For Europe to emulate Silicon Valley’s tech success, it should change its startup funding model
- Written by Michaela Hruskova, Lecturer in Entrepreneurship, University of Stirling
Tech startups will be enthused by the news that[1] Silicon Valley venture capital (VC) veteran General Catalyst is on the verge of raising US$6 billion (£4.8 billion) for backing new companies. It comes hot on the heels of an announcement from[2] Andreessen Horowitz, another major VC, of a new US$7.2 billion investment fund. These are among the largest fundraisings in years, coming at a time when the VC sector has been going through a lull[3], with worldwide total investments down from US$644 billion in 2021 to US$286 billion in 2023.
The bad news, depending on where you live, is that most of the proceeds are likely to be invested Stateside. American startups mop up around half of all global VC funding, while Europe and the UK are lucky to see a quarter. This is despite the fact that Europe[4] and the UK[5] have a slightly larger share of world GDP than the US[6] (17% v 16%).
VC investment by country (US$)
US startups like Airbnb had to survive on a shoestring to get funding.
AlesiaKan[15]
This is in stark contrast to European ecosystems. Recent examples from Berlin include language tutor marketplace HeyLama[16], which secured funding nearly immediately after inception. Meanwhile, pet care startup Rex[17] raised more than US$5 million within months after launching.
And yet, between 2020 and 2022, US$44 billion[18] was invested in early-stage deals in Silicon Valley as opposed to US$5.8 billion[19] in Berlin. Equally, roughly 31% of US[20] but only 19% of European[21] seed-stage startups progress to the next round of fundraising.
This doesn’t necessarily mean that the companies that do not raise follow-on funding fail, but it may help explain why Silicon Valley’s[22] exits amount to US$403 million on average, as opposed to US$53 million in Berlin[23].
So why is it not the case that US startups struggle more when they have to meet higher expectations to get funded? And could other ecosystems catch up by adopting the same strategy?
The ‘valley of death’
The journey of a business idea from inception to early traction is often referred to as the “valley of death”[24]. During this period, the startup needs to keep developing the business, build the product, and figure out a reliable business model. There is no one-size-fits-all blueprint and many companies fail, either because the idea is not viable or they run out of money.
Silicon Valley’s preferred funding model of investing into startups with traction somewhat decreases the risk of failure for VCs. In the long term this should result in more funds for reinvesting into new startups, which likely helped the whole ecosystem to flourish. There’s also a benefit to those entrepreneurs who can delay fundraising until they can demonstrate traction, since the startup is likely to be worth more. This means they can get more money or give up a smaller percentage of the business.
This would suggest that European startup ecosystems ought to think about moving towards this model. But it comes with a major downside. Few entrepreneurs have enough money to maintain the company through the valley of death – and it tends to be longer and deeper[25] for the most innovative ideas. This is particularly an issue for entrepreneurs from under-represented groups[26], such as disadvantaged socioeconomic backgrounds, women and immigrants, who are less likely to have the necessary resources or connections. Thus, adopting the American investment threshold could make the startup world even more inaccessible to them.
To get the benefits of the US system without damaging diversity, there need to be support structures[27] in place, such as incubator and accelerator programmes, to help startups gain traction. Even so, these need to be designed carefully to ensure they signal credibility[28], and therefore help – rather than hinder[29] – the incubated companies to secure their first round of investment.
References^ news that (www.ft.com)^ announcement from (www.ft.com)^ a lull (dealroom.co)^ Europe (www.statista.com)^ the UK (www.worldeconomics.com)^ than the US (www.statista.com)^ Dealroom (dealroom.co)^ CC BY-SA (creativecommons.org)^ Silicon Valley’s success (startupgenome.com)^ mutually reinforcing factors (www.tandfonline.com)^ demonstrate traction (www.startupgrind.com)^ Our research suggests (global.oup.com)^ AirBnb (www.businessinsider.com)^ DoorDash (www.forbes.com)^ AlesiaKan (www.shutterstock.com)^ HeyLama (medium.com)^ Rex (www.startbase.com)^ US$44 billion (startupgenome.com)^ US$5.8 billion (startupgenome.com)^ 31% of US (mattermark.com)^ 19% of European (dealroom.co)^ Silicon Valley’s (startupgenome.com)^ Berlin (startupgenome.com)^ “valley of death” (doi.org)^ longer and deeper (hbr.org)^ under-represented groups (www.oecd-ilibrary.org)^ support structures (journals.sagepub.com)^ signal credibility (www.sciencedirect.com)^ rather than hinder (journals.sagepub.com)
