Key messages
- Europe’s main weakness lies in scaling companies, not creating them. While the EU start-up ecosystem has grown significantly in the past decade, firms still struggle to scale in Europe.
- Europe’s scale-up gap is neither purely a supply-side nor a demand-side problem. Limited growth prospects and a financial system failing to channel capital into high-growth firms reinforce each other in a vicious cycle.
- The common underlying causes of Europe’s scaling problem are fragmentation and risk aversion. Capital and goods markets remain fragmented, while savers, investors, entrepreneurs and institutions systematically avoid risk.
- Addressing fragmentation requires harmonisation, consolidation and integration at the EU level. This includes aligning financial and corporate rules, pooling savings and ultimately creating a European safe asset, supported by institutional mechanisms that enable coalitions of willing member states to deepen integration.
- Greater integration would enable the pooling of risk, making higher-risk capital allocations consistent with the EU’s risk-averse social contract. This would unlock more capital for innovative firms while improving incentives for entrepreneurs through lower costs of failure, better access to finance and better leveraged assets.
Analysis
Introduction: scaling matters
It matters for the economy. Scale-ups increase productivity, generate jobs and boost exports. It also matters for security and autonomy. Scaling almost becomes a matter of survival in an era of platforms and intensifying strategic competition over technologies. At a time when location matters more and more, strong network effects lead to winner-takes-all outcomes. The inability to produce winners makes you gravely dependent on increasingly untrustworthy powers.
The EU needs winners. Yet it is this scaling stage where the EU is the weakest: it still struggles to scale its companies, despite recent progress. Evidence suggests that this is neither exclusively a supply nor a demand-side issue. Yes, the EU lacks scaling capital. But scaling potential is also limited in an imperfect single market. The EU’s scaling problem exposes the structural weaknesses of its unfinished integration.
Rather than on supply and demand theories, policymakers should focus on their common underlying causes: fragmentation and risk aversion. Fragmented capital markets result in a shortage of scaling capital, while a fragmented single market limits the scaling potential of firms. Scaling needs scale. Similarly, risk-averse institutional investors underinvest in venture capital (VC), while risk averse institutions undermine emerging businesses that, in turn, hesitate to access external finance. Scale also needs a reallocation of capital.
Risk aversion is present at all stages of scaling and rests at the core of the European social contract. Yet scaling up (and eventually growth) needs riskier ventures.
To reconcile scaling and growth with the European social contract, the EU needs to pool risks. This requires scale, and scale implies fighting fragmentation. The flow of goods and capital within the Union must be facilitated, which requires harmonising corporate governance and financial regulation. Then comes consolidation of capital through the creation of a consolidated savings product. Eventually, scaling in the EU would benefit from deeper capital markets and a lower cost of capital delivered through a European safe asset.
By tackling fragmentation and creating the necessary scale, the EU will be able to afford greater risks. This should then allow for rules to be revisited, allowing retail and institutional investors to invest in riskier asset classes. Meanwhile, riskier ventures should become more appealing for entrepreneurs due to reduced costs of failure, improved external finance options and better-leveraged assets.
Scale-ups: a long way to go, still
In the past decade, the start-up and scale-up ecosystem in Europe[1] has shown remarkable growth. The number of companies in the EU has grown by a factor of four to eight, depending on the growth stage. And when looking at tech specifically, the value of Europe’s ecosystem has grown more than fourfold. In a strong vote of confidence, over half of European founders would choose the same country if they had to start again.
However, the EU and Europe at large are still far behind the US. There are fewer companies at all stages of growth and Europe’s share of new global enterprise value remains three times smaller than the US’s, despite recent progress.
When focusing on the innovation frontier, the picture is even bleaker. In tech, Europe is not only behind but it is also losing ground, with its share of global tech revenues falling. EU firms are also losing ground in terms of R&D investment as the US and China gain. More worryingly, in contrast to the US, investment in Europe is concentrated in mature technologies, reflecting a static industrial structure. Not surprisingly, the share of respondents who feel less optimistic about the future of European technology has almost doubled in the past decade.
Crucially, the EU is progressively weaker as companies scale. While the EU hosted just over half the number of start-ups with a valuation below US$50 million compared with the US in 2021-23, the share dropped to 11% for companies between US$0.5-US$10 billion. And when zooming into the over-US$100 billion segment, there is hardly an EU company set up in the last 50 years[2]. EU companies are also valued at lower levels than US ones, with the discrepancy growing from half to a tenth for bigger companies.
