The world cannot afford for the VC model to falter given the situation in Ukraine.
Photo by Igor Karimov on Unsplash
The worst of the pandemic may be behind us, but as the economic fallout from the war in Ukraine continues, there are growing concerns that this devastating – and likely protracted – conflict will hurt global growth prospects for the third straight year.
And while economic headlines have been dominated by news of companies and financial institutions cutting ties with Russia and pulling out of the region, some pundits argue geopolitical risks pose an even greater threat to VC industry fortunes.
Certainly, the VC model is based on rapid growth and scaling, which requires free-flowing finances and smooth trading. Undoubtedly, many VCs have formal and informal ties to Russian founders and investors.
But can geopolitical tensions, economic sanctions and the current rebalancing of global capital really stop venture investing?
Solving the world’s most pressing challenges
In 2021, the European tech ecosystem saw record levels of both funding and exit activity. The number of VC-backed unicorns has more than doubled; Valuations of European VC-backed companies more than tripled; likewise the average value of the top VC financing rounds.
According to Goldman Sachs, Europe’s digital economy has reached an inflection point, narrowing the funding gap with North America and Asia – noting that US and Asian VCs are also expanding their presence in Europe to take advantage of lower valuations.
It’s an exciting time to be active in the European startup community. And while virtually all geopolitical issues impact market performance in today’s interconnected global economy, venture capitalists and start-ups are used to meeting these challenges with ease. Founders have had to demonstrate their resilience multiple times to deal with the mass disruption caused by Covid-19.
At the same time, the pandemic has helped put the spotlight on many areas of business, commerce and industry where rapid and deep change is urgently needed. Fundamental problems in logistics and supply chains. Flaws in FMCG production and distribution. Gaping holes in cyber defenses at both organizational and infrastructure levels. And of course escalating environmental, climate and sustainability challenges affecting every aspect of our lives.
These problems require technological solutions, and tech innovation is faster and more efficient in the hands of nimble startups and entrepreneurs unencumbered by company baggage and bureaucracy. This is precisely why risk investing is so important to our progress and development and the world cannot afford to see the VC model falter given the evolving situation in Ukraine.
Improved due diligence across the VC community
The exodus of Russian companies has far-reaching consequences for companies of all shapes and sizes. Many promising Russian-founded startups will struggle to survive, while VCs backed by Russian investors could face intense scrutiny or be frozen altogether. Of course, no European businessman wants to inadvertently finance Russian state aggression – or any other bad actor for that matter. Like the rest of the global business world, the VC world needs to put its house in order and ensure that any “dirty” capital is removed from the system.
In reality, these cases will be the exception, not the rule. The vast majority of established VCs are already very demanding about who they take on board as investors. Strict know-your-customer and anti-money laundering processes apply throughout the industry. Capital controls have been tightened across the board in the wake of the global financial crisis and if a result of the Russian invasion is a further improvement in investor due diligence, that can only be a good thing.
Pragmatism will prevail
As all Russian business relations now come under scrutiny, more questions about the West’s relations with China are bound to be raised. As a result, many VCs are understandably concerned about taking on Chinese investments or the impact of a supply chain disruption on their portfolio companies should East-West tensions escalate.
But we should not exaggerate the extent to which VCs are involved in or affected by such debates. Much of the current discussion involves little more than rudimentary delineations of what we in the West are willing to accept (or at least tolerate) in order to uphold free trade and protect our interests. For example, we say no to oil and gas, but yes to precious metals. We are unequivocal in our criticism of fast food brands, but we are willing to acknowledge the complexity of the pharma situation.
To be honest, these are all very nuanced issues that are difficult to solve in our interdependent global economy. And of course it is important that all companies and investors consider the moral and ethical dimensions of their activities. Ultimately, however, VCs are pragmatists focused on creating value by helping startups and entrepreneurs realize their potential. While the job description requires an element of political and macroeconomic analysis, VCs still view emerging geopolitical issues primarily in terms of impact on their founders. When certain trade routes suddenly appear undesirable or unsustainable, the VC’s role is to troubleshoot problems and work with its portfolio companies to find viable alternative routes.
The best entrepreneurs find a way
We should not mistake Russia’s temporary exclusion from the world economy as an indicator that the era of globalization and trade interconnectivity is coming to an end.
Trade routes will continue to develop in the face of the crisis in Ukraine, as they have continuously done throughout history. New alliances are formed while others perish.
The same applies to the VC world. Investment priorities may shift, fund structures may change, but with so many of the world’s most pressing challenges hinged on technological innovation, venture investors’ appetites to support and enable entrepreneurship will not be curbed by short-term geopolitical concerns.
Likewise, the best entrepreneurs will always find a way to achieve their goals. We’ve seen that 1,000 times during the pandemic. Indeed, with a huge contingent of young, talented Russian, Ukrainian and Belarusian tech workers migrating west at a rapid pace, Europe’s tech ecosystem could actually be further strengthened in the coming months.
Entrepreneurs come from all walks of life and walks of life, and while direct trade links with Russia may be taboo for the remainder of Putin’s tenure, venture investors will not discriminate based on a founder’s birthplace.
We need a concerted effort to support early stage companies
While the amazing advances of Europe’s tech ecosystem are unlikely to be derailed by the actions of a rogue dictator, many startups will still face a bumpy road in the coming months. They need the proactive support of their investors to understand exactly how the landscape is being reshaped and where strategic adjustments may be needed.
Moreover, this is not the only headwind for European startups. Macroeconomic conditions continue to deteriorate due to rising energy costs. Inflation and interest rates rise. Tech stocks have suffered a setback since the beginning of the year, impacting private markets in some industries as investors seek to risk their portfolios.
At the same time as VC funding levels in Europe have reached record highs, ownership of Europe’s fast-growing companies is increasingly being transferred to non-European investors. This shifts the investment landscape towards later-stage investments and creates a funding gap among early-stage startups that needs to be filled if we are to successfully nurture the next generation of European unicorns.
These are undoubtedly difficult conditions for founders, especially those whose companies are involved in the Ukraine conflict. But they’re far from impenetrable, provided founders have the right VC backing and support.
Although it has become a cliche, we know that with every crisis comes new opportunity. And we know – because it has been proven time and time again – that the VC model is the optimal way to address clear and urgent societal challenges at speed and scale. Right now the world needs the venture investment accelerator more than ever.
