This article is written by Mikko Alasaarela, the co-founder and CEO of Berlin-based startup Inbot. Inbot is an artificial intelligence -powered sales assistant that helps B2B salespeople to find warm leads and track their communication with customer prospects.
Having lived on both sides of the Atlantic Ocean, I have come to observe an interesting difference between the success models of the very best American startups and the very best European startups. I mean the unicorns and the breakthrough successes that everyone talks about.
In the USA, the best tech companies like Facebook, Alphabet, Amazon, Apple and Microsoft all built their success on superior technology and ground-breaking innovations. Elon Musk and other bold entrepreneurs have been taking even riskier, history-changing bets with technology startups like Tesla, Hyperloop or SpaceX.
Meanwhile in Europe, the only “real” European tech companies founded since 1980 that have gone to billion+ revenue range that come to my mind are ARM and Skype. Supercell is also in the billion+ revenue club, but more because of their mobile user experience skills than raw technology. The most successful European startups, the unicorn class, are primarily not driven by technology. They are most often online marketplaces like BlaBlaCar, Delivery Hero, Zalando, Spotify, JustEat, SkyScanner, ASOS or Vente Privee. The other big unicorn category is user experience innovators in financial space such as Klarna, TransferWise, Adyen, Powa or Skrill.
One could argue that these companies succeeded due to the business acumen and deal-making talent of their founders. They were from the beginning high on hustle, low on tech. To be fair, these companies offered a better user experience and new, innovative business models, but ultimately they did not win because of a game-changing, ground-breaking technology.
Why is this the case?
If you look at the social media, blog posts, decks and news circulated by European incubators, startup advisors and early stage investors, it becomes quickly obvious that they prefer scrappy teams that are low on tech and high on hustle. Teams that get their products to the market in 6 months, and are able to quickly hustle some revenue growth at least in their home market. To make that happen, technology must be in a secondary role.
It is naive to think that you can solve difficult engineering problems such as developing artificial intelligence with minimal budget and 1-2 developers in 6 months. These startups have to focus on incremental innovations, mostly based on a better user experience or an innovative business model. Such startups are not in a position to create disruptive innovations. The way for these companies to grow is to spend more money on the growth phase to acquire customers.
This early stage selection bias has a consequence to later stage investments. Venture Capitalists focusing on Series A and later stages receive the most mature and advanced pitches from teams who have been able to build their tech with minimum investment and gotten early success on their revenue metrics. These companies typically need hundreds of millions of funding to establish their leadership in a large enough market. According to GP Bullhound’s recent study on European unicorns, the average age of an unicorn was over 9 years, and the average funding raised to become an unicorn was $230 million. Vast majority of these companies are marketplaces.
The American & Israel model for tech investments
The most successful entrepreneurs in the Bay Area and Tel Aviv can receive tens of millions of early funding for bold technological innovations. This gives them a few years of development time and creates compelling opportunities for the most talented technologists and engineers. It also enables these startups to perfect their product and build a massive competitive edge against others before launching their business models, which typically grow their revenues extremely rapidly after the commercial launch.
Such American companies include Tesla ($155M before revenue), Oculus VR ($93M), Magic Leap ($793M), Vicarious ($72M), RelateIQ ($69M) and Planetary Resources ($14M). Israel has invested in companies such as Waze ($67M), X.ai ($11M), Mobileye (tens of millions before revenue) and Consumer Physics ($15M).
There are many more that I have left out to save space, but the point here is to illustrate that companies focused on developing disruptive technology raise more funding pre-product, pre-revenue than their European peers. These companies are also expected to deliver bigger returns down the line, when the technology matures and gives the company a sustainable edge.
Tech unicorns deliver outsized returns
What if the European investors took a page from the Israel model, where highly technology-focused companies raise larger amounts of funding early, and then need less money to support the growth because the technology advantage drives outsize returns? There are already examples of these: Skype ($25M) and Supercell ($12M) raised relatively large early rounds of funding, but required little capital for growth later, providing outsized returns (100-400x) to their early investors.
As a comparison, marketplace companies such as Delivery Hero and Spotify have raised hundreds of millions in funding to fuel their growth, making the multipliers for investors almost certainly much lower than those of Skype and Supercell.
Europe’s problem with tech innovations
European governments spend billions every year to research. This massive investment in research has yielded surprisingly few new dominating tech companies. The system seems to favor the established industrial giants, who have their own budgets to invest in research & development. These projects attract significant co-funding from the governments. It is almost embarrassing that in my native Finland, the largest old industrial companies are the largest receivers of government R&D grants. The situation is the same all over Europe. In other words, the billions spent on research keeps the existing European giants competitive, but does not create new, exciting growth stories that are the hallmark of the Silicon Valley ecosystem.
There are no simple solutions to this problem, but bolder bets by European investors to real, ground-breaking technology startups could eventually start yielding the future European Alphabets, Apples and Facebooks. Governments will likely join the party once the private sector starts it. But who’s the investor crazy enough to start?