Τhe start is similar, but the journey is tougher: while European companies are nearly as likely to raise any form of initial investment, the share reaching US$15 million+ rounds is half that of the US and it takes longer for them to get there.
Supply-side: a capital story
From banks to VCs
The usual explanation for Europe’s underperformance in scaling is capital. European entrepreneurs are as capital efficient[3] as US ones but Europe’s share of global funding has declined.
Yet the capital is available. The savings of EU households are almost double those of their US counterparts. It is therefore a matter of ability to transform savings and channel them into productive investment.
In transforming savings into investment, the EU is dependent on banks. Bank assets in the EU represent 300% of the Union’s GDP, while only 85% in the US. However, banks are unsuitable for financing start-ups and allocating growth capital for, at least, four reasons. First, bank risk management is highly dependent on physical collateral. Secondly, bank risk models struggle to assess the prospects of high-risk, initially unprofitable firms. Thirdly, regulatory and supervisory requirements further disincentivise banks from investing in high-risk ventures. Last but not least, banks do not have the expertise to help start-ups scale. In contrast, start-ups’ assets are mainly intangible, challenging the banking system’s risk management practices, and require long time horizons for return on investment, which are inconsistent with banking maturity and debt-servicing requirements.
Consequently, a bank-based financial system favours incumbents with assets. This is partly why start-ups depend on VC funds.
VCs: once again, a long way to go
The VC landscape in the EU has markedly improved. EU VC investment has grown faster than in the US and China over the past decade. In that time, the number of active European investors has doubled, VC funds themselves have trebled in size and capital raising rounds are bigger, too.
This growth can be partly attributed to strong public sector involvement. According to Kraemer-Eis et al. (2023), public agencies accounted for 25%-30% of VC fundraising between 2010 and 2021. In early 2025 government funding accounted for more than a third of total European funding. This is largely due to the role of the European Investment Fund (EIF), an institution that belongs to the European Investment Bank (EIB). The EIF supports almost half of VC-backed start-ups and is responsible for over 10% of total VC funding in the past decade. Notably, it also crowds in investment, with US$1 of government funding being matched by US$2.9 elsewhere.
However, despite this growth, the EU still has a long way to go. In aggregate, VC investment in US companies is six to eight times higher than in the EU. The EU has fewer VC funds than the US and analogous rounds are smaller too.
Not surprisingly, the EU is weaker at later stages of growth and funding. While US VC start-up capital is 50% more than the EU’s, the difference is 567% at the scale-up level. This may partly be attributed to the smaller size of European VCs. Despite the recent increase in the number of large European VCs, the US has six to eight times more VC funds larger than 500 million, resulting in ‘few funds able to meet individual start-ups’ calls for €30-€50 million of growth financing per round in the later-stage financing rounds’. Smaller funds also struggle to diversify risk.
And even companies that manage to scale, raise almost half of the cumulative capital their US counterparts raise, limiting their potential.
A story of fragmentation and risk aversion
To understand the root causes of the EU’s risk capital deficiency, one must look at how VCs raise money. VCs raise most of their capital from so called Limited Partners (LPs), including wealthy individuals, companies and institutional investors (typically pension and insurance funds).
The story is clear: VCs find it difficult to raise risk capital in the EU. The share of global VC funds raised in the EU is a staggeringly low 5%, compared with 52% in the US and 40% in China. European VCs also need one additional year to raise consecutive funds than US ones. I argue that this is because of two factors: fragmentation and risk aversion.
Fragmentation
Fragmentation is twofold. Capital is fragmented and sits in national silos. Institutional investors such as pension funds tend to be localised: cross-border pension products are rare mostly due to differences in national schemes and laws.
Capital flows are localised, too. VCs tend to raise money locally just as institutional investors (pension funds and insurers) invest locally as well. Home-country bias divides small pools of capital into smaller silos. Interestingly, financial disintegration of European capital markets is higher now than in the years prior to the financial crisis, despite efforts to create a banking and capital markets union.
Fragmentation undermines investment in VC because risk diversification becomes hard and risky investments less lucrative. Indeed, the IMF has found that cross-border risk sharing in the EU is undermined by fragmentation. Above all, fragmentation makes it harder for larger VCs to raise funds as they tend to need capital across borders.
