Will Europe Challenge the U.S. in Startup Dominance?

Feb 21, 2014

A logo sits on a sign outside 'Start up Lisboa', incubator offices for startup companies, in Lisbon, Portugal. Photographer: Mario Proenca/Bloomberg.

For Christopher Steiner, being accepted into Y Combinator, Silicon Valley’s oldest incubator, was like winning the lottery.  “Everybody wants to get into Y Combinator, but there’s only a 2 percent acceptance rate. It really changed the trajectory for our company,” said the journalist turned entrepreneur who co-founded Aisle50 with Riley Scott in 2010.

Aisle50, an online site that offers grocery store discounts directly from food manufacturers, was able to raise $2.6 million in seed money in large part because of its involvement with Y Combinator. “Y Combinator sped up the process fourfold,” said Steiner. “And there’s a reason for this, when you consider the companies that have come out of it like Dropbox, reddit, and Airbnb.”

The startup culture is thriving in the U.S., with more than half a million new businesses launched each month, according to the Kauffman Foundation. And while Silicon Valley is still the No. 1 region for startups, a recent report by Startup Genome and Telefónica Digital found that six of the top 10 global startup ecosystems are in the U.S.

The rankings—based measures such as the activity of entrepreneurship in the region, availability of risk capital, as well as jobs and other performance metrics—put Los Angeles in third place, followed by Seattle, New York City, and Boston. Only two cities are in Europe and two in Canada, with Chicago rounding out the top 10.

So what makes the U.S. a stronger startup incubator than Europe?

A number of factors are at work, starting with the large, uniform U.S. market. While the U.S. shares one primary language, culture, and political and regulatory system, the European Union is still very fragmented, making it difficult for companies to roll out across the continent.

Another big plus is the availability of capital in the U.S. For example, the U.S. tech sector raised $4.7 billion in funding in the second quarter of 2013, according to Dow Jones VentureSource. Meanwhile, the amount invested in the European tech sector was just shy of $1 billion during that period.

When it comes to the second or third round of funding, U.S. investors are simply more likely to open their wallets. In the second quarter of 2013, 70% of the venture capital raised in the U.S. went to second-round funding, compared with less than 25% in Europe.

Part of the funding problem in Europe is the relative scarcity of funds that can invest $5 million or more. About 200 European companies had deals worth $5 million or more in the first half of 2013, compared with 1,000 companies in the U.S.

Adding to Europe’s funding woes are cash-strapped banks in some E.U. member countries that are unable or unwilling to loan out money. New bank lending to small and medium companies in the euro zone as a whole has declined by 36% since the April 2008 peak, according to a recent report by the Institute of International Finance and Bain & Co. While the drop-off was steepest from 2008 to 2010, the decline has continued since then.

Capital issues aside, one of the biggest differences facing U.S. and European entrepreneurs is mindset: European investors tend to be much more risk-averse than their U.S. counterparts.

“Europeans are focused on what your business is now, not where is it going to be,” said Steiner. “Silicon Valley has always invested in the future, and now more U.S. venture capitalists invest the way people in the Valley do.”

When Europeans decide to invest in a startup, there’s a tendency to look for business models that mimics another successful—often American—company. He pointed to the example of Rocket Internet, a very active Berlin-based incubator that has drawn some criticism for making similar versions of U.S. startups such as Pinterest and PayPal and launching them in other countries.

Of course, imitation can be the sincerest form of flattery. “If someone starts a company similar to a successful model in the U.S., and it makes inroads in Europe, it can end up being a win-win situation if it’s bought out by the U.S. original company,” he said.

Yet, Steiner and others are quick to note that while entrepreneurship in Europe isn’t as robust as it is in the U.S., it is nonetheless gaining ground.

“One reason that Americans have historically been bolder investors is that the U.S. venture capital market is more established”, says Dörte Höppner, chief executive of the European Private Equity and Venture Capital Association (EVCA). “But Europe has learned important lessons from Silicon Valley and is now showing a renewed talent for home-grown innovation and entrepreneurship.”

Steiner concurs, noting that at least 35% to 40% his Y Combinator class was from Europe. All things considered, he said, “Europe is definitely a force to be reckoned with.”                                                            

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