European tech start-ups are on for a record year and US investors want in

Lars Fjeldsoe-Nielsen left Europe to work in Silicon Valley eight years ago. After significant stints at the likes of Uber and Dropbox, he returned in 2015 to find the region's tech scene had changed dramatically.

"There has been a shift in mentality, it's cool to be an entrepreneur, people are not afraid of taking risks," Fjeldsoe-Nielsen told CNBC in a phone interview.

"The market opportunity is huge and you can now launch a global company out of Europe."

Europe's booming start-up ecosystem is flourishing with new regions beyond just London and Berlin becoming significant tech hubs. And an increasing number of companies are finding funding to expand.

European technology companies raised $3 billion in the third quarter of 2016, down 17 percent year-on-year, according to a report released by London-based venture capital firm Atomico on Wednesday. Atomico, which was started by Skype co-founder Niklas Zennstrom, launched the report at Slush in Helsinki, one of Europe's fast-growing technology conferences.

Atomico noted that the number of deals, however, were up 27 percent and 2016 is still on for a record year of funding in dollar terms, forecasting $13.6 billion will be invested in technology start-ups in Europe, versus $12.6 billion last year. Tech firms in the region have been able to pull in large sums of money if needed. For example, British cybersecurity firm Darktrace raised $65 million in July, while German travel booking start-up GoEuro secured $70 million last month.

But many of the larger rounds in Europe have come with the help of U.S. investors with a funding gap still remaining. On a gross domestic product adjusted basis, U.S. venture capital funds raised 5.3 times more than their European peers. The gap is equivalent to around $25 billion a year, according to Atomico's report.

‘European tech scene really exciting’

There are signs that the gap could decrease in coming years. Total VC funds closed in Europe hit 4.3 billion euros in 2015, up 35 percent year-on-year. And the number of those that were above 250 million euros was 5, an improvement on the 3 seen in 2014. But this has not hampered the growth of Europe's start-ups thanks to strong participation from U.S. VCs.

"What we have seen is basically, these guys haven't been asleep and noticed good opportunities and have become active," Tom Wehmeier, head of research at Atomico, told CNBC by phone.

U.S. VC funds have made 292 investments in European start-ups so far this year, already eclipsing the 210 figure seen in 2015.

Josh Elman is one VC interested in Europe's start-ups. He is a partner at Silicon Valley VC firm Greylock Partners. The majority of his investments have been in U.S. technology start-ups but Europe's companies are beginning to look attractive.

"I think the European tech scene is really exciting. We've seen a couple companies ... Spotify and what it's doing in the music world, and Skyscanner in the travel world. So we spend a lot of time thinking about where can companies grow, and it doesn't need to just be in Silicon Valley, we think there's plenty of potential in Europe and we're always looking," Elman told CNBC in an interview earlier this month.

‘Deep tech’ expertise

Many of Europe's most valuable private companies have lent themselves to the consumer space - Uber, Airbnb and Snapchat for example. Europe's entrepreneurs, however, are attempting to take a lead in the so-called "deep tech" space which includes artificial intelligence, internet of things, virtual and augmented reality, and new forms of hardware such as drones and robotics.

British chipmaking start-up Graphcore is one of the wave of "deep tech" firms. It recently raised $30 million to accelerate the development of its next generation processing units designed for AI. Chief Executive Nigel Toon said deep tech start-ups have been able to take off due to the "pool of world class experts" out of Europe's educational institutions. Over half of Graphcore's team are PhDs.

"Once you build a really strong team, it becomes a magnet for more talent - the best hardware and software engineers want to work together," Toon told CNBC via email.

Investors have backed the region's deep tech start-ups with $2.3 billion of funding since the start of 2015 and is on track for around $1 billion alone this year, up nearly four times since 2011. And U.S. giants are increasingly coming to Europe to buy start-ups and along with that, the expertise to build next generation tech.

Google bought London-based DeepMind for a reported £400 million in 2014, while just this year, Microsoft acquired predictive texting start-up SwiftKey. So far this year, mergers and acquisitions in European deep tech have had a record year with transactions worth over $88 billion thanks to SoftBank's acquisition of semiconductor giant ARM for $32 billion and Qualcomm's $47 billion purchase of NXP, according to Atomico.