Risk aversion
Then there is risk aversion. EU households are risk averse in their investment decisions. Households keep almost a third of their savings in cash or highly liquid assets (mostly bank deposits), in contrast to just over 10% for US ones. However, ordinary households do not tend to directly invest in VC anyway.
This leads us to institutional risk aversion. Institutional investors in the EU are much less willing or able to invest in VC. US pension funds invest 1.9% of their assets in VC, while their EU counterparts only invest 0.018%. As a result, while EU pension funds accounted for only 7% of EU VC funding, this share is well over 50%[4] in the US.
Pension fund risk aversion is also caused by risk averse regulators and policymakers. Policies may go as far as placing quantitative limits on the amount these funds can invest in VC. Evidence from the other side of the Atlantic shows that institutions matter: a 1979 reform in the US led to a more than threefold increase of pension fund investments to VC.
The story is similar for insurers. Insurers are faced with Solvency II rules which attach high risk weights to VC thereby disincentivising such investments.
Demand-side: limited prospects?
However, capital need not be the cause of the EU’s scale-up challenge. In the words of the Draghi report, ‘causality is likely more complex: lower levels of VC finance in Europe reflect lower levels of demand’.
Investors may plausibly underinvest in EU start-ups if they consider the growth prospects in the EU to be lower. Indeed, results from the EIF 2021 survey show a heightened competition among investors for potential targets.
Once again, fragmentation and risk aversion
The underlying causes, I argue, are the same ones: growth potential is limited due to fragmentation and institutional risk aversion.
Fragmentation: Single Market and IPOs
Draghi’s principal explanation for the ‘lower levels of demand’ in the EU is that the ‘Single Market is fragmented and incomplete in the areas that matter for innovative companies’, offering ‘weaker growth prospects and requiring lower financing’. Indeed, in the 2024 Eurochambres Single Market Survey, almost seven in 10 respondents named differing contractual and legal practices within the Single Market as a significant barrier. Differing regulatory standards further hinder business expansion in the EU.
Fragmentation also undermines the pipeline of promising start-ups. SMEs lack the resources and the scale necessary to absorb the costs of navigating the EU’s fragmented rules and regulations. Effectively, SMEs lack access to the Single Market, and are hence prevented from realising their potential. This is why the EU has a disproportionate number of SMEs and micro companies.
Fragmentation is particularly harmful for tech companies, too. Constraints on data storing and processing increases compliance costs, divergent regulatory fragmentation hinders the flow of data, while data fragmentation hinders the creation of large integrated datasets to train AI models.
Then there is fragmentation in public markets. At the later stages of growth, start-ups may choose to undergo an initial public offering (IPO) whereby their shares are listed in one or more stock exchanges. This can be the culmination of a start-up’s growth journey turning private illiquid ownership into liquid, publicly tradable shares.
Yet IPOs in the EU are fragmented and hence less appealing. Europe (including the UK) has 35 listing exchanges compared with three in the US. Fragmented public markets were the top barrier to successful large-cap IPOs in Europe in 2024. Fragmented stock markets are less liquid, resulting in lower valuations and a substantially lower share of VC-backed IPOs. No EU stock exchange can accommodate the capital needs of big rapidly growing companies at the necessary speed.
Inevitably, inferior IPO prospects arguably discourage investors from betting on the potential of EU companies as exit options for VC and PE investors are lower. Indeed, the limited depth of European public markets is the second-biggest barrier to deploying more capital.
Risk aversion: procurement and entrepreneurial culture
The prospects of domestic start-ups are also undermined by risk aversion. Signs of risk aversion are found in the EU’s entrepreneurial culture. There is less demand for capital as the share of firms seeking external finance in the EU is 17%, less than half than in the US. The main reason given is that they do not need it, but this may be a chicken-and-egg problem. Weaker prospects lead to less need for external finance, which undermines growth potential. Additionally, evidence suggests that fear of losing control of the business is also a notable reason given –another sign of risk aversion–.
Risk aversion is also encountered in procurement processes. Despite recent efforts, as the Commission’s own EU Start-up and Scale-up Strategy admits, public procurement is often risk averse, favouring established suppliers over disruptive start-ups. Only 9% of public procurement has targeted innovation (vs 20% in the US) while almost 80% of it goes to non-EU providers, of which 63% goes to the US.
