E551 | This Week in European Tech with Dan, Mads & Joe Knowles

0:00Welcome to Upside, where we dig into the real stories that live behind the headlines affecting European venture. Today, it is Mads, myself, and we have a very special guest, Joe Nault.

0:22This show is not investment advice, and the hosts of this episode may be invested in the funds and companies featured. Now, Joe is from Smedvig Ventures, who are a London-based VC, leading A and B rounds across Europe. He's a B2B guy like us, investing in software and software-enabled businesses, a very super-duper outdoorsy, keen skier, surfer, and all-round cool dude. Welcome, Joe. Thank you so much for joining us. So we've got a bit of a left-field-y conversation about the history of US wealth creation. M &A is up. What does this mean? Mergers and acquisitions. Lots of acquisitions going on.

0:57We've got German Megafund. We've got another defense fund that's come out of the woodwork. So we're going to talk about that. Energy. Now, I've seen there's lots of news around energy, nuclear generation, battery storage, battery technologies. And then last up, we've got the latest in AI. As always, lots and lots of stuff going on in AI. GPT-5, taking a look at that. Some big deals, deep seeks, chip needs, and a few more topics. Let's crack on, gentlemen. Is the US the only place to make money? I was reading Ruchir Sharma. He wrote an interesting piece this week, challenging the widespread belief that the United States hold this unique and unassailable position in wealth creation.

1:36Now, around the world, there are many organizations of people who have built remarkable returns in wealth, as we all know. But to break down some of the figures, he looks at what he calls compound performers or companies that are returning more than 15 % annually. Now, of the 444 with market caps over$10 billion, 248 are outside the US. Of the estimated 13 trillion in private assets, nearly half is held outside the US. Now for VC and infrastructure, it's slightly more. It's about 50 % or just over. 40 of the top 100 unicorns are outside the US. 70 % of new billionaires are not in the US. However, only 2 % of the world's top 50 tech companies by market cap are European.

2:15Europe has only around 50 of his compounder firms. That's about 20 % of the market. it. But if we look at VC, it's growing five times faster than our lovely cousins over in the States. And the number of startups in Europe has grown. The numbers seem to be a bit blurry depending on which data set you look at, but it looks like from roughly 8 ,000 to 35 ,000 in the last decade. So growing and growing and doing fabulous stuff. So US obviously is a machine. We all know this, but they're also great at their own PR. So a question for the room, and maybe Mads, I'll pick on you first. What's wrong with this story?

2:51I think it's a very generous interpretation of what the US is or isn't doing. It's almost sort of presented as if the US only being 44 % of the global compounders is not quite the achievement one would expect. But they're putting into context of the United States being sort of what, you know, less than 5 % of the world's population and still creating, you know, more than almost half of the world's compounders. That's one thing. And I think the second thing is going to look at this in the context that this is the number of companies without the market cap. And we all know if we look at the market cap, the concentration to the U.S.

3:24will be even bigger. And that's one of the reasons why today, shockingly, over the last 15 years, we've gone from a Europe that looked like it was relatively close to the U.S. performance wise to the U.S. today having a median GDP per capita. That's almost twice Europe's, if not more. So, I mean, there is just more wealth that's been accruing there. The question is, you know, how can you unpack some of that stuff? There's nothing happening anywhere else. And I think there are some green shoots that he's pointing out in the article you referenced. So Europe has got more than 50 of these global compounders.

3:55It's 11 percent. It's not 44 percent. But we also have a lot less capital going into building these businesses. And that's one of the reasons why the internal rate of return, when you look at venture capital, actually is a little bit higher for European VC than for US VC, according to Cambridge Associates. So, you know, why is Europe still behind? I mean, there are all kinds of things there around capital allocation and how much money is invested and how do we build these capital accumulation and get enough money to the right companies. And I'm sure we're going to unpack that. But I would love Joe's thoughts on some of all this before we go there.

4:29Yeah, go for it, Joe. I mean, you invest across Europe. You've been in the game for a long time. Not saying that you're old, my dear man. The other thing I will very quickly point out before I hand over to you, Joe, is that Richie is Indian and there were lots of references to India. And it felt like there was a slight skewing to the motherland for him, which I don't blame him at all. But it did, to your point, Mads, it did feel like there was some skewing of the content and the article just to make it sound a little bit more non-US and a little bit more India and a little bit more other, which I'm not convinced by.

