Europe’s Digital Phantom Pains (or: How Start-up Programs Feed the Tech Beast)

There is a particular flavour of European techno-nostalgia. It says something like: We used to be the leaders. We used to be inventors. We used to make the fastest trains, the fastest planes and the fastest cars (well, that may still be the case). We used to be drivers of new technologies: telecom, microchips, and energy. But today, Europe asks itself: “What happened? Where are the European ‘digital champions’? Why has Europe not produced an Amazon or a Tiktok?” (Next instant, somebody says “Spotify!” and then what?).

These phantom pains may be the reason why there are so many EU policy and funding initiatives aiming to bring forth a European digital champion to rival those of California and China. The idea is that public support will bring competitive companies. That has worked really well for Silicon Valley and Shenzhen. The famous tech funds on Sand Hill Road are built on public funding in the form of federal loan guarantees of four public dollars for one private. 4:1. One detail: the US Small Business Investment Act dates back to 1958, giving America many decades head start. In China, the five year-plans provide ample funding for various technology industries. So plenty of public money to the West and to the East.

Can Europe catch up by pouring public money into digital start-ups? Could that bring the European digital champions we yearn for? (If you think those looks like rhetorical questions, it is because they are!) The answer lies in how the tech startup system works and the keyword here is “exit”. Let me try to make sense of it:

Digital entrepreneurs are not expected to make any money, they are expected to “scale.”. Investors don’t care about the profits of the company, they have a longer view of value. Of course, the company still has costs, but those are covered by the investors. There is a system of “rounds” called things like pre-seed, seed, series A, B, C etc. Each step of the way, investors get shares of the company, and what they pay for those shares determines the valuation.

If you pay one Million US-dollars for 10% of the shares in a “series A-round”, the startup is valued at ten Million. If, in the “Series B-round,” the next investor buys 5% of the shares for two Million USD, the startup is valued at 40 million, and the first investors shares have quadrupled in value.

The risk is considered to be lower in later rounds, so earlier investors get more shares for the same money. Note that this can go on for several rounds, with the startup operating at a loss. So… now you probably ask “how do investors get their money back?”. The answer is the magic word “exit”. Normally, this could be different things, for example, offering the company’s shares on the stock exchange or selling to a bigger company or investor. But for tech startup investors, the end goal is (almost) always the same. Exit by selling the shares to an internet skyscraper. Amazon, Apple, Google, Meta… the usual suspects. Those mammoths know how to make money from users, the investors cash out and move on to the next case. Happy end for all involved. (This system used to work much better in a low-interest rate economy, but the exit-principle is the same).

This means no amount of EU startup-funding will bring European champions: as long as the end goal is exit to Big Tech, all that tax-payer money only serves to reinforce the incumbents.