Europe is home to some of the world’s most famous unicorns.

These are privately held companies in the tech sector worth more than $1 billion. Among the European stable of unicorns are global household names including Spotify and the developer behind mobile games Angry Birds and Clash of Clans.

Technology is giving Europe the potential to grow many more such unicorns, as it enables the growth of start-ups across the continent. Operating in the cloud gives start-up companies access to a whole data centre of computing power, while Artificial Intelligence is speeding up their business processes. Social media, meanwhile, is giving new businesses an instant connection with potential customers.

But while technology makes starting a business easier than ever before, a new survey commissioned by Tata Consultancy Services and carried out by Brussels-based thinktank ThinkYoung reveals that there are significant barriers stopping many of these small companies scaling up to become unicorns.

 

Digital single market

The biggest barrier to Europe creating more unicorns is its fragmented nature.

Despite the EU in theory being a single market with free movement of goods, services and people within its borders, this isn’t the reality experienced by most start-ups.

ThinkYoung founder Andrea Gerosa says in the report that in “many cases, regulations have prevented some of these innovators from scaling and reaching their full potential.”

In order to scale-up, he says, European start-ups need easier access to more than 500 million potential customers across the continent.

“If a start-up opens in San Francisco it is an American start-up with access to 350 million customers from day one” says Gerosa.

“By contrast, at the moment, if a start-up opens in Madrid it is a Spanish start-up, not a European start-up, and its initial potential customer-base is therefore much smaller.”

The trade barriers underlying this fragmentation range from high cross-border delivery costs, to divergent VAT and contractual and copyright systems across EU member states.

And it is not only start-ups being frustrated by these barriers.

Although Spotify began life as a Swedish company, it moved its operations to the US in order to scale-up.

As Spotify’s founder and CEO, Daniel Ek, stated recently, “Sweden was too small of a market for us, that just wouldn’t happen, whereas if you start a company in the US you have access to a population of 300 million from the get-go.”

The EU is attempting to tackle the problem of barriers to scaling-up through its Digital Single Market initiative, which aims to make it easier to use online services across the EU.

The ThinkYoung report also recommends that more European nations follow the example of countries such as Sweden and Finland that have been successful in fostering a large number of start-ups and several unicorns

“The Swedish government developed a social, educational and corporate infrastructure that has supported innovative SMEs from as early as the 1990s,” says the report.

“This has a huge impact on what it can achieve today. Tax-breaks and subsidies were implemented for residents to purchase personal computers. Also, Sweden benefits from a low corporate tax rate, which is currently at 22%, providing an incentive for citizens to start their own business.”

Similarly, Finland, home to the developer behind Angry Birds and Clash of Clans, has been “highly successful in implementing many kinds of public funding and support services, which are offered to innovative SMEs on local regional and national scales.”

Finland has also invested in digital infrastructure, incentivizing the development of high-speed fiber-based networks, and start-ups are also supported by the country’s low corporate tax rate of 20%.

The ThinkYoung report says Europe must find ways of increasing the amount of venture capital investment available to start-ups.

Investment ecosystem

Another key barrier for new companies being able to scale-up was a lack of access to the capital investment they required.

The ThinkYoung report says many of the entrepreneurs interviewed said that while there was access to capital for start-ups through many regional funds, it was the next stage of scaling-up where support is harder to find.

Again, Europe trails the US in this regard. Compared to the US, Europe has a significant lack of venture capital investment. This is explained partly by the fact that approximately 30% of venture funding in the US is provided by pension funds, a figure that is significantly lower in Europe.

“The reason for this is partly regulatory, as pension funds are not allowed to take as many risks in Europe as in the US,” says the report.

“Yet perhaps a more important factor is the size of venture capital funds in Europe. Pension funds aim for investments of €50-€100m, yet European venture capital funds tend to have sizes which fall significantly below this threshold.”

The report says Europe must also find ways of further increasing the amount of venture capital (VC) investment available to start-ups. While in the US, start-ups can access millions of dollars from a mature venture capital sector to help them scale-up, the European structure is not yet at the same level.

“There needs to be a better ecosystem focused on helping European start-ups gain better access to financial assistance and improve their ability to access late-stage funding,” it concludes.

“This type of investment is pivotal to providing start-ups with the resources to scale and compete on the global stage.”

Download the report: Transforming European start-ups into global business leaders – developed by Tata Consultancy Services and ThinkYoung