Europe ventures into the unknown

The continent looks set to follow in the footsteps of the US as venture lending gathers steam, but challenges lie in wait.

At the tail end of last year, the European Investment Bank agreed a €20 million venture loan to AImotive, a specialist in artificial intelligence technology for self-driving cars. The aim was to fund R&D that would ultimately enable the Hungarian company to improve its products.

It was a deal that simultaneously showed both the potential of the venture debt market in Europe and the obstacles it faces.

On the one hand, the existence of a pioneering tech company far from the historical centres of London, France, Germany and the Nordics, testifies to the wide and deep pool of expertise across Europe that is working on projects that would benefit from venture loans.

On the other hand, how many potential lenders, or even their usual advisers, know about the business and legal environment in Hungary? How many can be reasonably confident they understand how a debt restructuring might work? These issues are particularly important in the higher-risk world of venture lending.

Venture lenders are acutely aware of the challenges of doing business across such a diverse continent, and these challenges are not just in relation to legal issues. “If I want to be a successful European venture debt lender and I want to lend to a French entrepreneur, they kinda want to talk to a French guy,” noted David Spreng, founder, chief executive officer and chief investment officer of Runway Growth Capital, in a recent conversation with PDI. The US venture debt provider has yet to make a European loan, but Spreng has in the past worked in Europe’s venture market.

Another challenge is persuading limited partners to take European venture debt investing seriously. Many recoil at the bothersome due diligence, and ongoing monitoring, that comes with in investing in a new fund, when the small size of many of these vehicles limits how much money LPs can invest. It’s a classic vicious circle.

But there are also plenty of reasons to believe venture debt will grow across the continent. In the US, debt makes three times the contribution to total venture funding that it does in Europe, after allowing for the markets’ different sizes – something we’ll be discussing in an article in our September issue. Yet there is no inherent reason why this should be so.

A cause for optimism is the growing size of the biggest European funds, which could create a virtuous circle by piquing the interests of the continent’s larger LPs. Kreos Capital’s 2019 vehicle, focusing on Europe and Israel, is worth €700 million, up from only €400 million for its 2016 offering (though Kreos styles itself as a “growth debt” rather than “venture debt” manager, as about half of its borrowers are already in the black).

Another reason to feel bullish is the harmonisation of insolvency and restructuring  regimes prompted by the EU Preventive Restructuring Framework Directive, which was agreed by member states in the same month that the AImotive deal was struck.

Various issues mean venture debt investing in Europe is unlikely to progress in a smooth and straight line, like (hopefully, at least) the autonomous vehicles that AImotive is working on. But it is still likely to grow – even if lurches forward, followed by juddering halts, will be the order of the coming years.

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