Smart Policies?

A recent set of surveys that the Aspen Institute Prague has conducted with partners in Poland and Slovakia attempted to describe the start-up ecosystem in the region. Apart from establishing a profile of an average startupper and deciphering their business models, the studies also sought to answer the questions of how start-ups in the region are financed, the extent of innovation they bring about, or the challenges they face. Most of the replies confirmed the expected.

Central European start-ups operate in software businesses, providing mobile and web services, SaaS, or e-commerce activities. Slightly above fifty percent of them offer entirely new products, while one third on average upgrades or adapts already existing solutions. Entrepreneurs do informally consult their products with universities or research centers but rarely are spin-offs themselves and less than a third has a patent or trademark. While financing is always a challenge, one of the most important handicaps turned out to be the sustaining of a well-functioning team. Majority of the surveyed start-ups are in the early development stages where the company or project is heavily financed from own resource. Only about half of them bring in stable revenues. In need of growth capital, most of the start-ups plan to attract an angel investor, strategic business investor, or benefit from a venture capital fund. Popularity of public financial showed most variance among the three countries: roughly one in five Czech and Slovak entrepreneurs see it as an option, while public subsidies are much more popular with their Polish peers, more than half of whom intend to induce growth with the help of the state. This interest may well be due to an increased activity of the Polish government in designing programs for innovative entrepreneurs. And Poland is no exception.

After innovation-driven SMEs, now it is start-ups that came to epitomize the promised engine of economic growth so much looked for in the post-2007 EU economy. Nevertheless, their position is already being threatened by another buzzword, namely the scale-up, start-up’s older brother. There is virtually no EU member state where at least one ministerial unit or agency would not be working on the start-up support agenda, not to mention the EU-wide initiatives such as the recent Start-ups and Scale-ups Initiative released in November 2016. These political efforts are motivated by the premise that—in order to remain competitive in the world where innovative products multiply—Europe has to optimize conditions for the creation and commercialization of inventions.

Yet, to incubate innovative entrepreneurs is merely the first step in the process of boosting the economy, where the EU countries do not in fact lag behind that dramatically behind other regions such as the often-cited America’s West Coast. The real question is how to keep successful companies at home so that the state, and thereby the society, can profit not only from taxes and employment but also from tertiary benefits these companies create. Such indirect advantages include the engagement of innovative companies in public life through the support for non-profit activities, education, or playing a role model for other entrepreneurs. What, if anything, can public agencies do to help innovation thrive?

Let us look at the modes of stimulating business ventures in the past. State or wealthy families and individuals have been for centuries the major source of capital for companies whose economic value or success was impossible to predict. Stock exchange, for long a rather dormant way of raising capital, is even today a suitable option for companies, which try to conquer the market, not for ones in the exploratory phase. For them the situation changed significantly with the introduction of the limited liability law in 1811 in New York and its successive global adoption. Relaxing the regulation on companies enabled the influx of capital to entrepreneurs, as shareholders did not vouch for the company with their entire property anymore.

Later, scientific advancements and consolidating capitalism prompted the mindset of adapting military and industrial technologies to commercial usages. Those who embraced it were often researchers, academics, and technology managers, leaving their expanding (thus less and less flexible) institutions to establish own ventures. This was happening intensively in California’s Santa Clara County, where among others Stanford University was conducting research for the military.

Such new ventures still could rarely obtain capital from traditional financial institutions and had to rely on savings and wealthy individuals. But again, one state “intervention” helped install an instrument fit to finance risky innovative businesses. Namely, the adoption of the Small Business Investment Act in 1958 led to creation of Small Business Investment Companies (SBIC), meant primarily to aid veterans and other disfavored open their own businesses. Themselves not successful, SBICs assisted in the formation of a working model for the financing of innovative starting companies: the venture capital fund as a limited-liability company, whose general partner (motivated by prospective interest from successful exits) does their best to fundraise for promising entrepreneurs and helps the project grow by non-financial means such as advice or networking.

This brief summary of capital instruments was meant to demonstrate three points. First, the successful state engagement was when it created environment conducive to channeling private capital into innovative enterprises. Second, different financial instruments are helpful at different growth stages of innovative businesses. It may be important to grant state aid to centers conducting basic research, whereas applied research requires the support of risk-seeking angel investors eager to see a new product. Then, if we want start-ups to remain in (Central) Europe, they need more of wealthier European VC funds, which will motivate them to seek scale-up capital on the old continent. Just to put this into perspective, according to a study by Thomson ONE in 2014 the gap in investment funds available in the US and the EU was €21 billion in favor of American ones. Moreover, VC funds and their general managers must be genuinely interested in the growth of companies, not merely in rent-seeking from the carried interest they would receive at the end of fund life. And when a company is ready for initial public offering, it should have the incentive to do so on the local stock exchanges, which in Europe is often not the case. Governments can enact plenty of instruments to mobilize growth capital that go beyond the establishment of own funds for start-ups.

Third, the state administration should not be straining to blindly copy- paste the success of Silicon Valley. As with all ecosystems, it was the result of historical conditions that were turned into entrepreneurial advantages. Why not do the same in Europe? Let us think of the European heterogeneity, welfare system, education models, and other idiosyncrasies as motivators, not obstacles, and capitalize on them. This is not only a task for the entrepreneur, who is used to finding his way towards new business, but for the state administration, provided it takes its pro-startup policies seriously.