European start-ups in the aftermath of COVID-19

Report from the event

Following a banner year for European startups, the massive disruption caused by the COVID-19 pandemic wiped revenues out of a number of startups while putting venture capital investors on edge. True to its mission of identifying and documenting major developments at work in the digital and digitally-enabled sectors, DIGITALEUROPE organized on 5 June 2020 a DiPP workshop to better assess the impact on startup ecosystems of the public health crisis we have been going through.

The European startup ecosystem has not been spared by a crisis that hit world economies across the board. However, its amazing resilience so far is no stranger to the breakthrough of 2019 when European startups raised €38.8bn in venture capital, up 42.6% on 2018’s €27.2bn. In turn, this record owes much to significant support received from the European Commission and the Member States.

Fostering ecosystems

To improve this resilience in the wake of the crisis, the European Commission is coordinating the €37 billion Coronavirus Response Investment Initiative to provide liquidity to small businesses and the health care sector. The ECB, EIB, EIF, and other European agencies will also offer enhanced pan-European support to young ventures and scaleups, not only with loans and guarantees but also with equity, including capital through the European public and private funds. See https://ec.europa.eu/digital-single-market/en/startup-europe  to find more than 20 open calls and funding opportunities aimed to facilitate strategic moves such as gaining access to new customers or virtually entering into new markets.

Furthermore, the European Innovation Council Forum, an informal gathering of all relevant authorities, focuses on regulation, ecosystem-2-ecosystem and public procurement. The European Innovation Ecosystem Working Programme is loaded with €500 million while the European Innovation Council will invest €10bn in Deep Tech startups, seed series and series A. To take but one example, 2,235 new cross-border partnerships were generated in the two days of their latest hackathon: a momentum worth keeping.

Moreover, the European Commission is about to launch a new AI and Blockchain fund of €100m with a leverage effect of €500m in partnership with EIF as a testament to their eagerness to support the most advanced machine learning and ledger technologies from all across Europe.

The report just released by the Commission shows that startups have become the leading job growth engine in Europe: they provided approximately 2m jobs in 2019 and are adding more new jobs each year than any individual sector.

Interestingly, areas where passport-style licensing is available, like for e-payment, boast the highest concentration of unicorns, a testament to the fact that tearing down barriers unleashes more fluid, speedier cross-border growth.

Leveraging the DSM and the Single Market as a whole

The EU is host to a meager 11% of the world’s unicorns (6% of which in the UK): how long can we afford to rob ourselves of this matchless reservoir of fast growth? Even before the crisis struck, DIGITALEUROPE has been advocating a KPI of 25% of world unicorns by 2025.

How do we leverage startups’ growth potential as we come out of the COVID-19 crisis? Next Generation Europe has potential if it puts startups at its center by earmarking more resources for digital. More can be done too when it comes to the Single Market. A strong Startup Nation Standard (part of SME strategy) is the first step to this effect.

Every crisis has two faces

Most experts believe that this crisis is opening a world of opportunities, with attending challenges though. Heavy disruption has been wreaked across the board: it is not necessarily bad news in sectors such as education or healthcare, in dire need of a radical overhaul. In addition, the ‘survival of the fittest’ effect will wash away the not-fit-for-purpose fraction of new businesses, those unable to pivot. Two caveats are worth bearing in mind in this respect: loss-making is not a sure sign of unhealthy business models; pivoting should not breach common sense: a bird in hand is worth two in the bush. Furthermore, the crisis will strengthen the startup ecosystems by making the corporate-startup bond more robust, by tightening up possible slack between diverse ecosystems and by making regulators less trigger-happy.

This is not to ignore huge challenges on the investment side (see more in the section below): Chinese VC deals dropped 57% vs the rest of the world over the last three months, for instance. Also, investors’ behaviour has worsened lately, with unrealistic strings often attached to funding: while regulation cannot help, name and shame on social networks do.

The investor corner

There is still a lot of money around. Mindsets are what is changing the most: a principled, reasoned vision is taking over from the opportunistic quest for a quick buck. This is encouraging since we need to start anew, not from past achievements: there is a whole new world out there, and you cannot lead change without changing business models. This much comes out of a survey of 300 CEOs in the Netherlands: value-driven leadership able to cope with nasty surprises such as COVID-19 substitutes plain pandering to fast RoI. Sounds like: Startups, the time to unite is now! When push comes to shove, you need indeed to rise above worn out recipes for fast money and learn how to learn; long term vision and planning start to look more attractive than short term goals, if only because they may secure sustainability. And the most effective way to learn is within a coalition, or better yet, a coalition of coalitions. As a matter of fact, it is easier to get around problems if you are not alone: you can shift in stride from a disappointing test to a truly successful solution as long as you have access to a whole gamut of experiences.

These recent developments may reorient the focus of risk capital from RoI to human capital, provided that investors let go of their inclination to own everything: that’s where coalition building skills come to play, as a way to bridge the increasing scarcity of financial capital. On creating coalitions, be open and agile: for lack of working here, your solution may work elsewhere with proper adjustment.

