Corporate innovation to benefit from healthy start-up outlook

European investment in start-ups bounced back from an initial dip after the onset of the pandemic, and is now on track for a record year, according to the latest State of European Tech report by venture capital firm Atomico. This bodes well not only for the start-up ecosystem itself but also corporates whose digital innovation initiatives benefit from the ideas and offerings it incubates.

Overall investment took a knock in the first half of 2020, with mid-size rounds of between $20m and $50m the hardest hit as growth-stage companies struggled to garner the traction they needed to convince investors, the report finds. But activity rebounded in the third quarter of the year, setting European tech investment up for a record $41bn year, mirroring a similarly strong performance by tech across the Atlantic.

On the whole, the outlook for European tech is bright, says Tom Wehmeier, partner and head of insights at Atomico. “The headline of this year’s report is that Europe’s tech industry has been a net beneficiary of the shift to digital brought by Covid-19,” he says. “While this flywheel is spinning more slowly for certain sectors, growth stages and countries, overall we are seeing an acceleration in investment and innovation.”

The focus of investment has shifted this year, away from previously hot areas such as fintech in favour of health tech and telecommunications. The change in focus has led to a change in the geographic spread of funds across countries. Leading tech hubs like the UK and Germany saw investment levels fall compared with 2019, while other countries including France, Sweden and Finland registered record levels.

But even where start-up funding did drop, the levels remained impressive, says Wehmeier, with the UK still representing more than a quarter of capital invested across Europe and countries like France, Sweden and Finland registering record figures. ‎

Although start-ups sometimes pose a disruptive threat to established companies, in general corporate innovation benefits from a healthy start-up ecosystem. Venture capital-backed start-ups yield innovation spillovers – ideas and techniques that other companies can use – more than nine times higher than corporate R&D, according to research by the Centre for Economic Policy Research (CEPR). And these spillovers are especially beneficial to large, established companies.

Corporations often tap into start-up innovation by funding accelerators and incubators. According to Marta Domínguez, associate professor of innovation and technology at IE Business School, Covid-19 has prompted corporate backers of accelerators to shift their attention from early stage investment towards driving adoption of more mature offerings.

“Rather than supporting the breeding of start-ups no matter their industry, as in a traditional start-up accelerator, some big companies are using the early adopter user model,” she says. “An example in the telecom industry is Telefonica Tech using the services [and investing in] start-ups in cybersecurity.”

But it’s not all good news. Artificial intelligence, machine learning and cloud computing, all high priorities for enterprise organisations, saw the steepest drops in investment. While funding for enterprise software start-up is dropped 10% year-on-year.

More worrying for the future, investment in companies focused on developing deep tech capabilities – which includes areas like machine learning, artificial intelligence and big data – fell almost 13% on 2019 levels to $8.9bn in 2020, according to the Atomico report.

Deep tech requires large amounts of scientific R&D and so does not have the same momentum as other technology, says Domínguez. “I don’t see as much activity in scientific advancements as I see in other technologies,” she says, adding this is potentially “due to the scientific type of innovation, which is slower and has fewer unicorns making the headlines”.

But while investment has slowed significantly for sectors including real estate, travel, and transportation, some of the strongest companies in these sectors, such as Omio and GetYourGuide, have defied the odds and raised huge rounds despite a collapse in demand, says Wehmeier, signalling that there is still a lot of momentum behind good ideas.

“For other sectors, the pandemic has been a tailwind,” he adds. “Health tech companies raised record amounts this year, and European SaaS is also firing on all cylinders.”

In recent years, Europe has been the breeding ground for leading software-as-a-service (SaaS) tech, a key driver of faster innovation. This year it continued on its upwards trajectory with a record $12bn windfall, taking total investment since 2016 to more than $40bn.

More broadly, the pandemic will act as a catalyst for innovation spillovers between start-ups and enterprises by forcing corporates to adopt a faster pace of digital transformation.

With companies reorienting themselves to changing preferences and spending patterns, this is already underway, says Wehmeier, adding that the shift in attitude is reflected in hefty acquisitions of venture capital-backed companies such as Spain’s Puig and Germany’s Flaschenpost by multinationals.

“That shift has injected urgency into boardroom discussions. It’s been a topic for years, but this is the year that things had to move from talk to action,” he says.