5:03But Joe, what would you pick up on here? I agree with what Mads said, but I think the US has undeniably been a huge value creation machine, and that's been great for the US, and it's actually been great for everyone else as well. I think an important piece of context is, to Mads' market cap point, the numbers are heavily skewed by the fact that the US won the internet race. And so there's sort of five to 10 internet infra hyperscalers that have just had completely outsized value creation. And that's obviously great for the US. Would have been lovely if that happened in Europe. But it's very concentrated, right?

5:36It's a small number of companies and individuals that have benefited from that. I think that does skew the overall perception. And actually, if you strip those things out, there is a slightly more balanced picture. I agree with Mads, though. It's still the sort of comparison benchmark of, oh, the US is only 15%. It's still a slightly skewed way of viewing it. But I do think you've got to bear in mind that context of those very small number of hyperscalers that skew the numbers. I think if you look at Europe, though, what have we got? We've got some amazing engineering talent. We've got entrepreneurial spirits, amazing entrepreneurs, and actually a culture of founding businesses.

6:10The stat you referred to, Dan, around the rate at which it's growing and closing the gap in the US is very promising. We've got great early stage funding, including some smart government incentives. I think the issue really is around later stage funding and the exit market, which is in part a byproduct of this kind of ecosystem that's emerged around the hyperscale. I think that's probably the biggest issue we face in Europe to this point. There's some other things going forward that we'll come on to around AI and choking points and power of compute. But I think just in the rear view mirror, it's that late stage funding and exit market that I think has really held Europe back.

6:44I'm sure we can discuss a bit more why that is. Yeah, no, I agree. I mean, just for context, it looks like the US has roughly double the number of startups in action at the moment than Europe and the UK, about 73 odd thousands. And it is, as we've been discussing, there is a massive growth rate difference. Europe is growing much, much quicker than the States because there's obviously a long space to catch up. Focusing specifically on Europe, what levers do we have and what competitive advantage and where should we lean in? European companies generally are more capital efficient. The cost to create an additional dollar of revenue for a European B2B startup is lower.

7:27It costs, I think, more than two times as much to create an incremental dollar of revenue for a U.S. B2B company as it does for a European company. So, you know, we're just more capital efficient. And, you know, part of that is sort of making virtue out of necessity. There's less capital. So you've got to be smart about these things. But if we want to create lots of big companies, we have to put more capital to work. We can't let all of them be acquired by large U.S. corporates or even IPO in the U.S. We've got to have money here to invest and to let these companies grow. And so if you look at some of the root cause analysis, I mean, we've talked about pensions before.

8:01In the U.S., the allocation to venture from the pension ecosystem is about 100-fold what it is in Europe. When you look on a percentage basis, there's almost no European pension money in venture. And so that just means there's a massive chunk of capital that you don't have in the system. And it's really interesting when you think about why that might be. And I think we've discussed part of some of the things you could do to solve it previously. But why is the system locked the way it is? And it turns out that if you take the UK, for example, so UK pension funds, they hold more than 25 % of all guilt, all kind of the UK government debt.

8:41And so the government needs the pension funds to keep buying UK debt. And so there's some analysis that says that if the UK pension funds stop buying as many gilts as they do, interest rates would go up. And so there is a conspiracy theory that says that the reason why the pensions are not being set free is because the Treasury actually is quite happy to have these four pensioners being flocked, all these gilts, because we need them to service this dreadful deficit we're lumbered with. And of course, a much better thing to do would have been to put more money into productive assets so we could create a faster growing economy and create more tax receipts and have less of a deficit.

9:19That's a UK thing, right? Rather than a European one? Yeah. So it turns out that some of the rules you have around kind of these, the prudent man rules and some of these systems that prevent more allocation to venture actually are quite similar in the UK, in France and in Germany. and they've all originated from different places, but you have fee caps and you have restrictions around what trustees should do. And specifically to the UK, the rules I know the best, specifically to the UK, when you're a trustee, the prudent thing to do is not to have volatility in the performance of your investment.

