European start-ups are 30 percent less likely to raise follow-up funding or make an exit than startups in the US, consultant McKinsey said in a new report. These are the five main causes.
With Mollie (photo above) and MessageBird , the Netherlands recently acquired two unicorns, or unlisted companies that are valued by investors at at least 1 billion dollars. But that threshold get European startups much less common than in the US, contend the market researchers from McKinsey.
To find out why, they took a closer look at a group of European, American and Indian startups that raised venture capital between 2009 and 2014. After that first capital injection, European startups turned out to grow 30 percent less often to at least a Series C financing or an exit (sale or IPO) than American startups.
And although 36 percent of all startups worldwide come from Europe, only 14 percent of all unicorns. The US supplies 45 percent of all start-ups and 50 percent of all unicornis.
Not that European startups fail more often, McKinsey emphasizes, they just grow less often and then remain stuck at a lower – but often still profitable – level. The consultant suspects that this means that a number of companies have untapped growth potential.
To complete the vicious circle, less growth means there is less choice for investors, as they do not so much prey on profitability as on a hefty exit.
Five things that slow the growth of European startups:
1. A fragmented market
Open borders or not, Europe is still a collection of countries, each with their own language, consumer behavior and rules. While a US startup can roll out its marketing to all states with relative ease, Europe requires a country-by-country approach. To be able to approach the same market in terms of size, a European startup must conquer 28 different countries.
This fragmentation also explains why 70 percent of all European unicorns are also active outside Europe, while only 50 percent of American unicorns also operate outside the US.
2. Lack of later internship capital
In terms of growth capital, the differences between Europe and the US become particularly clear with larger rounds of roughly 60 million euros. This not only has to do with the range of start-ups, but also with relatively risk-averse European investors. Also, European investors are often simply unable to put in larger amounts in a follow-up round. Not surprising that companies such as Mollie and MessageBird also turn to American investors.
Some startups are more likely to let themselves be taken over by, for example, an American rival due to a lack of later stage growth capital. McKinsey cites, among other things, the famous example of Booking.com, whose Dutch founders decided in 2005 to sell their company for – a paltry – 135 million dollars to Priceline, instead of growing independently with the help of a new financing round.
The good news is that, partly thanks to the entry of European pension funds, the number of large funding rounds in Europe is increasing. In 2019, there were four times as many rounds of 100 million (dollar) or more than in 2014.
3. Risk-averse culture
European start-up entrepreneurs experience greater pressure to show (early) success, while a ‘ failure ‘ in the US is seen more as proof of experience, says McKinsey. The consultant points out that this sentiment is reflected in the media: for example, stories about entrepreneurship in Germany are positive in 17 percent of the cases, compared to 39 percent in the US. A more risk-averse culture means that entrepreneurs are more conservative and less likely to steer towards hypergrowth at the expense of short-term profit.
4. Less options for talent
Compared to American hotspots such as San Francisco or New York, developers in Europe are a lot cheaper. But attracting talent in Europe is hampered by unfavorable stock and option schemes, entrepreneurs tell McKinsey. In the Netherlands , Techleap and Dutch Startup Association have been arguing for a while for a scheme whereby employees are taxed at a later stage.
At the same time, there is a chicken-or-egg problem: there are fewer people in Europe who have experience with scaling up a company. That kind of operational knowledge is indispensable to bring a startup to a listed company, for example.
5. ‘Superhubs’ are too small
European ‘super hubs’ such as London, Paris and Berlin are emerging, but they do not have the same concentration of capital, knowledge and talent as San Francisco or New York. As a result, only 30 percent of European startups are located in such a city, compared to 50 percent in the US.
Moving is easier in the US, but that advantage over Europe now seems to be diminished by the corona pandemic. Remote work – such as Message Bird last week a ‘ work anywhere ‘ policy introduced – would be the importance of ‘super hubs’ can sometimes reduce even suspect McKinsey.
In order to overcome all the challenges, Europe should – put simply – become more like the US, McKinsey seems to suggest. Rules and policy should be more attuned to each other, so that startups can more easily expand to neighboring countries.
One of the biggest opportunities is in the field of B2B startups, helping other companies digitize. Large companies and governments could boost this type of entrepreneurship, especially now that the corona pandemic is creating more demand for digitization. Europe is also a ‘leader’ in sustainable business, says McKinsey, ‘and is in a good position to reap the benefits’.