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3 reasons why startup investments in Europe need a serious shake-up

There are quite a few problems in this sector that nearly no one talks about

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Reijo Pold
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Reijo Pold

MD, Innovation HeadsReijo Pold is an Estonian-born, London-based investment expert with 15 years of experience in European and China markets. He built the Innovation Heads community for practitioners in the corporate inn… (show all) Reijo Pold is an Estonian-born, London-based investment expert with 15 years of experience in European and China markets. He built the Innovation Heads community for practitioners in the corporate innovation arena to share knowledge from the front lines of the industry and access strategic tech. Some of the brands represented in the community are Airbus, Samsung, Unilever, to name a few.

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For the past twelve years, my work has been either to find startups to invest in, or find investment for startups that need funding. It has never been an easy game, no matter which side — the VC fund or startup – I was on.

Over the years, the European startup ecosystem has grown significantly. Within the last decade, the total amount of funding European startups have attracted has increased by 273 percent, and the number of unicorns has grown from one to 61

The numbers are good and show that we’re more or less on the right track when it comes to fostering innovation. However, there are a few aspects that make me question whether that’s entirely true.

Here’s what worries me:

1. Small country innovations are inherently isolated 

London, Paris, Berlin — this is where the major funding deals usually take place. In 2018, UK-based startups alone attracted $7.7 billion of venture capital (VC), which was almost a third of the total $24.4 billion raised in Europe that year.

In the meantime, startups from small countries like the Baltics are geographically isolated from these international tech and investment ecosystems. There are innovations with great potential, but entrepreneurs lack access to international investors and funding that would help them attract customers and scale their startups faster. While there are local VCs that try to fill the gap, they’re unfortunately relatively small in comparison to international investors.

I’m not saying that small countries are completely ignored — they’re not. For example, every year investors from all over the world come to Estonia, Latvia, and Lithuania for tech conferences like Latitude59, TechChill, and Login. However, very rarely do these visits result in anything more than a few new connections on LinkedIn.

So, it seems that there is investor interest, but not enough commitment and readiness to get involved. While this may sound like a problem for small countries, it’s also something investors should be thinking about. Not only are they losing out on great deals, but they’re also missing out on the innovation happening behind the borders of the same old pools.

In the meantime, Estonian, Latvian, and Lithuanian entrepreneurs have mastered scaling their companies without — and regardless of — any VC investment. There are several examples of bootstrapped startups from the region, which goes to show that there are numerous investment opportunities in these countries.

For example, the Estonian time tracking tool Toggl has been bootstrapped from the start, is used by more than 1.6 million users worldwide and generates $10 million annual recurring revenue. Another example is Latvian startup Printful that has self-funded its growth to over 500 employees and six facilities across the US, Mexico, Latvia, and Spain.

Clearly, there is potential in tech coming from small countries, there’s talent and strong teams that can make innovation happen. For that reason, it’s time for our industry to become more open to the tech coming from other regions. Not only will that deliver financial results, but there will also be more innovation that could bring significant social impact across Europe and beyond.

2. Startup success is measured by investment raised

Europe — and generally, the rest of the world — has a tendency to measure startup success through investment rounds. That is: if you raise funds, you are somehow considered as more qualified of becoming the ”next big thing.”

Startups that attract funding get media and public attention, as well as bigger interest from investors. Unfortunately, there are multiple examples of how this can lead to a spiraling bubble with disastrous consequences, like companies that have gone from unicorn status to filing for bankruptcy. 

The fact that a company has been able to attract investment is great — outside capital can help startups fuel their growth, which usually means building or improving their tech and getting more clients. However, it seems that by putting the focus on how much a startup has raised, other — and more relevant — success indicators like revenue and profitability seem to be overlooked. 

There is no guarantee that a startup that has had a steady drumbeat of financing rounds will be profitable in the end. After all, isn’t there already a disproportionate number of startups projecting four years in the red, hoping for a hockey-stick rocket to profitability in year five?

The tech industry’s reliance on investment has increased to the point that it has become a norm. And companies that need investment to take off are valued even higher than those who have reached decent figures without outside help. 

What I’m saying is, we should pay more attention to the outputs, like revenue, growth, and scaling, and stop concentrating and even glorifying the inputs — funding. Because it seems that our focus on investments has really gone too far.

3. Corporate investment and innovation programs have untapped potential

Corporate venture capital (CVC) — that corporates directly invest in external private companies — deals in Europe have increased quite a lot in the past years. When compared to 2011, deal values by CVCs have increased 5.2 times and reached €8.8 billion in 2018.

The motivation behind it is clear: traditional industries — from taxis and telecommunications to banking and beyond — are being disrupted by new industry players. Corporates, of course, want to get a piece of the new tech that could shape their industries, and therefore invest in startups that make them.

The bad news? 

Corporate investment and innovation programs are often inefficient due to their lack of experience when it comes to investing in the ever-changing ecosystem. That is merely due to the fact that corporate companies are often isolated from the startup and investment ecosystem.

As a result, corporations lose significant amounts of money because first, they have to pay third parties to connect them with the startup ecosystem. And then, they deploy seed-capital to start-ups, hoping that they will figure out product-market fit and how to make money. 

The reality, however, is that a large proportion of startups run out of money before even signing a significant deal. That raises the question of whether simply giving startups investment is the best way to invest in innovation or is there a better way?

There are several corporations that, instead of just giving startups funds, help them scale by becoming their partners. For example, Latvian Mobile Telephone, the leading telecommunications provider in Latvia, support innovations with the aim of creating new services that they could further offer to their customers. The company recently helped a local startup to test their high-altitude internet solution – they not only provided it with funding to implement the prototype but also with the know-how and tools necessary to do that.

Other examples include Telefónica, RBS, and Santander that do a similar thing in other countries. Instead of requiring free trials, which can be extremely damaging for startups, these companies can not only invest, but also become their customers, distributors, partners, and advisors. 

For corporations, this type of collaboration means both cost savings and new revenue streams. Because first of all, paying for startup tech would cost companies much less than, for example, launching their own accelerator. Secondly, instead of letting startups burn investor money, strategic startup technologies can bolster the corporate product portfolio, which would provide additional revenue streams. 

The input to output potential here is exponential. But most importantly, such an approach would significantly decrease the startup ecosystem’s dependency on investments and help innovations to thrive on a completely new level.

Published August 21, 2019 — 11:00 UTC