9:53Now, you and I, we might say, well, actually the prudent thing to do is to figure out how you can maximize long time returns for your pensioners, but that is not how the rules are interpreted in the UK. then much more narrowly to say you should not have drawdowns and therefore you should have a bigger proportion of your assets in in gilts and bonds and something that isn't as volatile and already there you can start to see part of the issue yeah presumably if you lifted that cap that would that would help with the later stage funding proper right because the pension fund gap is what can fuel a lot of that later stage level of capital i think there i think there's three three aspects to this so one is you've got you absolutely you have to lift that the second thing is what equities do you then invest in if you invest in equities?

10:36Do you invest in U.S. mecca caps if you put money in Europe? And again, it turns out that you get the same tax breaks that are very generous, by the way, more than 40 billion pounds a year is with the treasury spends on pension tax breaks. You get the same tax breaks whether those pension funds are invested in productive assets for the UK economy or whether they're put into U.S. mecca cap stocks. And one could question whether we should subsidize those U.S. mecca caps twice quite as much as we do. That's the one thing. The second thing is, once you've said, okay, more into equities, the question is, which geography do you put the equities into?

11:10And there's kind of the incentive. And the third thing is fee caps, because we know that private equity and venture capital is more expensive to run than listed equities. Now, I'm a huge fan of having more liquid listed equities. I think we should have many more companies go public. I'd love for them to go public in the UK. You're going to have a feeder system. You're going to have growth capital. and if you have fee caps that are very low, you can't afford to put money into venture capital. And again, there's a structural issue with how the pension system is set up. So I think you've got to tackle some of all these things in parallel and then you can start to unlock the capital.

11:43Anything else, Joe, that you'd add? I mean, what other blockers can you perceive? What else would you add to the argument? Yeah, I think the late stage funding is the big one for me. And I think the way pensions are structured here is a big factor for that. The second is the IPO and the exit markets. One factor of that is the later stage funding, because if you have to go to the US to get the later stage funding, then you're going to end up selling or IPOing over there. The other is that, unfortunately, one of the byproducts of the US winning that internet race over the last couple of decades is that the NASDAQ has absolutely ruined.

12:14And there is, again, a small number of very inquisitive companies in the US. I think that's going to take time to unwind. But ensuring we have that late stage funding here, I think, is at least one step towards that. AI is the new internet race, right? Yes. You could argue. So how do we maximize our opportunities with AI? Yeah, and this is what I'm really worried about, right? Because there was a winner of the internet race, and that was the US, and that was great for them. Would it be nice if it could have been Europe? But arguably, it's not the end of the world that it wasn't. There's still huge amounts of value created off the back of the internet here.

12:48The thing I'm worried about with the next phase, which is the AI race, is not that we don't win it. Again, we might do, but it's unlikely. I think the US probably will again. What I'm worried about with the AI race is that we actually lose it by quite some margin. And we're not a sort of second player. That's what I'm most concerned about with this. Some of the other continents are placing strategic bets in AI computes and power. I do think Europe has been a bit too slow and is not acting strategically enough there. When you think about some of the bottlenecks and choke points that are coming, I do think we could be strategically disadvantaged.

13:20And that's a big concern for me. Yeah, it's something we talk about a lot. We do rattle around a lot. I mean, we are going to talk a bit about energy later, which I think will be a massive unlock if Europe can get low-cost energy into business and into data centers, et cetera, et cetera. But the other topic that I want to talk about very quickly now is M &A. H1 has been bumper for startup acquisitions. Why is this important? We're going to come on to in a second, but a few facts and factoids. H125, M &A total nearly 100 billion, up 155 % year on year, Deal count in the mid 400s, which is fairly static.

13:55However, the value is significantly up. So that's over the last three quarters. Deals over a billion and over 5 billion have gone up 17%, 16 and 17 % roughly compared to 24. Obviously, Google buying Whiz was a mega deal. It accounted for a third of that 100 billion at nearly$32 billion. That was the biggest deal in the part. Of the largest 12 deals, two are not US. There's one Oz and one Chinese. So it's not all, but it is pretty much US centric. The other thing that kind of caught my eye was what is an AI business in this context? So 15 million was disclosed as AI M &A, but I don't know how you work out what is an AI company and what isn't.

