Why Raising Capital Is a Challenge for European Startups
A look at residual consequences and how the EU is working to foster a favorable funding climate.
The early days of a startup are a thrilling time. Late nights, too much caffeine and oh! the realization that you need cash (someone else's) to bring your idea to life. Sound familiar? It should. Nearly every budding entrepreneur's quest for cash begins this way.
Armed with a polished pitch deck and a fresh batch of hustle, you're ready to sell your idea, and a chunk of equity, to the highest bidder. But, what if hustle isn't the primary factor in scoring cash for your startup? What if your geographic location impacts access to funding?
Here's the thing: It does. If you live in the United States, you've got access to a larger pool of venture capital than your European counterparts. For European entrepreneurs raising capital, the harsh reality is that fundraising isn't just difficult on this side of the Atlantic, it's that the European VC piggy bank is significantly leaner.
In 2016, venture capital investment in the EU totaled €6.5 billion compared to a whopping €40 billion in the United States. And here's the kicker: The economy of the European Union, measured by Gross Domestic Product (GDP), is nearly the same size as the U.S. economy, but venture capital investment volumes were five times higher in the United States in 2016.
So, what gives?
While Europe may be flush thanks to the success of its industrial and manufacturing economy, the United States is the world leader in producing "unicorns," or startups with more than $1 billion in market valuation. With the U.S. startup climate serving as an incubator for global giants such as Uber and Airbnb, it begs for a closer look as to why Europe lags behind in funding and, consequently, innovation.
Europe has the lowest startup activity relative to any major region.
Global Entrepreneurship Monitor (GEM) measures the proportion of adults who have founded or are running a business over the past three and a half years, and labels it the Total Early Stage Entrepreneurial Activity.
With entrepreneurial activity peaking in the 25-34 and 35-44 age groups, Europe has the lowest Total Early Stage Entrepreneurial Activity at just 8.1 percent. By comparison, entrepreneurial activity in the U.S. weighs in at 13.6 percent of the adult population.
To take it one step farther, venture capital funds in Europe are much smaller than U.S. funds; in turn, funding rounds are, you guessed it, much leaner. Venture capital funds tend to invest in 10-20 startups per fund. The smaller the fund, the smaller the average investment amount.
So, even if a European startup can successfully raise an angel or Series A investment round (e.g. early stage investment), European startups struggle to raise larger rounds of financing ("late stage" investments) down the line.
In analyzing smaller funds and shorter track records, European venture capitalists tend to be more risk averse. Backing more experienced teams with significant industry experience, investors are less likely to fund younger or unproven founders. An unfavorable combination, nervous banks and a weak investment funds market leave European startups with limited access to capital funds.
What this means for European startups
On one hand, this lack of funds means European startups are forced to mature early on, focusing on generating revenue and profits, as opposed to growth alone, which U.S. startups tend to prioritize. In my own startup experience, a lack of funds and an unproven track record meant my concept, an online pdf editor, was funded by my full-time profession until I could grow the concept to a profitable stage.”
On the other hand, this means that Europe tends to miss the boat on innovations that are pioneered by unproven entrepreneurs. Some of the largest U.S. technology companies, such as Facebook, were founded by young entrepreneurs, and did not generate profit for many years.
Thus, the probability of producing European "unicorns" is relatively limited in comparison to the U.S. market. Which begs the question, "Is Europe's unfavorable startup climate self-induced?"
How Europe is finally taking action
The shortage of venture capital in Europe is so severe that the European Union is intervening by injecting public funds into the European venture capital market. Announced earlier this year, the EU is committing €410 million to a "fund of funds" that will invest in European venture capital funds.
A bailout for startups?
The widening gap between Europe's startup market and the rest of the world has finally prompted the creation of a detailed plan to increase investments while attracting large investors who have historically avoided smaller European venture funds. The influx of capital will be dispersed among medical technologies, energy and information and communication technologies.
So, while the EU has quite the mountain to climb, there's now an increase in resources to help with the journey to the top.
Will the European Union's plan yield a competitive position in the startup race? Tick tock, only time will tell.