These are companies that could potentially be eligible in the medium term for an IPO. Our goal for them – and for our entire portfolio – is to do everything possible to maximize the chances for a strong IPO when it’s relevant. We believe the public markets will form the foundation of the next stage of their financing journey.
Conclusion
The frothiness that resulted from many of these recent trends has ebbed. In Europe, we saw declines of as much as 50% in Crossover Investment in 2022, with a particularly sharp drop in Q4. The reality is probably worse because a large number of companies in Europe announced 9-figure fundings in early 2022 that were likely closed in 2021.
But this is likely a pause, not a full-blown retreat. Over the long term, we believe that the sluggish market for late-stage fundraising will pick up again.
At uncertain moments like this, it’s more important than ever to hold tight to that long-term outlook. Over time, the trends we identified will resume and continue to rewrite the rules. Crossover Investing is here to stay and will play an increasingly important role in the ecosystem by reinforcing sound governance and sustainable growth.
As Crossover Investors, we are bullish about the capacity of our category of funds to provide companies with the right partnership and tools to guide them on their path to IPO.