14:35Mads, start with you. Big bumper H1 for M &A. What is being bought? Who's buying and why? How do you unpack the 100 bill? You've already mentioned some of the big deals. I mean, if we look at three categories that dominate, one is clearly around the code generation. It keeps being the poster child of AI productivity enhancements. And if you look at the new frontier there, well, Windpurf, as you say, was in the headlines, kind of just shy of$3 billion deal that happened with Google buying parts and then, you know, others buying other parts. But the key thing there is Google is behind Anthropic when it comes to market share of LLMs for coding.

15:15So Anthropic is the competitor on the LLM layer. And then you have Cursor that's doing super well on the application layer. And Google is trying to play catch up. And so for them to get some of those windsurf skills, I think were key. Clearly, I want to make a big push there. Google was also very active on the security side with WIS acquisition. Again, you know, when you have more agentic enterprises, you need more zero trust security. and you have Google on one angle finding that AI battle and on the other hand still playing catch up as a hyperscaler behind Microsoft and Amazon. And so they need those security credentials to bolster their fight.

15:56And then the third thing is vertical applications within healthcare, within finance and elsewhere where buyers really want to prove an enterprise traction with AI, so not just tech. And so some of these companies that were bought there already have 100 plus enterprise customers. using AI. So those, I'd say, are some of the three big areas where we've seen the acquisitions. Joe, we have kind of mooted the fact that application layer is where Europe is going to shine. What would you, anything, any of these themes or topics that you would shine a light on or anything that's worth noting or anywhere where Europe can take a play here?

16:33Yeah, I think this is great for Europe, actually. I think the M &A and IPO markets have been cool for a while, mainly due to macro factors, rising interest rates, Ukraine, tariffs, etc. I think that period of wait and see is thankfully coming to a bit of an end now. But I think more importantly, there's been a sort of wait and see period on AI, a lot of hype. But now we're starting to see some things shake out, new categories being formed and some front runners in those categories appearing. Daily, there'll be the headline grabbers, some of the things Mads just talked about. The interesting bit for Europe, given where we are, is actually, I think, that second tier of acquisitions.

17:07Some of the incumbent strategics are now having to place bets to stay relevant, bets in the application layer, and or some of the more exciting businesses on IPO paths need to make bets to form their IPO story. I thought quite an interesting one was the nice acquisition of Cognigy. I think smaller ones would be, for example, Zendesk buying Klaus. I think there's going to be a lot of activity in that second tier of M &A, which is really good for the European companies, actually. I think the other really interesting trend is around AI-enabled services. This is an area we've been investing in a little bit, where I think actually businesses doing traditional services, but with their own AI core, so they can have a step change, better margin and scalability, they're going to start getting bought up by PE, especially as interest rates come down, as roll-up plays for legacy services businesses.

18:00So you can get a margin and a multiple arbitrage play. And again, I think that's probably pretty good for European VC as well. So I think it's pretty exciting, actually, as this window opens up. I think you're going to see a lot of that second tier of strategic M &A. And I think there'll be a lot of opportunity there. Mads, just stepping back, why is M &A important? For those that are, I mean, obviously, if founders are listening, they're kind of deep in it. They don't really kind of pay much attention as to what's going up upstream. But why is this all so important? Everybody's got a boss. Everybody's got a customer.

18:34If you're a founder, you're raising money to build your company. You're raising it from venture capital investors. If you're a venture capital investor, you're raising money from limited partners, which could be endowments or family offices. And even some of those, like fund funds, might be raising money from somewhere else. Everybody's going to get money and capital from someone. And at some point, they're going to expect some money back. And obviously, the time they get that back is when we have some exits. And some of that might be IPOs. Some of that might be trade sales. And clearly, this second piece here, this M &A activity when you have trade sales.

19:07That's when the dollars flow back up, the stack back up to investors so they can deploy new capital to new great things. And so it's a wonderful circle of, if not life, then at least of the venture and startup industry. And so it's absolutely essential. These exits, they're the lifeblood of what we all do. Yeah. And how else would you conclude this? What are the key aspects would you bring out? We've seen some really, really exciting companies come out of Europe and achieve unicorn status here in the last six months. That's not exits yet. That's still paper gains. But tomorrow's exits and dollar gains are created on the back of today's business progress.

