To Compete in the Global Economy, Europe Needs to Boost Its VC Ecosystem

Governments worldwide recognize the importance of promoting high-potential start-ups and the institutions that fund them. Europe is no exception. In 2024, Mario Draghi, a former President of the European Central Bank and one-time Italian Prime Minister lamented in an influential report on European competitiveness that “no EU company with a market capitalization over EUR 100 billion…has been set up from scratch in the last fifty years, while all six U.S. companies with a valuation above EUR 1 trillion have been created in this period.” What accounts for this dramatic difference and what can European business and politcal leaders do to close the gap? A Weak VC Industry The discrepancy Draghi picks up on may reflect the weakness of Europe’s venture capital industry. All six U.S. firms in the report (and the two others that have crossed this threshold since) were originally backed by venture investors. Overall, fully half of all U.S. companies that have gone public over the past two decades—the most successful and dynamic firms in the economy—were venture backed. What’s more, these venture-backed firms undertook almost 90% of the R&D undertaken by young publicly traded firms. As a paper I coauthored points out, essentially, almost all the innovation by young American firms is undertaken by those backed by venture financiers. Meanwhile, Europe has struggled to build a dynamic venture sector. Despite a roughly equally sized economy, European venture investment each year has been only about one-fifth that in the U.S., as noted in Draghi’s report. While activity in the U.S., China, India, and Israel have boomed in recent decades, Europe firms’ share of global venture investment activity remains modest, representing 13% of the global total in the 2024. Europe’s paucity of venture funding has driven many entrepreneurs away. One example (of many) was the struggle of the Collison brothers in late 2000s to raise funding for their Limerick-based startup that developed software for eBay sellers and buyers. After their funding proposal was rejected by Enterprise Ireland—the government innovation agency that was (and remains) the key anchor venture investor in the nation—they moved to San Francisco to join an acceleration program run by Y Combinator. After a successful exit, they went on to found Stripe in the Bay Area, recently valued at over $105 billion. The poor state of European VC is in some measure explained by its relative underperformance. Data from global asset custodian State Street suggests that the annual rate of return of European venture funds in recent decades has been 8.6%, compared to 14.6% that U.S. funds have enjoyed (and 10.4% for those based in emerging markets). When we look at the ratio of value created for investors (either realized or unrealized) to the capital invested, a similar picture holds: European funds report a multiple of 1.66, as opposed to 1.79 for the U.S. and 1.83 for the developing nations (numbers privately supplied by State Street bank, applying a methodology described in a paper I coauthored). The VC gap between Europe and other regions has only widened in the 16 months since the Draghi report was released, largely because an increasing share of venture funding is now backing firms seeking to develop these models and exploit them in different industries. This funding is highly concentrated in a few hubs, far more so than venture capital as a whole. The Bay Area, which in recent years has represented about one-quarter of venture funding overall, hoovered up over half the global venture investment in AI in 2024. While Europe has its success stories such as Mistral, AI investing is increasingly looking like a “winner take all” market that the U.S. and China are dominating. There are, however, some potentially helpful trends for the European VC industry. The Trump administration’s “America First” orientation has created enormous pressures on Europe to boost its self-reliance in national security. Given the limited scale and lagging competitiveness of many major European defense contractors, new ventures are likely to play a critical role, as organizations from European Investment Bank to the North Atlantic Treaty Organization have recognized. These represent a potential source of improved investment returns for European investors, who will be well placed to make the right choices. At the same time, cutbacks to academic funding in the U.S. have created an opportunity to reverse the long-time flow of European scientists and technologists to the U.S. To be sure, the extent to which European universities and policymakers can respond quickly to lure back U.S.-based talent remains unclear, especially given the competition from other would-be innovative hubs like Singapore and Australia to attract them. Nonetheless, they should certainly experience less difficulty retaining young academics going forward. But if Europe is to ride these trends successfully, major changes need to be made in how VC firms conduct business in the European market and in attitudes to start-up investment more generally. Closing the VC Gap While there are significant structural challenges that handicap Europe in comparison to the U.S. and China, such as its cultural and linguistic diversity, a concerted effort by industry and political leaders could make a real difference in boosting the venture activity there. Three avenues for reform stand out. 1. Resist the segmentation of capital markets Abundant academic evidence suggests that large public markets geared toward young entrepreneurial firms encourage entrepreneurial vitality. With listing and disclosure requirements geared toward young firms and legions of investors and analysts who understand the risks and opportunities associated with these firms, these markets can boost high-potential entrepreneurial activity. In the U.S. and China, capital flows freely across their economies, with investment rounds typically combining funds from many different states or provinces. When it comes time to go public, the main markets geared towards entrepreneurial firms—New York’s NASDAQ, Shanghai’s Star Market, and Shenzhen’s ChiNext—are reliable homes for new venture-backed firms to list. In contrast, one of the defining characteristics of European venture markets is its segmentation. French companies, for instance, continue to largely raise capital from French funds, who in turn access capital from French financial institutions and the government. If and when firms go public, they are likely to do so on a French exchange. The aftermath of the October 1987 