This matters. Procurement accounts for 14% of the EU’s GDP and can no doubt move the needle. A one percentage-point increase in procurement spending on innovation would lift GDP per capita by 15%.
Testable implications: VC returns, foreign capital, dry powder, relocations and small scale-up nations
To address the EU’s scaling problem, one must understand its cause. And to test the supply and demand theories, we shall look at their implications.
VC returns
The obvious indicator to consider is VC returns. Here the signs are encouraging. Some argue that after years of EU VC returns lagging the US, they are now on par. Others suggest that they are higher. Undeniably, investment opportunities in the EU have improved. This result is more striking if we consider that smaller funds are associated with lower returns and that EU VCs are less likely to take risks. Interestingly, though, many in the market are still concerned.
Foreign investors
The EU’s inability to channel capital into scaling start-ups should incentivise foreign investors to fill the gap, if they deem the investment opportunities to be attractive. Indeed, international investors account for 43% of the capital invested in Europe.
Not surprisingly, the dependence on foreign capital is even greater at growth stages. Foreign investors account for almost half of total growth funding in Europe, while US investors alone account for over a third. If Europe wanted to match the US or China’s reliance on foreign growth stage capital, it would need an additional US$75 billion in larger rounds. This makes sense: foreign investors step in where smaller EU VCs struggle.
This indeed suggests that there is a capital problem: EU-based investors fail to invest in opportunities that foreign ones find appealing. Yet this is not enough. The EU notably lags the US even if we take foreign investment into account.
Dry powder
On the other hand, the existence of uninvested capital (dry powder) is often used as evidence against the capital story. My calculations[5] suggest that in the EU in 2024, dry powder stood at 37% of VC assets under management (AUM), while in the US this share was 26%. This means that there is proportionately more uninvested VC capital in the EU than in the US.
More uninvested capital may indeed suggest that there are fewer appealing opportunities in the EU. However, dry powder is also affected by the business cycle, prices and other idiosyncratic factors. Interestingly, more dry powder could also reflect greater VC risk aversion. VCs in the EU indeed have a lower appetite for risk than US counterparts, which may plausibly result in a more cautious deployment of capital. While there is uninvested capital, EU businesses seeking external finance are indeed more likely to be rejected.
Relocation: what for?
The most convincing sign that prospects in the EU are poorer is the tendency of EU start-ups to relocate. Strikingly, two in five founders have considered relocating. Relocations of EU-founded scale-ups are two thirds more likely than for scale-ups founded in the US and are particularly common as companies grow. Most importantly, almost three quarters of relocating EU firms end up outside the EU, compared with around half of US-founded ones.
Sixty per cent of founders relocated primarily to secure better access to capital and, through this, better growth prospects. Evidence supports this logic: an investment by a US VC is more likely to result in relocation the harder the firm’s financial conditions are and the less developed the local VC market is.
But this is not it. Firms may also relocate because better growth prospects abroad will help them attract more capital. Evidence suggests that this is also true: EU companies with non-EU finance raise almost the same capital cumulatively as those with EU finance, but much less than those based in the US. In plain English, the origin of the capital is less relevant than the location of the HQs.
The desire to list abroad also incentivises relocation, as headquarters and the chosen stock exchange tend to be in the same country. Since 2010 the share of EU IPO market cap listed in the US has skyrocketed, mostly driven by a few big listings. Inferior exit options result in start-ups being sold or listed prematurely. And when scale-ups do list abroad, they have higher valuations at IPO despite raising less capital during the IPO. Interestingly, anecdotal evidence suggests that foreign funding can sometimes be offered conditional on firms listing abroad. This suggests that foreign investors may only be willing to invest if growth prospects are improved by listing on a foreign exchange.
Last, scaling knowhow may also imply better prospects, thereby incentivising relocation. US VCs are better at guiding start-ups through the scale-up journey than EU peers.
Small scale-up nations
But are prospects inferior because of the EU’s fragmented single market? The existence of small economies successful at scaling up their companies may suggest that market size is not a destiny. Indeed, Israel has managed to evolve from being a start-up hub, to scaling companies domestically. Within a year, Israeli companies doubled the amount they raised in mega rounds and now late-stage deals account for 40% of total funding.