19:43And so I think we're definitely seeing that. We've seen N8N. We've seen Lovable. We've seen some amazing companies wave out of the UK. Great, great businesses that will be tomorrow's exits. conundrum that European founders of VCs might face is you know that there's a load of incumbent system of record type players in almost every industry and I'm sure you guys have seen as we have a whole swathe of automation players sitting on top of that creating automations of the workflows and actually now we're getting to a stage where those system of record players will be looking for M &A to buy that layer above to protect themselves and that can be extremely attractive for VCs and founders.

20:23But probably the original vision of that automation there was actually, what's the need for the system of record? We can replace that in another five years, 10 years of growth. And that's the really big win. But how have we got the appetite for that? Because you've got to raise again, you've got to go really into battle with people that have been a bit friendly to this point. And so I think there's going to be some really interesting decisions that boards are going to have to make around, do we take a 500 million billion acquisition from an incumbent or do we actually go again and try and take them on?

20:52I think it's going to be really interesting to see that unfold industry by industry. I think you're connecting the dots here in a beautiful way, Joe, because that is exactly the experience that we have seen firsthand of the difference between a European ecosystem and a US ecosystem. If you want to displace the incumbent systems of record, it is a different level of investment to build that full stack platform from a capital perspective. And it's a different level of investment from a go-to-market perspective. It takes a lot more sales resource to get a Fortune 500 company to rip out their ERP platform than to buy some tools and stick on top.

21:27And so if we want to compete, we need more capital. And I think that's exactly the type of growth capital you were talking about earlier. So I agree with you. We should aim higher. We should go for gold. Well, let's talk about some more money coming through Europe, which is obviously only a good thing. So this week, we've seen Porsche and Deutsche Telekom in talks to anchor a 500 million euro defence fund. This is going to be run by DTCP, a Hamburg-based investment company. Now, interestingly, Porsche has dropped a previous requirement that it couldn't invest in defence. It was only doing dual use by its own terms before, but now it's relaxing its own rules.

22:08Alongside EIF, who are a mega investor across Europe and KFW, they're also relaxing their requirements around defence. Lake Star is also raising a 250 million euro defence fund. And I know of at least three other new and specific defence or dual use European funds that are coming online this year, one in France, one in the Netherlands and one in Germany. So we are really waking up, really waking up quickly. Question for the room, Mads, maybe I can start with you. Is this announcement specifically between Porsche and Deutsche a big deal? And where does it fit in context. I don't think it's a big deal in monetary terms.

22:44I mean, they've got 500 million euros, a quarter of a percent of what Europe needs. But I do think it matters who is doing it and how. I think Porsche and Doja Telecom are total mainstream corporate firms, and that's a super big market shift. If we think back, you know, for 70 years, German industry has been working really hard to avoid anything that looked like or felt like military. And so Porsche is probably backing weapons startups. That cultural shift is probably worth a lot more than the money themselves. We can unpack a little bit what's been going on under the covers. European defense tech investment, I think it was about$5 billion.

23:27So the$500 million is not a tsunami, but it's a sign that the tide is starting to turn. I think that's a good thing. To put that in context of Helsing and Enduro. We've actually seen Enduro founded about four years earlier than Helsing. I think it was 2017 and Helsing in 21. And although Enduro has a high valuation now, I think it's 30 billion versus Helsing's 14, it's taken longer to get there. So Helsing is actually growing a bit faster right now. And that's exciting. But the interesting thing is to get Helsing off the ground, we needed Daniel X money. And we just don't have that many you know founders that have built 100 billion dollar companies around that could fund this out of their pocket money and so that's why it's essential that we get the lease season to get it's all this off the ground so i'd say the money themselves not a huge shift but the fact that it's happening and that the sign that the tide is turning is very meaningful that comes back to your recycling point doesn't it it's not just money that gets recycled it's the actual founders that get recycled as well and then you can do magical things joe what would you pick up on here Would you think this is a good, bad, big thing?