Monday, December 11, 2023

A list of factors that act(ed) as drag on the European Tech/Startup scene

This post is an adaption of a Twitter thread where I listed the various factors that in my experience led to a divergence of the trajectories of the US tech industry around Silicon Valley (SV) and the tech industry in Europe. Not all of these factors are current (some of the cultural ones are less pronounced today than they used to be), and some of them could be relatively easily fixable.

I'll add a separate post on policy suggestions at a later point.

I should also note that there's many great things about Europe -- I still live here, I'd build my next company here, and I don't think I'd ever want to migrate to SV. I'll also write about the advantages in the future.

Now, on to the list, which was spawned by a thread with @martin_casado and @bgurley on the website previously known as Twitter.
  1. Cultural factors: When I was growing up in the 90s, there was significant uncertainty in the labor market, and one way to achieve economic security was seeking a government job. In many European countries, running a limited liability construct into insolvency effectively bans you from running another one in the foreseeable future. The mentality of "start a company in your 20s, and if you fail, you can either try again or get a job" wasn't a thing. So we are operating from a risk-averse base, due to a labor market with then-sluggish job creation and strong incumbent effects. (Bert Hubert has written a more extensive article on the cultural factors here).
  2. A terrifyingly fragmented market, along legal, linguistic, and cultural lines. Imagine every US state had its own language, defense budget, legal system, tax system, culture, employment law etc. - in the US, you build a product and you tap into a market of 340m people. The biggest market in Europe is Germany at 80m, not even a quarter of the size. Then France (65m), Italy (59m), Spain (47m), and then things fragment into a long tail. By the time you hit 340m customers, you're operating in 9-10 countries, 7+ languages and legal systems etc.
  3. Equally fragmented capital markets that are individually much smaller. Take the US stock market and cut it into 10+ pieces. This has knock-on effects for IPOs: IPOs, when they happen, tend to be much smaller. Raising large amounts of capital is more difficult, while big wins are smaller. This has terrible knock-on effects all the way down to seedstage VCs: If the power law home run you're angling for is 1/10th the size of the home run in the US, early stage investors need to be way more risk averse. You can see this even today where most European VC funds will offer less money at worse terms than their US counterparts. It was much worse in 2006-2007, when the Samwers were almost the only game in town for VC in the EU.
    Smaller IPOs also mean that it is comparatively much more attractive to sell to an existing (US-based) giant.
  4. The absence of a DARPA to shoulder fundamental research risks in technology. Different stages of R&D require different investors. The government is in the strange situation that they can indirectly benefit from investments without having an ownership stake because it gets to tax GDP. That means at the extremely high risk end of R&D, fundamental research, it can afford to just finance many many long shots blindly and (comparatively) simply, as it doesn't need to track ownership. So how do you fund fundamental R&D without it devolving into scholasticism? Interestingly, the most basic test ("can I use this to cause some damage") is already helpful. Europe's defense sector has never since WW2 grasped it's role in advancing technology, and it's terribly fragmented, underfunded, and can't do much research. DARPA has financed the early-stage development of many enabling technologies. Having a guaranteed customer (DoD) for high risk research has enabled better and higher risk-taking, and had large downstream effects.
  5. Terrible legislation with regards to employee stock options. People talk about how many big companies in Europe are family-owned as if that is something good. It's also a symptom of legal systems that make (or made) it terribly difficult to give lots of equity to early employees. This is slowly changes through concerted lobbying, but it is still difficult in most jurisdictions, and not unified at all.
  6. The way the EU is constructed where the EU gives a directive and each country implements it's own flavor is worst-case for legal complexity. Imagine if every state got to re-implement its own flavor of each federal law.
  7. Founder Brain Drain. Why would an ambitious founder not go to where the markets are bigger, capital is easier to raise on better terms, and incentivizing early employees is easier?
  8. Ecosystem effects permit risk-taking by employees in SV. SV has such strong demand for talent that an employee can "take risks" on early stage startups because the next job is easy to get. If you live in a place with just 1-2 big employers, leaving with intent to return is riskier.
  9. Network effects and path dependence. The fragmentation of the market led to smaller players in search and ads that then sold to larger US-based players. Without the deep revenue streams, no European player had the capital or expertise to go into cloud. As a result, there is no European player with enough compute, or datasets, or capital to effectively compete in cloud or AI. China has homegrown players, even Russia has to some extent, Europe's closest equivalent are OVH and Hetzner, which sell on price, not on higher-level services.
  10. GDPR after effects: EUparl saw that in situations where US states are fragmented they can act as a standards body, and there's a weird effect of "if we cannot be relevant through tech, we can still be relevant through shaping the legal landscape", and that's what leads to this terrible idea of "Europe as regulatory superpower", where it is more important for members of EUparl to have done "something" than having done "something right" - a mentality that seems to prefer bad regulation over no regulation, when good regulation would be needed. GDPR led to higher market concentration in Ads, which arguably undermines privacy in a different way, and it's imposed huge compliance and convenience cost on everybody. But in EUparl it's celebrated as success, because hey, for once Europe was relevant (even if net effects are negative).
  11. Pervasive shortsightedness among EU national legislators, undermining the single market and passing poor laws with negative side effects for startup and capital formation. The best example is Germans "exit tax": Imagine you are an Angel Investor in the US but if you move out of state it triggers immediate cap gains on all your illiquid holdings/Angel Investments at the valuation of the last round. It essentially means you can't angel invest if you don't know if you'll have to move in the next 8-10 years because you don't know if you can afford the tax bill. It's hair-raisingly insane, and likely illegal under EU rules, but who wants to fight the German IRS in European court?
I think these are the most important factors that come to mind. I'll add more if I remember more of them.

Also, given that this post has a strong resonance with extreme "anti government" and "libertarian" types, please be aware that I am very much on a different area of the political spectrum (centre-left, somewhere where the social democrats used to reside historically in Germany). I am strongly in favor of good and competent regulation to ensure markets function, competition works, and customers are protected.