The EU is investing in startups now — here’s why it *might* change everything

A couple of weeks ago, Bloomberg ran this story¹ about how the EU will directly invest and become a shareholder in startups and early-stage technologies for the first time, thanks to the new multi-billion euro European Innovation Council Fund. The reaction from the tech community was best summed up by noted tech analyst Benedict Evans, who tweeted that it ‘seems like a guaranteed way to kill any companies unwise enough to engage’.

Dramatic and expensive failure may well be the most likely scenario. On the other hand, the optimist in me — somewhat bruised though 2020 may have left him — sees the potential for a transformative impact on the European startup ecosystem. By de-risking sectors, technologies, and companies previously considered too perilous, this sort of government intervention could ‘crowd in’ private investment and kickstart Europe’s journey towards becoming a tech powerhouse.

Right now, Europe’s tech industry is a clear step down from its American cousin. In 2019, more than $36 billion of venture funding was invested in European startups² This sounds impressive until I tell you that the equivalent figure for the USA was roughly $122 billion³. Things are improving — 2019’s venture funding figure was an annual increase of 24%, and Crunchbase recorded 21 new unicorns created that year⁴ — but the European startup ecosystem remains markedly less effective at turning new companies into late-stage successes⁵.

So how exactly might this be changed? Usually, a government wishing to boost entrepreneurial activity does so by making marginal changes. These might include favourable tax laws for startups, reducing bureaucracy, and other such interjections designed to allow the invisible hand to do its work as efficiently as possible. The approach embodied by the EICFund, however, dispenses with this sort of fine-tuning and aims to make much faster, structural changes. So often the lender of last resort, here the state is the investor of first resort. They will invest directly in nascent technologies and companies that others are unwilling to fund. This helps them reach the point of viability for private investors. When repeated at scale, it boosts company creation and draws in more private funding, kicking off a virtuous cycle. This momentum is then compounded by numerous happy side effects like a growing culture of entrepreneurship, universities and R&D labs getting more heavily involved in startups (both from a talent and a technology perspective), denser support networks, the creation of new clusters, more helpful regulatory environments, and so on.

Obviously this is easier said than done, and I don’t have to tell you that this form of aggressive government intervention in private markets often goes spectacularly wrong. It might thus surprise you to know that the American startup ecosystem owes a massive amount to policies like this. In 1982, the Small Business Innovation Research Program (SBIR) was created. Since then, every federal agency with a large enough R&D budget has to disburse a set percentage of that in SBIR grants, to directly fund R&D activities with potential commercial merit. Those with really chunky R&D budgets must also give out STTR (Small Business Technology Transfer Program) grants, which emphasise links between the recipient company and a formal research institution. Since its inception, that adds up to 179,000 awards totalling more than $54 billion by the end of FY19. This money funds nascent technologies through their early development to help them reach the point where private investors will take them forwards. Although the total funding amounts ($3.5 billion in FY19 for example) are not massive in the grand scheme of things, the key difference is the sheer number of startups reached by the SBIR⁶ program. Up to 2013⁷ the program gave money to on average 5–7 times more companies than the number who receive VC funding in a given year⁸. This extraordinarily broad support is an integral part of the story of America’s technological dominance.

Any good story needs notable characters, and the cast of successful companies that have benefited from government-funded research & development is Oscar-worthy. As the economist Mariana Mazzucato points out in her book ‘The Entrepreneurial State’, the PageRank algorithm that propelled Google to its lofty corporate perch was actually the result of an initiative funded by the National Science Foundation. Virtually all of the technological advances that made the original iPhone so groundbreaking were the product of government-funded research, as you can see in the image below. The acronyms all refer to different (mostly American) federal agencies.

The list goes on. Tesla’s battery and solar panel technology came from Department of Energy grants, and the National Institute of Health’s drug research funding is responsible for (by Mazzucato’s estimate⁹) 75% of the most innovative category of new drugs.

There are success stories closer to home as well. In both Israel and Finland, radical policy innovation and deliberate government action turned two historically low-technology economies into European leaders. In Finland, a modestly-funded government foundation called Sitra founded in 1968 began pursuing unconventional policies to promote entrepreneurship, such as helping private companies to fund risky long-term research. Later on, Sitra used its endowment to buy equity in high-technology companies and to support private venture capital. In just 11 years, Finnish early-stage capital investment went from 2.8 million euros in 1989 to 135 million in 2000, and the share of high-technology manufactured goods in exports increased eightfold from 1980 levels¹⁰. In Israel, the creation of the Office of the Chief Scientist had an even more dramatic effect. As well as softer initiatives to encourage Israeli firms to invest in R&D, they provided loans to subside private R&D projects that would be repaid depending on the profitability of the resultant product. These turned out to be so successful that the royalties they recouped this way rose from $8 million in 1988 to $139 million in 1999. Later on, they created three programmes: one to help knowledge workers to become entrepreneurs, a $100 million fund to attract foreign venture-capital investment to Israel, and an initiative to help smaller firms collaborate with corporates to create communally owned intellectual property. Today, Tel Aviv is one of the most vibrant startup hubs in the world.

So where does all this leave the EICFund? Well, there are a few reasons that I mentioned my inner optimist at the start of this piece. The elephant in the room is the usual incompatibility between small, fast-moving startups and the large, unwieldy, well — elephant that the EICFund appears to be. Indeed, successful avoidance of this problem is a common thread throughout the examples I provided: the SBIR programme is piecemeal in its awards and highly decentralised, and Sitra and the OCS were only able to innovate so effectively because of their initially minor status in their respective governments. If you wondered why you hadn’t heard of these two agencies, it’s because their success led to increased exposure to politicisation and bureaucracy that has since severely hampered their efforts. Furthermore, the EICFund’s predecessor, the EIC Accelerator, was marred by bitter disputes with founders, one of whom told Politico “don’t touch this instrument because it’s going to kill your business.”¹¹ Not exactly mincing his words.

Overall, I think it’s wrong to dismiss the EICFund out of hand. Although suboptimally designed for its objective, it has chosen its focus well and could go a long way towards boosting the European tech ecosystem. The broader point I’d like to leave you with, however, is that we should acknowledge and celebrate the role of the state in accelerating private innovation and entrepreneurship. Not because I think Larry Page, Elon Musk and the like get too much credit, but because the effective use of government tools has the potential to be more transformative than any of them.

Footnotes

1. EU Will Become Shareholder in Startups for the First Time — Bloomberg
2. European Venture Report: VC Dollars Rise In 2019 — Crunchbase News
3. North American Venture Funding Was Below Peak In Q4, But 2019 Totals Are Still Near Highs — Crunchbase News
4. European Unicorns Break Out In 2019 — Crunchbase News
5. Europe’s start-up ecosystem: Heating up, but still facing challenges | McKinsey
6. To avoid boring both the reader and myself, from here on SBIR will refer to both SBIR and STTR
7. Such are the limitations of statistics without access to paid providers #firstworldproblems
8. Keller and Block (2012)
9. Op-Ed: How taxpayers prop up Big Pharma, and how to cap that - Los Angeles Times (latimes.com)
10. Breznitz and Ornston (2013)
11. ‘It’s going to kill your business’: Startups turn on €2B EU fund — POLITICO