Consolidation of European Startups: Challenges and Strategies for Growth

By Johanna Kunze

The European startup ecosystem has emerged as a stable and flourishing startup market, maintaining its position as one of the world’s leaders in research and development (R&D), groundbreaking innovation, and market development. However, reports on the European startup ecosystem[1] reveal a disparity: Europe produces 36% of global startups but only accounts for 14% of the world’s unicorns. Furthermore, European startups are 30% less likely to progress from seed to a successful exit compared to their counterparts in the United States. This indicates that Europe’s ecosystem may be less effective in fostering sustainable growth and transforming startups into late-stage successes. But what are the underlying reasons for this? What challenges are European startups and venture capitalists (VCs) currently facing, and what strategies are other markets, such as the US, employing more effectively? Could there be a lack of collaboration and consolidation among European startups that is hindering their growth?  

Europe’s startup ecosystem, while robust, often struggles to foster sustainable growth and reach late-stage success as effectively as its American counterpart. Several factors contribute to this disparity, and while this overview is not exhaustive, it highlights the most prominent ones from a European perspective.  

The Funding Landscape Disparity 

One key difference is the funding landscape. Europe generally has less venture capital available compared to the U.S. ($44 billion vs. $179 billion in the US)[2]. This means that more startups are effectively condemned to failure, facing limited opportunities for (re-)financing. Despite having less available capital, European startups encounter a level of competition for funds that is comparable to their U.S. counterparts. This intense competition for a smaller pool of resources severely restricts the chances of survival and growth for startups in Europe. 

Moreover, despite Europe’s success in nurturing indispensable innovation hubs like Sophia Antipolis in France, Europe still lags behind the U.S. when it comes to nurturing established ecosystems like Silicon Valley.  

Market Fragmentation in Europe: A Blessing and a Curse 

Another significant aspect to consider is Europe’s market fragmentation. When comparing U.S. and European startups, it is important to remember the perception of Europe as a single market is misleading. Despite the EU’s efforts to open borders and markets, Europe is still a collection of dozens of different countries with distinct languages, cultures, and government policies. This presents unique scale-up challenges, hindering the growth of European startups.  

For instance, customer behaviors and preferences can differ significantly even between neighboring countries, necessitating tailored marketing and branding strategies for each market. This often requires more investment and time to adapt to various languages and payment methods than is typical for a startup in the United States. In addition, distribution and marketing channels must be customized due to these differences. Furthermore, the regulatory environment in Europe adds another layer of complexity. While the EU is working on standardizing regulation, European legislation is still strict and more fragmented compared to the U.S., with significant variations across industries and verticals.  

Navigating Fragmented Markets through M&A 

Given these challenges within Europe’s startup ecosystem, the need for startups to pursue mergers and acquisitions (M&A) becomes clear, with more cooperation and consolidation required, especially in cross-border activities. These strategies are essential for startups aiming to navigate and ultimately thrive in the complex and fragmented European market. 

Access to diverse markets through cross-border M&A is crucial due to the fragmented nature of the European market. Startups often face barriers when attempting to scale across different countries. Consolidation offers a strategic solution, allowing startups to quickly enter new markets without the need to build a new customer base from scratch. By merging with or acquiring companies in different European countries, startups can gain immediate access to established networks and customer bases in those markets. For instance, in 2017, Zalando acquired Munich-based Kickz, well-known for its basketball and streetwear retail, diversifying its portfolio and reaching new customers. Scale-focused startups thrive on rapid sales growth and achieving economies of scale. Zalando is a prime example as the ecommerce giant expanded quickly through aggressive sales tactics and market domination. This approach allowed them to achieve significant economies of scale, which is vital for their sustained growth. 

Cross-border M&A enables startups to learn from the experiences of other companies in different European countries. This shared knowledge is invaluable in navigating the diverse regulatory landscapes and consumer preferences across Europe. Leveraging the insights and expertise of local companies helps startups adapt more effectively to different markets. Startups that heavily rely on national networks, such as BlaBlaCar, a carpooling platform that acquired German carpooling.com, can benefit from merging their network with another existing one[3]. These network-focused startups operate in markets where local dominance is key, necessitating a tailored approach to each new market entry. BlaBlaCar’s success can be attributed to its ability to adapt and dominate in local markets, leveraging network effects for growth. 

Risk Management and Diversification 

European startups often seem to be risk-averse, which can be addressed through M&A by spreading the risk across a larger, more diverse entity—often termed, economies of scope and horizontal diversification. Integrating with companies in other European countries brings a deeper understanding of various cultural nuances, aiding in developing more effective localization strategies. 

The complexity of the European regulatory environment can be a significant hurdle for startups. M&A facilitates better navigation of these regulatory landscapes since acquiring or merging with companies that have already established compliance in their respective countries can provide a clearer pathway for others to follow. 

The relatively lower availability of venture capital in Europe compared to the U.S. can be a major constraint for European startups looking to scale. Through M&A, startups can consolidate resources, share risks, and access new funding avenues, which can be particularly beneficial for startups struggling to secure sufficient funding independently.  

Engaging in M&A activities is also a sign of a company’s maturity. The M&A process itself demands a significant level of expertise, is inherently lengthy, and carries considerable risk. Successfully navigating an M&A transaction indicates a company’s advanced operational, strategic, and financial acumen, marking its readiness to tackle complex business challenges and opportunities. 

Secondary Markets and Future Investment Strategies

Amidst the growing importance of consolidation and cooperation, the startup and investment sector is seeing an increased focus on secondary markets, where shares of private companies are traded among investors after the initial issuance. Venture capital firms, like London-based Launchbay Capital, are significantly investing in these markets. Launchbay recently raised $25 million towards a $100 million fund, anticipating a booming secondary market by 2024[4].

