A few years ago, setting up shop in Europe was the soup du jour for North American VCs. From OMERs and Lightspeed to Bessemer Venture Partners, the market attracted firms of all sizes, and the Spotify IPO seemed to wake up North American VCs to Europe’s potential to create outsized exits. VCs wanted to make sure they didn’t miss out on the next wave.

But it’s unclear that they were able to catch it. Trends haven’t fully reversed since the happy days of 2021, but they’ve come pretty close.

Still, the European startup market has grown rapidly over the last decade. Deal volume has more than doubled in that time frame, according to PitchBook data, and there have been numerous success stories like Klarna, Deliveroo and Arrival. North American VCs, understandably, want a piece of that market, but setting up a successful, long-term strategy in the region hasn’t proved easy.

Big names like Coatue and OMERs formally pulled out of the region in recent months, and the venture funds that have remained are significantly less active. Navina Rajan, a senior analyst at PitchBook, said that the overall value of European deals with at least one U.S. investor declined 57% in 2023 compared to a year earlier, and deal count declined 39%. To compare, overall deal value declined 46%, and deal count declined 31% in the same time frame.

The European startup market comes with nuances that make it a difficult one for North American investors. Each country in Europe comes with its own language and sometimes currency. Investing in both Romania and Italy is different from investing in both Texas and California. Plus, startups and universities produce different networks for European startups than in the U.S.

Taken together, all of those nuances make for a challenging market in the best of times, let alone the doldrums of the past couple of years. It’s no wonder then that North American investors have struggled to find a secure footing as they try to straddle the Atlantic.

Easier said than done

Another reason why North American VCs are struggling in the European market is that while their interest in the ecosystem has grown, so has the European VC market. Today, there is much more competition for the best deals, especially at the early stages, which is where prices are the lowest and the potential for a big return is the highest.

Sten Tamkivi, a partner at operator-led venture fund Plural based in Estonia, told TechCrunch that the startup market has changed drastically since he started off as a founder a decade ago. Early-stage startups in Europe used to look to the U.S. for funding by default, he said, but that’s not the case anymore. “Over the last decade, the early-stage investing has shifted way more toward local players; 80% of capital deployed in Europe is European,” he said.

Unless a startup is planning to expand into the U.S. right away, instead of launching in other European countries first, Tamkivi explained, it makes more sense to work with a local investor who would know the nuances of the local markets. He added that there isn’t nearly as much European venture capital at the late and growth stages, meaning startups can bring on these investors later while having a local focus early on.

It probably doesn’t help that most North American VCs have been setting up shop in London, which isn’t part of the European Union anymore and is only one of the region’s startup hubs. Having “boots on the ground” in London does not equate to having “boots on the ground” in the rest of the continent.

“A lot of the American traffic stops in London,” Tamkivi said. “[The market] is way more diverse. If you set up shop in London, that may or may not give you visibility into Copenhagen. When you’ve made it to the U.K., you probably need to make a little effort.”

This U.K. focus also drives up the competition for deals in London, making it that much harder for North American GPs to get a stake. It also means they might be ignoring opportunities elsewhere.

These dynamics explain why a firm like General Catalyst would merge with a seed-stage firm in Europe. General Catalyst in October said it was merging with La Famiglia, which is based in Berlin. General Catalyst was already investing in the region via an office in London but said this partnership would help it better invest in early-stage opportunities in mainland Europe.

Borys Musielak, the founding partner at SMOK Ventures, said that he has lost out on deals to U.S. investors in recent years, but now many of them are sitting out from deals. He’s hoping the pullback allows his firm to capitalize on strong deals with its new fund.

“I think those guys are waiting a bit more,” Musielak said. “So it’s actually an opportunity for me and our friends who raised funds for this region. We will be able to get into all the top deals from the local ecosystem. The American guys will enter anyway at the Series A or B.”

Reason to keep trying

Despite all those challenges, though, North American firms are still trying to plant roots in the region. While some firms pulled out in 2023, Andreessen Horowitz and IVP both opened offices in London.

There is good reason for many firms to still try to set up shop: regulation. Hot startup categories including AI and crypto continue to operate in the still-gray areas of regulation in the U.S., and these sectors have no real clarity in sight. This makes it harder for startups to build and for investors to know which companies are compliant — or even if they will be in the future.

That’s not to say that Europe has all the regulations figured out; regulators there aren’t as magnanimous to companies in these new sectors as they could be, but they are at least clear about what they want to see. A16z’s London office is largely focused on blockchain and crypto, likely for this reason.

U.S.-based LPs have also been showing increasing interest in Europe. When Plural went out to raise its first fund in 2022, Tamkivi and his team approached U.S. endowments to start a relationship, hoping it would lead to an investment down the line. But to their surprise, many decided to invest in that fund, and cut even bigger checks for the firm’s recent Fund II.

David York, founder and managing director at Top Tier Partners, a fund of funds, said that LPs have long been asking for a way to invest in managers backing European startups, and after successes like Spotify, that interest has only grown. He suspects it will continue to rise as large markets like China become less attractive.

“Europe has become more reliable as a creator of outcomes,” York said. “It started originally with Spotify, but we’ve had a bunch of liquidity there over the course of the last six [to] seven years. I do think there is a tailwind, as China looks inward and globalization happens. I think Eruope will end up being one of the international markets people want to build businesses in.”

Rajan, from PitchBook, and Musielak both feel the European ecosystem remains largely underpenetrated despite its growth and the difficulties North American VCs face. So it appears there is definitely room for international VCs to set up shop and build a portfolio. Firms just need to figure out a strategy that ensures their efforts will pay off.