However, start-ups in such countries are set up with a global market orientation from day one. They are also facilitated by agreements ensuring market access. In Israel this is facilitated by the country’s deep trading, financial and near-unconditional political relationship with the US, providing Israeli start-ups with a natural market for their products. Indeed, almost a third of Israeli exports end up in the US.
Effectively, small economies need access to big integrated markets in order to scale their companies.
A vicious cycle
Evidence suggests that the supply and demand theory are not mutually exclusive, but mutually reinforcing, resulting in a vicious cycle of missed potential, prosperity and power.
Fewer growth opportunities for start-ups imply lower expected returns for investors. This reduces investment in VCs, further undermining the growth prospects of those start-ups. Low investment even reduces commercialisation and new businesses.
Subsequently, relocation of the most promising companies weakens the flywheel effect whereby incumbent entrepreneurs support the next generation of start-ups. Founders that cross the Atlantic stay there. There is a founder who previously worked in Europe in more than one in 10 new US companies. This leakage leads to the creation of more than 800 companies in the US rather than Europe. This is particularly damaging if it is considered that repeat founders also have a much higher success rate.
The way forwards
From supply and demand to fragmentation and risk aversion
Rather than focusing on whether the EU’s scale-up problem is one of capital or growth prospects, policymakers should focus on the shared root causes. There are two root causes, present in all aspects of scaling.
Fragmentation is present at all levels. There is fragmentation in institutions and infrastructure (notably in data), and this in turn leads to fragmented markets for capital, goods and services.
On the other hand, risk aversion is present at all stages. EU savers are risk averse, avoiding risky investments, while institutional investors underinvest in risky asset classes like VCs. But even EU VCs are more risk averse than their US counterparts; and then, founders in the EU are more averse to seeking external finance. Lastly, risk averse institutions further discourage risk taking at all those stages.
Indeed, risk aversion rests at the core of our social contract. The above manifestations of risk aversion precisely reflect this, as does Europe’s elaborate social safety net, which minimises risks by socialising them.
It is often argued that if we want more growth in the EU, we must accept more risk. Yet, beyond the practical difficulties of delivering this, it is also not obvious that EU citizens are comfortable with higher risks. In other words, it is far from clear that Europeans are ready to abandon their social contract.
Thankfully, growth is not incompatible with this social contract. Yes, growth requires capital allocations in riskier ventures. Yet this need not increase the risk exposure of EU citizens. By addressing fragmentation first, sufficient scale can be achieved allowing us to pool those higher risks. In an integrated market with pooled risks, EU savers will be able to invest more of their savings in productive assets and institutional investors will allocate more capital in VCs. Meanwhile, VCs themselves will deploy their funds less cautiously and founders will benefit from easier access to external finance.
Undeniably, entrepreneurs will have to take risks. But entrepreneurs always belonged to the tail end of the risk tolerance distribution. Importantly, they will enjoy better prospects (payoffs) in a less fragmented market that channels capital to productive investments. Addressing fragmentation before risk aversion is the only way to make growth consistent with the social contract EU citizens have chosen.
Fragmentation
The Single Market and the capital market
Tackling fragmentation requires harmonisation, consolidation and unification. On the capital market side, a drive towards harmonisation of financial regulation and supervision shall remove barriers to the flow of capital. This is precisely what the Savings and Investment Union (SIU) is about. Yet the devil is in the implementation.
An important step would be to reform the European Securities and Markets Authority (ESMA) from being a coordinating body to something that resembles a single regulator. In doing so, policymakers can draw from existing institutions like the Single Supervisory Mechanism (SSM) and the ECB’s Governing Council.
Then, harmonisation of corporate rules shall address fragmentation in the single market allowing businesses to operate frictionlessly across borders. This requires a wider alignment of corporate rules. Yet harmonisation here will not only be difficult to achieve but may even prove counterproductive, given the diverse economic structure and realities across member states. Perhaps the most realistic way forwards is the Commission’s 28th regime, a single, optional legal framework for innovative companies. However, to achieve alignment, this should take the form of regulation rather than a directive, and be attractive enough for firms to choose it.
Piecemeal harmonisation is not enough. Figuring out which rule is harmonised is costly. Businesses must be able to quickly navigate the rules they face.