M&A Challenges & Post-Merger Management 

Successfully navigating mergers and acquisitions presents several challenges. Traditional M&A processes are time-consuming and demand substantial financial and HR resources, requiring legal and financial advisory services. This complexity can deter startups that lack the resources or liquidity to effectively engage in these activities. M&A can be a double-edged sword; it offers opportunities for rapid growth and creating additional value but can also divert attention and resources, particularly for early-stage startups, which may prevent their organic growth. Therefore, startups must carefully consider their organizational capacity and resources to successfully integrate acquired entities. Post-merger, companies face numerous challenges: cultural and operational integration, communication issues, financial strain, and legal compliance.  

So-called “killer acquisitions”—where a larger company acquires a smaller, innovative startup to eliminate future competition—can have detrimental effects on startups. Such acquisitions often halt the development of innovative products or services to prevent future competition, stifling innovation and reducing market diversity. This not only limits the incentive for startups to innovate but can also lead to market monopolization and reduced consumer choices[5].

European startups often adopt more conservative growth and exit strategies than American companies, driven partly by concerns about raising significant follow-up capital. This is exemplified by the acquisition of CityDeal, a German collective-buying platform, by Groupon after just six months of operation, as well as the sale of iZettle, a Swedish payments company, to PayPal amidst preparations for an IPO. These cases highlight the cautious approach of startups trying to survive in the face of rapid market changes and the challenges of securing further investment. 

Yet, smaller companies are typically more agile and responsive when addressing immediate challenges or trends. They benefit from streamlined communication channels and fewer bureaucratic layers, enabling quicker and more precise responses to market shifts or problem-solving. Their independence allows for greater flexibility in market positioning and a better capacity to adapt to external circumstances and developments. Therefore, in some cases, close cooperation might be a more reasonable and tactical choice than the path of acquisition. This is the classic dilemma of security versus freedom.  

Venture Debt as a Consolidation Tool 

Experienced investors and venture capitalists can facilitate cooperation by identifying consolidation opportunities, introducing founders to one another, and brokering M&A deals. Venture debt or growth debt suppliers can significantly foster consolidation efforts in Europe. They provide a valuable alternative to equity financing, allowing companies to raise capital without diluting ownership and leveraging a buy-out. This form of financing offers flexibility and can be a more affordable option due to its lower cost in the long term. It is especially useful for supporting strategic acquisitions and maintaining growth momentum during consolidation phases. Moreover, venture debt can serve as a bridge to profitability or the next round of funding, all while allowing company founders to retain more control over their business decisions and directions.  

Consolidation: From a Venture Capital Perspective 

In recent years, the European venture capital landscape has also faced several challenges leading to lower exit rates, marked by a significant decline in both initial public offers (IPOs) and mergers and acquisitions, as highlighted in the 2023 State of European Tech report. The number of M&A transactions halved in 2023 compared to the previous year, and the IPO market is nearly at a standstill[6]. This downturn has created a growing urgency for VCs to “deinvest” in order to return capital to their limited partners (LPs), who are increasingly looking for returns on their investment as highlighted by industry expert Marc Fournier, co-founder and managing partner at French VC Serena Capital.  

Market volatility and economic uncertainties caused by the pandemic, wars, and other recent crises have greatly influenced investment choices, dampening the attractiveness of IPOs and making them less feasible. Venture capitalists, in response to these market conditions, are increasingly favoring M&A as a strategy for liquidity. M&As offer a more immediate route to liquidity compared to the traditional IPO route, which is particularly crucial in a market where IPOs are slowing down. 

Additionally, startups often face high valuation expectations, which can create a mismatch with market realities, further complicating public listings. Regulatory hurdles across Europe’s fragmented market also add complexity to the exit process. This fragmentation complicates not only the IPO process but also affects the feasibility of M&As, although to a lesser extent, making them a more viable option for VCs looking to de-invest in the current economic climate. 

Strategic Pathways for European Startups

The European startup ecosystem is at a crossroads. While it continues to foster innovative and dynamic startups, the path to scalable growth and success requires a balanced approach, combining organic growth strategies with strategic consolidations. This approach, coupled with an evolving investment landscape, will be crucial in defining the future trajectory of the European startup ecosystem.  

Recognizing the importance of collaboration among founders and entrepreneurs, as well as strategic alliances, is key to strengthening the European ecosystem of businesses. The financial and regulatory support and promotion of these consolidations should increasingly be brought into focus. Particularly in light of the macroeconomic changes caused by digitalization and globalization in recent decades, it is crucial for the EU and European companies to act as a united front. This unity is necessary to continue facing the growing and imminent geopolitical and ecological challenges and to protect the strengths of our multifaceted continent. 

[1] McKinsey, 2020, https://www.mckinsey.com/industries/technology-media-and-telecommunications/ourinsights/europes-startup-ecosystem-heating-up-but-still-facing-challenges  

[2] Crunchbase, Oct. 2023https://news.crunchbase.com/venture/europeleadsusstartupvcgrayequidam/

[3] McKinsey, 2021, https://www.mckinsey.com/industries/technology-media-and-telecommunications/ourinsights/winning-formula-how-europes-top-tech-startups-get-it-right

[4] Sifted, 2024, https://sifted.eu/articles/secondariesfund100millionvc

[5] OECD, 2020, https://one.oecd.org/document/DAF/COMP(2020)5/en/pdf

[6] State of European Tech Report, 2024, https://stateofeuropeantech.com/executivesummary

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