Europe Nursed a Hangover in 2022 As VCs Flag Return to Fundamentals

• VCs returned to slower capital deployment and due diligence processes after a record-breaking 2021.
• Higher cost of capital, inflation, and lower growth expectations have put investors back in charge.
• European startups raised $16 billion in the third quarter – a 44% annual drop, per Crunchbase.

If 2021 was the year of FOMO, then perhaps 2022 could be characterized for investors as the year for the joy of missing out.

The COVID-19 pandemic and the last remnants of the era of cheap money led to reckless abandon in funding markets with tech startups raising capital at record rates, often at valuations untethered from reality.

Funding to European startups more than doubled to $116 billion in 2021, according to Crunchbase data. VC cash dried up considerably this year with investors pumping $16 billion into startups in the third quarter of 2022, a 44% annual decline.

Now, with interest rates spiking, inflation at multi-decade highs, and fears of a recession impacting growth forecasts, tech investors appear content to take their time again before making a few select deals. 

“I don’t think it happened overnight but there was definitely the feeling from last year, into the first quarter of this year, that growth was just never ending and that trees grow to the sky,” Sarah Hinkfuss, a partner at Bain Capital Ventures, told Insider at the Slush conference in Helsinki. “There was a total disconnect between what growth projections were and what was actually happening in the world.”

Numerous VCs told Insider the past two years had felt like an out-of-control celebration with many “now looking around at the aftermath and thinking about tidying up. “

“The ecosystem is nursing its hangover after two years of a big party,” Arne Morteani, founding partner at Kiko Ventures said. “As with every big party, sort of slightly, regretful about a lot of unreasonable things that have happened. So, those mistakes will take some time to clear themselves out.” 

After the party’s over

The result is that investors are going back to a slower deployment pace with longer due diligence processes. Valuations have dipped significantly too, a boon for VCs who are looking for massive outperformance to return their funds versus the lower thresholds required from sovereign wealth funds and crossover funds, like Tiger Global, for example.

For Morteani, a number of less traditional – or tourist – investors placed enormous pressure on the European tech ecosystem, ramping up prices in the process.

“So now they’re leaving,” he said. “Now the ecosystem is on its own and can do reasonable things again.”

A focus on business fundamentals has been widely touted by investors, alongside a push for profitability over growth, and an emphasis on unit economics. Portfolio companies have been advised to extend their runways and plan for the worse and the bar for completing new business has been raised by funds.

VCs told Insider that the quality of revenue was now being brought into starker focus plus an increased emphasis on burn rates, customer acquisition costs, as well as managing their hiring and marketing spend.

“I want companies to have their budgets in order and to figure out what they have to prove to get to the next step,” Hinkfuss added. “We’re looking for an actual business plan, not a hope that money just falls from the sky.” 

Chasing high-quality, recurring revenue now could be too late – ideally investors would have safe companies before a downturn.

Tech startups at the growth stage have also been caught between a rock and a hard place, with increased growth and revenue figures no longer in demand, businesses have been forced to cut back. Others have found the market unsympathetic to their capital raising needs with the looming spectre of down rounds leading some to consider structured funding rounds with onerous terms.