How Europe’s Growth Tech Can Win the New Reality

Written by: Torsten Kurth, Vikas Taneja, Mike Deimler, Johanna Puetz, Sebastian Jung, Courtney Dong, Ryah Whalen, Colleen McDonald, Sebastian Hillebrand, Mena Luesse

Despite the disruptions in demand and the decline in VC funding because of the COVID-19 pandemic, Europe’s start-ups will flourish in the more digital future.

The COVID-19 crisis has disrupted the decade-long boom in Europe’s start-up sector. Flourishing startups with digital business models, called growth techs, some of whom had attained unicorn status with values of $1 billion or more before the pandemic struck have been hit hard by fluctuating demand and a slowdown in venture capital (VC) funding that had fueled the previous expansion (See Exhibit 1).

However, despite the short-term disruption, there’s a great deal of optimism about the future prospects of growth techs. BCG conducted in-depth interviews with 35 growth tech experts as well as a pulse check with 70 investors. Three things became evident:

• VC funding will fall sharply in 2020 but is expected to rebound quickly next year.

• Many growth techs will benefit from the COVID-19-induced boost to the digital economy, but others will face short-term demand disruptions.

• Growth techs can win the rebound by taking actions that are appropriate to their state of funding and demand in their industries.

Most VCs in Europe are Bullish about a Rebound in 2021

Over half of all growth techs are concerned about a pandemic-induced funding squeeze in 2020, according to a survey conducted by the German Startup Association. That’s because, as the BCG investor pulse check showed, most VCs will not invest in 2020 as planned. Only one out of ten VCs still has all its investments on track in 2020 while the rest will delay at least some of the investments they had planned.

Market uncertainty is the primary reason for the delay in investments, which was best described by one of our interviewees as the “lack of clarity about how long COVID-19 will keep straining the markets, customers, and revenues of startups.” In fact, 60% of VCs consider market uncertainty to be the prime reason for slowing investments while other causes that are often discussed, such as the lack of attractive opportunities (21%) and inadequate funds (20%), trail that factor.

Luckily, the funding decline (expected to amount to 15% of investment volume in 2020) will be followed by a rebound in 2021. While VCs are bearish about 2020 (67% of them plan to invest less than they did in 2019), they are extremely bullish about 2021, with 84% expecting to invest as much as, or more than, in 2019 — a record year for VC investments in Europe. Thus, VCs expect their investments to return to their pre-pandemic levels — quickly (See Exhibit 2).

VCs Will Prioritize Europe’s Growth Techs’ Resilience

Interestingly, the rebound will come with some changes to the rules of the game, with most VCs likely to evaluate investment opportunities with different criteria. VCs will increase their focus on time to profitability while growth-at-all-cost strategies will find it harder to find backers.

Only seed and angel investors will attach importance to a digital start-up’s speed of growth but most investors, particularly, early- and late-stage VCs, will shift their focus to gauging the time to profitability and identifying “a short and verifiable path” to break even and positive cash flow. That’s a trend triggered by a few IPO failures, which saw valuations crash once some growth techs listed.

A significant number of VCs will look closely at the crisis management actions of the growth tech’s leaders as well as their ability to adapt the firm’s technology or services quickly to post-pandemic customer needs (See Exhibit 3).

Growth Techs Will Emerge Stronger than Incumbents

Many growth techs were not exempt from demand disruptions because of the COVID-19 lockdown and suffered from revenue and liquidity pressure just like the established players in their sectors. In the medium term, however, growth techs could gain a disproportionate share of the rebound.

Unlike traditional rivals, growth techs depend on digital technologies and business models, which have gained in popularity during the lockdown. The growth techs are asset-light and agile, which facilitated a reduction of the largest expenses, such as digital marketing, when the pandemic hit, and an increase during the recovery. Also, with public funding schemes in many countries, Europe’s growth techs have made limited use of layoffs so far, which has allowed them to retain their best human capital.

The Rebound Depends on Two Factors

COVID-19 affected the demand in sectors in which the growth techs operate in different ways. Because of the lockdown, digital services related to health, food, and education were among the short-term winners while those relating to people’s mobility and transportation were losers. Due to the reduction in B2B spend, services dependent on the level of economic activity, such as those of the fintechs and insurtechs, were also among the short run losers (See Exhibit 4).

The return to pre-COVID-19 growth trajectories is not expected to happen at the same pace for everyone. For some winners and losers, VCs expect the pandemic’s impact to linger a little before they return to their pre-crisis growth rates, making a V-shape recovery. However, for most growth techs, VCs predict a lasting pandemic impact and a slow, U-shaped recovery.

In fact, our analysis yields a surprising insight: The initial winners, such as digital health and education technology firms, will quickly slow to their pre-crisis growth rates, faster than say food delivery growth techs. That’s partly because of investors’ concerns that because of the structural barriers to digital business models, those growth techs cannot accelerate beyond their pre-COVID-19 growth rates.

For example, reimbursement by public health insurances is critical for the monetization of digital health models. But the current regulatory requirements have turned approvals of digital services into a lengthy process. Similarly, in virtual education, the existence of the digital infrastructure and the digital literacy of teachers and learners is critical for operationalizing tech-based business models. Unless digital devices and training are provided to learners and teachers, the crisis-induced step change in demand will not survive for long (See Exhibit 5).

Europe’s Growth Techs Have Four Winning Options

Europe’s growth techs have an opportunity to emerge as winners during the post-COVID-19 rebound. Based on the demand changes caused by the pandemic and the time to their next funding round, growth techs can follow one of four distinct winning sets of strategies. Top management teams can group them to develop an effective response in the short run (now) and the medium term (later).

The four sets of strategies are (See Exhibit 6):

1. Recover. Growth techs must retain cash and talent now, and later, generate funding from existing VCs by showcasing the resilience of their operating models and go-to-market approaches.

2. Rebound. Digital start-ups must focus on conserving cash, optimizing sales, and making only critical investments now to nurture operating models, and, later, as markets pick up, revamp their product portfolios and target existing and new customers through pricing and promotions.

3. Thrive. Growth techs must harvest new customers through promotions while keeping budgets tight now, and, later, sustain the tailwinds through customer retention strategies. They must attract funds from new VCs for the next stage of their growth.

4. Conquer. Firms must use the window of opportunity to amplify marketing and M&A activities now, and later, shape the future of their markets by accelerating product pipelines and fighting the structural barriers in the marketplace.

As the COVID-19 crisis catalyzes a new digital marketplace, Europe’s growth techs can become the leaders of the future, attracting funding, talent, and market share. It won’t be easy, though; the growth techs must move quickly to execute a resilient strategy that is built on innovation, technology, and agility.

BCG’s Growth Tech practice focusing on high growth industries and emerging technologies