stock market crash illustrates the value of large, robust public markets like NASDAQ. In the wake of the crash, IPO activity in Europe dried up, as it did in the United States. While the U.S., recovered fairly quickly with a “hot” IPO market beginning in 1991, in Europe the story was very different. With the reduction of activity, small European firms and their venture backers were left with few options. The most promising firms could list in the US. But for the vast majority of European firms, the only options were staying private or selling out. The poor state of the European IPO market discouraged venture capitalists from making new investments and asset owners from backing new funds. To address these issues, a group of venture investors led the creation of a pan-European stock exchange in order to promote IPOs. They envisioned a substantial market, with many listed firms and frequent and low-cost trading. But competing efforts soon appeared: the Nouveau Marche in Paris, the Alternative Investment Market in London, and exchanges launched by, among others, the Amsterdam, Brussels, and Frankfurt exchanges. Many of these national rivals had modest listing requirements, which attracted dubious firms. As a result, EASDAQ was unable to achieve a critical mass, while scandals on other exchanges raised questions about the validity of small-capitalization markets in general. In 2003, EASDAQ was shut down. European leaders need to try again, and this time protect their new EASDAQ from local competition by agreeing on stronger, universal listing requirements. 2. Focus on a few clusters. One enduring obsession of Europe’s policymakers is to encourage geographically widespread venture activity. Funding initiatives of the European government bodies—a key source of funds for venture capitalists in Europe—frequently seek to “share the wealth” across many member states. Behind these patterns lie intense political pressures and conflicting interests. Within countries, the same dynamics lead to funds being spread widely across regions. The desire to assure equality of opportunity is in some senses admirable. Unequal growth is likely to have broad social and economic consequences. If stagnant regions could gain vibrant innovative clusters, much hardship and social turmoil might be alleviated. But despite its social worthiness, spreading investment runs afoul of the realities of startup economics. Around the world, entrepreneurial businesses are often clustered geographically; venture-backed businesses even more so. These patterns reflect not just venture returns, but also the creation of innovations and high-quality jobs. Geographic inequality is striking in science-based entrepreneurship, so often the focus of policymakers: research shows that location has an especially strong impact on the successful commercialization of scientific inventions. In short, innovation, especially venture-backed innovation, is very much an “increasing returns” business, as spillovers between inventors and firms make each other far more effective in clusters. A dramatic illustration of co-dependency of local inventors is illustrated in Enrico Moretti’s study of Rochester, New York. Traditionally, innovation in Rochester was driven by film-maker Kodak, which was the fifth most prolific patenting entity in U.S. But as adoption of the digital camera rose in the 2000s, Kodak stock price and employment collapsed. By 2007, the number of Kodak inventors in Rochester had declined by 84%. Interestingly, other inventors in Rochester—even those inventing in areas far removed from film—experienced a collapse of productivity over the same period, seemingly due to the loss of spillovers from their former neighbors. Unfortunately, many European efforts to boost high-potential entrepreneurship end up directing far too much funding to areas with little activity or potential. Funds that could be very helpful in a core area end up where they are not useful. This needs to change. 3. Learn from others The legacy of policies worldwide to boost venture activity has been a mixed one. While many efforts in the 1990s and 2000s were well intentioned, the harsh law of unintended consequences led to many disappointments. In large part, these failures reflected the fact that many of the programs were being tried out for the first time. Fortunately, leaders today can learn from both the good and bad experiences of their predecessors. Avoiding the mistakes of the past is a key guidepost. Yet many efforts in Europe today recycle bad ideas from the past. One of the most egregious examples is tax policy. There is substantial evidence, dating back to the 1980s, that venture capital is sensitive to tax rates. These rates appear to both influence potential entrepreneurs’ decision to begin firms and where they choose to locate them. Yet there is a growing European fascination with taxing entrepreneurial wealth—even paper gains that have not yet been realized. An illustration is the traction that the proposed “Zucman tax” has gained in France. This appeal is despite the dismal track record in the nation that pioneered such taxes, Norway. After the initiation of this tax in 2022, the annual out-migration rate of affected households increased from 0.2% to over 2%, with over 40% of the departures being of active firm owners. Rather than recycling bad ideas, Europe would be much better served looking at the role models elsewhere, such as Singapore. Political and business leaders there have taken a broader view, seeking not just to address deficiencies in the availability of capital, but the many other barriers that limited the creation of an arena in which entrepreneurs can thrive. Efforts to address these limitations have been carefully evaluated and restructured to boost their effectiveness. . . . Creating a vibrant venture sector is more important than ever for Europe. The secret to doing so is not simply to spend public funds, but to carefully craft policies that address the barriers that entrepreneurs face. This imperative suggests the need for European entrepreneurs and venture investors to grab a firmer “seat at the table.” The European policy establishment is large, and all too often out of touch with the entrepreneurial realities on the ground. They need to hear more from those who are struggling to create companies, and to understand how policy prescriptions, however compelling they sound in Brussel conference rooms, must be refined to reflect the unique challenges and opportunities of the moment.

To Compete in the Global Economy, Europe Needs to Boost Its VC Ecosystem

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