Europe`s start up ecosystem: Heating up, but still facing challenges

In recent years, Europe’s start-up ecosystem has seen a surge in the number of unicorns and the pace at which they are created. Of the 99 venture-capital-backed European unicorns, 14 were added in 2019 alone. These include Germany’s neobank N26, France’s healthcare scheduling service Doctolib, and Lithuania’s online used-clothing marketplace Vented. Despite this accelerated activity, European start-ups still lag in achieving successful late-stage outcomes when compared with other start-up ecosystems.

To better understand the forces at work behind the outcomes of European start-ups, we conducted a cohort analysis that examines Europe, India, and the United States, using the latter as a benchmark for a healthy start-up ecosystem. We also assessed the trends and challenges affecting those ecosystems and interviewed start-up founders and investors to add context to our findings. Though our data is historical and conditions are definitely changing for the better, our analysis of Europe’s start-up ecosystem illustrates the ongoing underlying issues that entrepreneurs face.

A startling disparity

Although change is happening quickly, according to our analysis Europe’s start-ups are still fewer in number, raise less money, and have a lower likelihood of success. While Europe generates 36 percent of all formally funded start-ups, it creates only 14 percent of the world’s unicorns. Adjusted for population and GDP, the number of seed-stage start-ups that Europe generates is only 40 percent of that generated by the United States.

Historically, Europe’s ecosystem has been less effective than that of the United States at turning start-ups into late-stage successes. To analyze the steps between the seed stage and success, we looked at start-ups that received seed or angel funding between 2009 and 2014. For example, European start-ups were 30 percent less likely to progress from seed to a successful outcome, as compared to start-ups that raised seed funding during that time in the United States.

Further, European start-ups have consistently lower total success rates and show less progress through all series rounds when compared to US and Indian start-ups in aggregate. For instance, for the cohort of start-ups raising seed or angel funding between 2009 and 2014, the US and Indian ecosystems are 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 cohort, European start-ups experience lower success rates than those in the United States progressing through subsequent funding rounds.

Being less successful at progressing through this funnel, however, doesn’t mean that Europe’s start-ups are outright failures. In fact, as measured by bankruptcy rates across rounds, European companies don’t fail more often than US companies. Rather, European companies are more likely to stall after a fundraising round, meaning they simply don’t advance to the next stage of funding or don’t manage a successful exit in the form of an IPO or some sort of acquisition. This happens to 10 percent more European start-ups than US start-ups after securing series a funding. While these companies may actually be growing and profitable, and thus self-funding, they could be sacrificing further growth potential. This effect may dampen the appetites of venture capitalists (VCs), for whom operating at a profit is not enough as they tend to rely on big sales or IPOs to get high returns on their investments?

Even though conditions are improving, the challenges facing Europe’s start-up ecosystem remain significant. To overcome them, there are three key areas in particular to consider. The first among these is harmonization and active policy making. Europe could continue to streamline its regulatory frameworks, which remain complex for start-ups to navigate easily. Many European start-ups are seeking to expand operations to multiple regions early on. Similarly, legal frameworks could be reassessed to allow European start-ups to attract and retain the necessary talent to build and scale new companies. Underpinning all of this could be a vision that aims both to defend Europe’s existing strengths and to build and support areas of potential growth.

Second, leveraging Europe’s assets, which include its public sector and its relative strength in the B2B arena, is critical to growing the start-up ecosystem. As large contractors, governments are key drivers with the power to support innovation. Through this lever, Europe can actively promote its start-up ecosystem. The B2B sectors offer particularly fertile ground here, as the continent’s entrepreneurs have already established a solid foundation of innovation by digitizing the activities that serve other businesses and even more so now, as the corona virus crisis has created an expectation that more business will be conducted digitally. Europe could also build on another relative strength, sustainability, as the business opportunities around the growing conversation of stakeholder responsibility continue to expand. Europe is a leader in this area and is well positioned to capitalize on this asset.

Third, Europe could look at how to support the culture and capital needed to further grow its start-up ecosystem. Entrepreneurs could take advantage of the improving conditions for start-ups to broaden their ambitions and aim for global leadership. Governments could further this through more risk-willing capital, and considering allocating more semi-public funds toward growing the ecosystem, as well as fostering collaboration between ventures, academia, and industry. It could also prove beneficial to improve conditions for capital and funding for example, by leveraging European and global partnerships with aligned incentives to allow them to scale faster.