Corporate Europe waking up

It's not just U.S. technology firms on the hunt for innovative European start-ups. Traditional corporates in the region are also in on the act. Companies in a range of sectors are facing threats from nimbler and more innovative start-ups and one way to fight back is to invest in technology start-ups.

"The old model of this monolithic R&D department that will churn our new great innovations is over. All large corporations are re-thinking their innovation model," Bo Ilsoe, a partner at Nokia Growth Partners, the VC arm of the Finnish network equipment phone maker told CNBC in an interview last week.

The thinking has led to the top 50 European corporates by value investing in 72 tech start-ups this year, just shy of the 80 investments made last year.

Renault is one company that has been very active in acquisitions and investments in technology. In September, the carmaker announced the acquisition of software firm Sylpheo. Carlos Ghosn, the chief executive of Renault, said the company requires an increasing number of developers as the car industry moves towards driverless vehicles.

"Obviously we are mainly an engineering company…but these engineers are going to have to shift their competence … but more and more what we need is computer skills, software engineers and we don't have them. So ... we are partnering with companies who have a lot of these engineers, or we are acquiring companies who have these kind of skills," Ghosn said during a CNBC-hosted panel last month at a tech conference in Lisbon.

Lack of blockbuster IPOs

It's not a totally rosy picture in Europe where the tech scene is still growing up. One area where Europe still struggles is being able to attract blockbuster initial public offerings (IPOs).

Surprisingly, Europe has more public tech companies than both China and the U.S. with 914 listed firms. But they typically have smaller valuations with 615 of those companies commanding market capitalization of less than $100 million, according to Atomico. In the U.S, only 197 companies have market caps of less than $100 million.

On the upper end of the scale, the U.S. has 17 listed firms valued over $50 billion versus 1 in Europe - software giant SAP.

A key issue is that larger tech companies tend to see the Nasdaq or New York Stock Exchanges as better places to list. Britain’s King - the maker of hit mobile game “Candy Crush” - went public on the NYSE in 2014, while Sweden’s Spotify, which is slated for an IPO soon, is said to aim for a U.S. listing. Still, stock exchanges in Europe are pointing towards the success stories over the past year to show that the region’s public markets are supportive of big tech IPOs.

Andrew Burton | Getty Images

Daniel Ek, CEO and Founder of Spotify

"The activities of the big US companies often grab the headlines but 2015 was a breakout year for U.K. tech IPOs," James Clark, business development manager for tech and life sciences at the London Stock Exchange, told CNBC by email.

"Last year, London played host to the IPO of fintech company Worldpay, the largest tech IPO globally with a deal size of $4 billion and Sophos, valued at $1.6 billion, the world's largest cybersecurity IPO of the year. This demonstrates the U.K.'s and Europe's ability to grow and nurture tech companies."

Next Facebook from Europe?

Unicorns - tech start-ups valued over $1 billion - were elusive a year ago in Europe, but have become a lot more prevalent in recent times. The latest confirmed unicorn was Skyscanner which was sold to China's Ctrip for $1.75 billion.

Europe has even managed to create a so-called "decacorn" - start-ups valued over $10 billion - in the form of Finnish mobile game maker Supercell which was sold to Tencent earlier this year.

But decacorns and firms valued over $100 billion are rare and that's what entrepreneurs in the region are aspiring to next. In the U.S., there has been 126 tech firms worth over $1 billion founded since 2003 with a combined market cap of $843 billion, Atomico's report found. In contrast, Europe has founded 36 unicorns since 2003 worth just $107 billion.

Investors are bullish that multi-billion dollar tech firms will be made in the region.

"Over the course of the next 10 years we will see multiple companies get to this level, and we will see Europe produce a company on the scale of Google and Facebook," Atomico's Wehmeier told CNBC.

"What you have to remember is Europe's tech ecosystem realistically is only really 20 years old, the U.S. had multiple decades headstart."

But to get to this level won't be easy and might require a bigger appetite for risk, according to Balderton's Fjeldsoe-Nielsen. The VC pointed towards Facebook's acquisitions of Instagram in 2012 which was questioned at the time.

He said the acquisition of Instagram "stretched the risk membrane" of the social networking site's leadership then made them feel comfortable with acquiring both WhatsApp and Oculus. Europe's entrepreneurs need to follow this example, the VC urged.

"The missing piece is we still have to be bolder. There is already a big difference for appetite for risk versus 8 years ago, but at the same time we need to take it a step further," Fjeldsoe-Nielsen told CNBC.

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