The European Startup Ecosystem – Trends and Challenges

Over the past decade, the European startup ecosystem has been growing at impressive rates. It has been possible due to the maturation of the Venture Capital Industry as well as the influence of several big accelerators and business angels providing seed capital and mentorship.

Europe’s start-up ecosystem has seen a rise in the number of unicorns. Out of the 99 venture-capital-backed European unicorns, 14 were added in 2019.

Facts and Figures

Europe’s startup scene is growing rapidly but there is room for improvement. Its start-ups are still fewer in number and raise less money. Europe generates around 36 percent of all formally funded start-ups, but only 14 percent of the world’s unicorns. The number of seed-stage start-ups generated by Europe is 40 percent of that generated by the United States.

European start-ups have low total success rates when compared to US and Indian start-ups in aggregate. According to a report by McKinsey, for a bunch of start-ups raising seed or angel funding between 2009 and 2014, the US and Indian ecosystems were almost twice as effective as Europe’s at moving start-ups from Series C to Series D funding rounds, or even Series B through Series C. For the same bunch, European start-ups experience lower success rates than those in the United States progressing through subsequent funding rounds.

European companies are more likely to face problems after a fundraising round. They find it difficult to get to the next stage of funding round or don’t manage an exit in the form of an IPO or acquisition. This is prevalent in 10 percent more European start-ups than US start-ups after securing series A funding. This often means that they are sacrificing further growth potential, which might be a negative sign for venture capitalists, as they don’t just look for profitability, but also big sales or IPOs to get high returns on their investments.

Challenges that face Europe

• Difficulty in Raising Late-Stage Funding

Raising large rounds of capital is a major challenge in Europe. European investors also stay constrained largely to their own local markets. It has been difficult for European companies to raise large funding rounds due to a lower supply of late-stage capital, especially in the Series D and E stages. The main reason for it being the European investors’ risk aversion. If we compare with US businesses in comparable industries, they are able to raise funding at higher valuations than their European counterparts. The reason for this could be a low supply of late-stage capital that is a mixture of funding sources: governments and corporate investors who have a different set of interests and goals as compared to the biggest funders, such as large retirement and pension funds of US VCs.
But in recent years, European VCs have been raising more money. US funds have also expanded their presence in Europe. The European venture capital ecosystem is maturing and catching up to that of the United States gradually. The capital invested in rounds of US$ 100 million and more in Europe was four times in 2019 than in 2014.

• Fragmented Market

Europe is not a single market. This has an effect on what start-ups must focus on in their early years. Even though Europe has open markets, it is still a collection of different countries with different languages, cultures and governments. Therefore, tastes and preferences, consumer behaviour and utility factors vary from country to country, forcing brands to change their strategies from market to market. This requires investing both money and time. Furthermore, Europe’s startup landscape also faces regulations that are stricter and more fragmented depending from sector to sector.
In order to scale, European companies must expand quickly and early across many countries. Around 70 percent of European unicorns had to establish a global or partly global geographical footprint to reach the unicorn stage, as compared with 50 percent of US unicorns. Therefore, European startups have to focus on wider internationalization to reach a higher scale and valuation.

• Risk Aversion Among Entrepreneurs

In Europe, the pressure to perform and succeed earlier is much more. In countries like the US, failure can be a badge of honour, but not in Europe. Such VC, government, founder or media sentiments can increase the pressure on startups, and if they fail, they may be portrayed in a negative light. In Germany, 17 percent of press coverage portrays entrepreneurship in a positive light, as compared with 39 percent in the United States. This causes founders to act conservative and lose on their growth potential. They tend to become risk-averse and focus on building a sustainable business than being a global disruptor.
There is also stigmatization of bankruptcy in several European countries, and thus a lack of the risk-taking attitude. European startups are thus not able to confidently aim for global dominance. But a few success stories like that of Delivery Hero, N26 etc have emerged that could inspire other startups to aim for hypergrowth rather than short-term profits.

• Difficulty in attracting the best talent

As per a report by European Centre for the Development of Vocational Training, between a half and two-thirds of EU firms with difficulties finding skilled workers face the problem for reasons other than lack of skills like unattractive job offers (unwillingness to offer a competitive market wage/ bad job quality/ precarious contracts) and lack of employer commitment to talent management. While the remaining firms meet genuine skill shortages like inability to find job applicants with the right skills, despite their willingness to pay the price for the skills sought. In Europe, salaries for software developers are lower than in New York or San Francisco Bay. Unfavourable equity and stock-option rules often act as a deterrent for employees in Europe.

In order to be able to find the right talent, European companies have to offer high-quality apprenticeship and good quality jobs, taking a long term perspective to hiring and talent management. This can be done by widening the potential applicant pool and strengthening internal talent. At the govt. level, legal reforms are required to allow European start-ups to attract and retain the necessary talent to build and scale new companies.

The condition of the European Startup Ecosystem is improving, but some challenges remain to be faced. In order to overcome these challenges, active policy-making, revisiting regulatory frameworks that could help startups navigate easily and attracting the right talent is imperative. Governments should be able to infuse more risk-willing capital and consider allocating more semi-public funds toward growing the ecosystem and fostering collaboration between ventures, academia and industry.

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