ExchangeWire recently published a piece on the subject of how venture capitalists are failing UK ad businesses. This prompted a lot of discussion; in particular how this issue isn't just limited to the UK, but is prevalent across all of the EU. Jan Jilek (pictured below) has 12 years' experience within ad tech start-ups, is president of the IAB Croatia, founder of 1000startupsEU and is CEO of audience measurement company, Dotmetrics. He talks to ExchangeWire about the challenges facing B2B startups across the EU and what needs to happen to turn their fate around.

The internet is global. So, it shouldn’t matter where your startup is based, should it? Think again! Unfortunately, founding a B2B startup in the EU is much riskier than in the US. There are many reasons for that, but one main reason that fuels all the others is the market.

In the US, the development of venture capital started more than 75 years ago; because the market demanded a solution to be able to finance companies developing great products, to allow the distribution to be scaled across the entire US market – a risk which banks didn’t want to take. On the contrary, Europe was, and still is, a divided region, with many borders to protect their people and their businesses. Consequently, the individual markets were much smaller and in most cases a simple bank loan sufficed to allow the scalability required. The risk to banks was significantly smaller, so the European markets didn’t have a requirement for venture capital; hence why the EU lacks an equity culture.

The EU is a politico-economic union, not a country; we still have borders and these borders cause a few more challenges to startup businesses in this region, versus their US counterparts. If local businesses are protected by borders, is there a need to innovate? No. As a result, large corporations in the EU don’t buy innovative products and services from startups, which causes the EU to lack a culture of innovation.

For more than 200 years European entrepreneurs and innovators have gone to the US, because it is easier to succeed. The US market has the infrastructure for fast growth and heavy competition is driving the adoption of innovation. The conversion rate for startups becoming fully scaled businesses is higher; more entrepreneurs succeed and promote the benefits of entrepreneurship to others.

When you are developing a B2B startup in the EU, you aren’t starting it on the whole EU market of 508 million people. You are starting it in one of the 28 member countries. There are much fewer potential customers, traction is less, and incomes are lower. Expansion is also much harder and much more expensive. If you need to employ somebody within the new market, you are not just paying for his or her salary – you also have to pay for an accountant who will calculate that salary. New office, new lawyer. Now calculate that expense for 28 EU countries. As a result of all of that, startups don’t grow in the EU like they grow in the US. So, it is fair to say that the market risk for B2B startups in the EU is much higher. Because of smaller traction and bigger risk, the valuations of startups in the EU are much lower than in the US. And lower valuations bring us to another problem. If B2B startups have smaller incomes, valuations are lower and growth is more expensive, how can startups compete with their US counterparts, who have much higher incomes and are getting more money from VCs based on a much higher valuation?

So, there is a paradox: to be able to level up the playing field, and to compete with our US counterparts, startups in the EU, with much bigger market risk, should get higher valuations than US startups.

With a 75-year history of venture capital culture, the US has a wealth of much more experienced and sophisticated VCs to enable startup growth. There is a significant lack of VCs operating within smaller markets in the EU. What you actually need in this region are VCs from different markets who will help to take your product cross-border. However, to lower the risks associated with investment, EU VCs tend to invest in startups within their local markets, where they understand the legislations and barriers to entry. Local market investment also enables the VC to be close to the team in which it is investing, monitor activity, and build rapport.

It is a dilemma: in the EU you will probably pitch and be awarded investment from a local VC, when you actually need to be pitching for investment from VCs who can help you expand into new markets – that’s how you will speed up growth of your startup.

The reality is that fewer entrepreneurs succeed in the EU. With lower valuations, they are burning their equity much faster, so when they get to the valuation of €100m (£78m), they are probably left with only 20% equity; which means it is time for them to exit. And they are mostly bought by US startups and corporates, because EU corporates don’t buy startups. The reason for this is simple: how many EU startups have outgrown EU corporates in their field? EU corporates are not scared of EU startups. They know startups won’t outgrow them; and, because of that, they won’t buy them in the same way that US corporates are buying and investing in US startups.

The EU market dynamic has to change; but, unfortunately, that is not happening. On the contrary, the European Commission is doing exactly the opposite. Instead of building the infrastructure for growth in the EU, they are trying to build borders around the EU with policies like GDPR. This will significantly slow down the growth of foreign internet companies within the EU – and, thus, the whole digital industry. Most importantly, most US corporate internet companies and well-funded US startups will have the necessary capital to comply with the new EU data protection rules; a luxury which will not be afforded to startups within the EU. We will arrive at a situation where the EU will realise that their data protection policies were counterproductive and remove them. But, by this point, the US startups will have continued to develop their products within their local market and will be many years ahead in terms of growth, development and value, further reducing the opportunities for success for EU startups.

This is a reality that we have to be aware of, but we can’t let it stop us. The only way to fight scale is with innovation, so we have to be even more innovative. The internet will bring competition regardless of market borders; and larger EU companies will have to adapt and embrace the innovation coming out of startups. This will be their only hope. And we won’t have to wait long for that day to come. The EU market will have to change, because the internet has irreversibly changed market conditions for the whole world.