Then comes consolidation. Consolidated pools of capital can be facilitated by a retail financial product designed to mobilise private savings in Europe and channel them into long-term investment. A useful reference point is Sweden’s investment savings account. This is the idea underpinning the Long-Term Savings Product suggested by Letta. Previous attempts such as the pan-European Personal Pension have only seen limited uptake. Building on recent progress, a product with auto-enrolment and a greater scope can help fight capital fragmentation, creating the scale necessary to fund the EU-level VC ecosystem.
Lastly, unification. Harmonised rules and regulation could pave the way for what the EU desperately needs: a unified stock exchange. A single stock exchange may sound like a distant dream. However, the transition can be gradual. The first step could be a conglomeration of the big European stock exchanges.[6] As a starting point, it could be a voluntary alliance under enhanced cooperation and continent-wide analyst coverage. This conglomeration can then operate under a single trading platform and eventually even offer a streamlined listing process. This will constitute a big breakthrough if we consider how concentrated European stock exchanges are at a country level.
Specialisation is another possible avenue. The EU could create a Deep-Tech Stock Exchange with specifically tailored rules and regulations, catering to the needs of deep-tech start-ups. An alternative is a listing platform for scale-ups. Also, a specialised section for SMEs, with simplified listing requirements, can also help. This could also be an area in which EU stock exchanges cooperate by pooling their small and mid-sized segments, or their tech/growth segments, paving the way for wider cooperation.
Yet the big catalyser shall be a pan-European safe asset. Once again, the market for EU-issued bonds is fragmented and small, lacking the necessary scale. This is precisely what this safe asset, also known as Eurobonds, shall address. As Blanchard & Ubide argue, at a time when global investors are looking for alternatives to the US dollar, Eurobonds can help the EU achieve financial autonomy, creating a liquid financial system with cheaper public debt and private capital. Apart from reducing the cost of capital, it can also improve its allocation by allowing investors to compare and price risks. This is crucial if the EU aspires to channel its capital to productive uses, such as scale-ups.
How: institutions
The economic case for alignment is unquestionable. It is politics that is the problem. While the EU has made notable progress on this front, it cannot beat fragmentation through soft coordination. Minor policy and regulatory differences often translate into high costs for businesses.
The EU cannot beat fragmentation through unanimity either. Qualified majorities can help, but deep integration cannot be driven by majorities imposing rules and policies on minorities. This route would likely result in piecemeal superficial integration. Importantly, it would further widen the EU’s democratic deficit.
Where the above fails, fragmentation can then be addressed by coalitions of the willing. Such coalitions can reconcile the economic drive for integration with democratic accountability. These shall remain within the scope of the treaties to secure democratic legitimacy via the European Parliament and judicial oversight via the Court of Justice. One option is enhanced cooperation by likeminded nations as foreseen by Articles 20 TEU and 329 TFEU.
To achieve this, the EU needs a suitable institutional vehicle, a platform for willing member states to negotiate alignment on different policy areas.
The key is to get the incentives right. Member states must be incentivised to initiate the process: early-joiners must be rewarded through agenda-setting powers. To achieve this, progress must be incremental. No late-joiners shall be allowed to revisit the initial agreements without the consent of early-joiners. On the other hand, states that do not join early will be incentivised to join the group because staying out would imply a strategic disadvantage. If a critical mass of members has aligned, opting out would increase the cost for their businesses.
Crucially, coalitions of the willing should keep their doors open to new joiners, subject to meeting some conditions. This is where this differs from the E6 initiative, which has aspired to push forwards the SIU agenda. While this may indeed help build momentum, coalitions of the willing cannot remain closed to only willing and able members.
Risk aversion
A more integrated EU will be able to afford bigger risks. Capital must be allowed to flow to VCs and scale-ups. For this to happen, Solvency II capital requirements shall be revisited. High risk weights attached to VC and other risky long-term investments will be less justified for consolidated investors as long as the risky allocations do not exceed some reasonable threshold. Such reforms can enable consolidated insurance and pension funds to finance scaling.
Rules constraining the types of investors eligible to invest in VC should also be revisited. Currently, the Alternative Investment Fund Managers Directive (AIFMD) discriminates against large VCs, constraining their investor base. But as the risks and information gaps for investors do not change in the case of larger VCs, the eligibility criteria should be aligned across fund sizes. This should allow more investment in large VCs.
Retail investors should also be allowed to directly invest in start-ups and SMEs in the form of peer-to-peer lending or equity crowdfunding, as is currently the case in Sweden. Fintech platforms allow EU savers to directly access classes with higher yields, bypassing traditional banks, while maintaining key investor protections. For this to work in practice, the associated bureaucracy must be minimised for investments below a certain threshold.