The patient investor breed

Not surprisingly, business angels hold a slightly different perspective: by definition, they have ‘skin in the game’. They bring not only their own money to the table, but also their experience of management and their network within a said sector. This rare breed of a patient and smart investors contribute the much-needed wherewithal to bridge the so-called ‘Death Valley’ where startuppers have to survive with only costs, no revenue. Angel investors have been going the extra mile in the past two months to save their portfolio companies and even invest in new opportunities: there is only anecdotal evidence of a slow down coming. But the collapse of corporate finance will impact their deferred returns, thus preventing them from reinvesting after two or three years. Their ability to pivot with agility has proved particularly helpful in the throes of a public health crisis which has ensured that the world will never be the same again. Angel investors should be leveraged – by the Commission, Member States, but also startup founders – at all times, and even more so “when the going gets tough”

In short, big challenges turn out to be big opportunities to solve problems together through generating long term, sustainable value. High ambitions seem to offer a European way out if we dare play our signature assets: a unique ability to thrive in diversity, an early determination to take sustainability seriously for what it is, i.e. an unparalleled catalyst for growth.

What keeps startuppers awake at night?

The coronavirus has put the industry to a severe agility test: 18% of European startups have pivoted, mostly to help confront the public health emergency, e.g. a pregnancy app shifting to a corona tracing app. Startups indeed rose to the COVID-19 challenge, thus providing blatant evidence that they are part of the solution.

But for all its inspiration to move faster, the crisis has had a huge impact, with massive layoffs and venture capital in short supply. It will take two to four years for the startup ecosystem to recover. A nagging concern is how to make sure that EU – not just French and German – ecosystems survive, and to share enough best practices to this effect.

How to scale up comes next. Money does matter: the lack of it can be a hurdle. Only a few months ago, one of the most successful European unicorns saw a majority of European strategic investors contribute to their latest round of fundraising. However encouraging this might sound, today’s top concern is definitely cashflow.

Because the road to hell is paved with good intentions, it is important to provide effective assistance. If 48% of startups die in their first year, it is partly because of regulatory compliance stifle business growth. Or take the Temporary Framework for State Aid: it fails to give the Member States enough flexibility to support startup ecosystems. In particular, the definition of an ‘undertaking in difficulty’ is intended to apply to loss-making businesses, which won’t qualify for support: this discriminates against many startups being loss-making by design in the early years as a result of a calculated bet on expected exponential growth and associated job creation, a self-inflicted wound to the EU’s driver for future economic and job growth.

People do matter too: until recently, scarcity of talent was actually the top concern. As an example of how national regulations may get in the way of hiring, a local presence is often a prerequisite, and a cumbersome one for startups: they would get around by contracting with freelancers. But to be fair, regulatory constraints keep being lifted.

The view from across the Channel

UK mindset towards investment is admittedly closer to that in the US: they tend to pour more money into incumbent recipients. This being said, £10.41bn, a record, were invested in UK tech companies in 2019 (+ 44%). See Tech Nation’s latest report for more statistics: https://technation.io/report2020/#download

Despite shining results, the UK is not immune to the blow the coronavirus has dealt to investment. The labour market is badly hit, especially in construction, finance, legal. However resilient the tech sector has proved thus far these hits cannot be ignored: government action is needed to attract global talent and to design fast learning solutions likely to accelerate the scaling up. Like elsewhere, peer-to-peer meetups enhance a sense of community among British startuppers. Tech Nation’s Digital Business Academy has never been so popular. On the financial front, the Bank of England has provided a lot of help though more solutions are needed to bridge loans. Whether through British Business Bank, Innovate UK, or other sources, a slew of measures are available to improve resilience in order to weather the current emergency and emerge with a stronger fabric of UK startups.

A tool for sovereignty?

In the course of this wide-ranging debate, it was observed that AI is a resource way more strategic than most people would suspect: think of a laptop without processors because the country they originate in has put constraints on their export. The same may hold even truer for telecom infrastructures. Europe’s sovereignty is definitely at stake here: it is critical to gain independence from third countries’ own sovereign decisions.

Thanks to strong, consistent and persistent advocacy, the EU market fragmentation, i.e. the worst enemy of European startups, is receding, but not fast enough. Let’s hope that the coronavirus will work as a wakeup call for faster progress in this respect. EU institutions and national governments have done an impressive job of lifting startups and other high tech SMEs – whose EU future depends on – to the next level, but more is needed, especially on the regulatory side, to ride the coronavirus storm. With streamlined regulation and a steady flow of investment and appropriate talent, startups communities across Europe are poised not only to rebuild but to reinvent European business. As if to illustrate that there is no better time than a crisis to discuss how to steer a different course, this panel discussion held under the auspices of DIGITALEUROPE has contributed its humble lot to the lofty ambition we owe to the forefathers of the Union as well as to our youth.