For investors to take more risks, the latter must be potentially rewarding. Improved investment prospects imply greater entrepreneurial risks. While this may partly be a cultural issue, institutions matter too.
First, the costs of failure must be lowered. The adoption of common rules for insolvency proceedings shall make it easier for firms to navigate bankruptcy in the EU, while tools like pre-pack proceedings give entrepreneurs useful ways out.
Yet, more should be done on restructuring. Restructuring is estimated to be 10 times costlier in the EU than in the US and also longer, with impacts on exit prices for VC funds. This also leads to lower investments in technology. Part of the story is related to labour market rules. Yet imitating the US is not a solution: in fact, it may even increase costs. Here the ‘flexicurity’ model of the Nordics could help lower the costs of entrepreneurial failure, while protecting the EU’s social model.
Secondly, the EU can better leverage its strong banking sector by investing in intellectual property (IP) finance. Allowing start-ups to access bank loans using their IP shall improve access to external finance. This is an area already under the Commission’s radar and traditional UK banks already offer such options. However, if the EU is serious about this, it needs to standardise valuation methodologies and perhaps subsidise IP finance at its early stages in order to de-risk it and give it time to develop credibility. That way, the EU’s strong banking sector can help finance start-ups.
Last, the EU should leverage its assets. In the technology space the most important asset is data. Shifting towards an open-source ecosystem backed by a fund that can help maintain it should encourage both innovation and adoption. This, however, requires carefully thought-through, sustainable and safe models of commercial exploitation.
Back to VCs
The above shall facilitate the flow of capital to VCs and improve prospects of EU start-ups. Hence, it shall set the foundations for a developed private equity and VC ecosystem with deep capital pools at an EU level. This will take time.
For this reason, the EU has focused on expanding the scope and resources of the European Investment Fund (EIF) and the European Investment Bank (EIB). While this has contributed to the notable growth we have witnessed over the past 10 years, it is not enough. Those public institutions cannot be a substitute for a mature private equity market. When managing public money, it is (rightly) difficult to escape bureaucracy, while funds with strategic and politically motivated remits are not a good substitute for generalist ones.
The aim is not a US-style VC ecosystem where the 10 biggest funds capture over a third of capital raised and 40% of VC investment goes to four companies. The aim is a VC ecosystem enabling European businesses to reach their potential.
Conclusions: an existential matter
Scaling is a matter of survival. In a world where location matters, EU autonomy requires catching up on frontier technologies. To catch up, it needs big players capable of competing with giants in the US and China. Otherwise, it will be doomed to uncomfortably depend on others, unable to determine its destiny.
In explaining the EU’s relative failure, policymakers should look past the dominant supply and demand explanations and focus on the common root causes: fragmentation and risk aversion. The EU suffers from fragmented capital and single markets combined with risk aversion deeply ingrained in the European investor, entrepreneurial, institutional and policy DNA. As a result, capital is not allocated to promising ventures, which in turn fail to realise their potential.
Scaling needs scale. Fighting fragmentation requires harmonisation of rules, consolidation of savings products and eventually a unified European safe asset and unified (segments of) stock exchanges. Negotiations can be facilitated by an institutional vehicle where willing member states will negotiate alignment.
Addressing fragmentation will then allow the EU to pool greater risks, reconciling growth with its social contract. The EU should then revisit regulations allowing capital to be allocated to riskier ventures. Meanwhile, policy should reduce the costs of entrepreneurial failure and increase the likelihood of success, incentivising economic actors to pursue those ventures.
The answer to this pressing existential issue is first and foremost political. We know what must be done. EU politics must once again demonstrate its survival instinct.
[1] While Europe includes non-EU countries, most notably the UK, similar trends are seen when focusing on the EU exclusively.
[2] While the Draghi report claims there is no EU company in this category, research suggests there is at least one example. Inditex, with a market cap of over €200 billion was founded in the 1985.
[3] Capability of turning investment into scaling companies.
[4] In particular, it was over 50% in 1986. Today, anecdotal evidence and quick calculations bring it to around 70%.
[5] To calculate this share, I divide EU dry powder data with VC AUM.
[6] At a later stage, this could even include the London Stock Exchange.
