Europe’s Tech Startup Boom

Europe’s Tech Startup Boom

Fueled by plentiful venture capital, plus cheap talent from Eastern Europe, tech entrepreneurs are pulling in U.S.-size profits

by
Gail Edmondson
June 12, 2007, 12:42PM EST

Two-year-old London-based startup Garlik
has the whiff of Silicon Valley about it. Its co-founders, Tom Ilube
and Mike Harris, sold their first Internet-based company for an
estimated $1 billion to Citigroup (C).
The bulk of Garlik’s research and development is outsourced to talented
computer engineers in Poland who work for a fraction of what they’d
cost in Western Europe. And it is backed by $18 million in venture
capital.

With the speed of a well-heeled California startup, Garlik has raced
to market in 18 months with DataPatrol, a privacy program that surfs
the digital universe and, to deter abuse, tracks all the information
about an individual on the Internet. Users now top 56,000 and Garlik is
being hailed as a pioneer in the sector.

There’s plenty more startups like Garlik emerging in Europe these
days, fueling a tech-investing boom not seen on the Continent since the
dot-com days. Successful serial entrepreneurs, cutting-edge technology,
flush venture capital backing, and unfettered access to a continental
talent pool: That quintessential Silicon Valley alchemy, once missing
in Europe, is now powering venture investment to record levels. Venture
funds raised last year for startups and early-stage companies in Europe
rose 60%, to $23.5 billion, according to data released June 12 by the
European Venture Capital Assn.—the second-highest level since the
record 22 billion euros raised in 2000.

Soaring Returns

Just how big a boom is this? Consider that seed funding—capital for
companies that do not yet have a product to market—jumped from $134
million in 2005 to $2.3 billion. "Europe is entering a new phase in
entrepreneurship," says Sven Lingjaerde, managing partner at Endeavour
Vision, which is raising a $214 million European venture fund for
information technology and life sciences.

Further evidence that fortunes are changing in Europe: After years
of disappointing returns, European venture capitalists are finally
starting to show improved financial health, narrowing the returns gap
with the U.S. One-year net returns in 2006 averaged 17.2%, while
three-year average returns hit 5%, up from 1.7% last year. The average
return since 1980 by the top-quarter funds was 17.4%.

The new, European crop of software and Internet startups driving
those returns has sparked U.S. fund managers’ interest. Enthralled by
the sale of Skype Technologies (EBAY), the venture-backed, Luxembourg-based, Internet telephone service sold to eBay (EBAY)
for $2.6 billion in 2005, many investors are now setting up funds in
Europe and scouring the Old World for deals. The U.S. was the largest
source of European private equity in 2006, providing 28.8% of the total
$150 billion raised. "We are more bullish than ever on Europe," says
Fergal Mullen, partner at Boston-based Highland Capital Partners,
which recently closed an $800 million European fund. Mullen is now
setting up an office for Highland in Geneva. "Skype was a truly
European company, with Swedish and Danish founders who came together in
London and offshored their development to Estonia," Mullen says.

Access to Eastern European Talent

That kind of cross-border mobility for startups was once unheard of
in Europe. Long plagued by national regulations, red tape, and 15
different currencies, they typically set their sights on small domestic
markets. Now the 20-year-old drive to forge a single European economy
is finally helping entrepreneurs tap a continent of talent,
technologies, and markets, and target the global market faster.

One of the biggest catalysts for Europe’s startups is the 2004
arrival of eight new eastern European countries to the European Union.
World-class science and math education in the former Soviet bloc has
created a deep pool of technology talent that puts the equivalent of
India in Europe’s backyard. Western startups are now racing to hire
Eastern European computer scientists, who make 20% to 50% less than
Western Europeans and often are more highly motivated. It’s now
possible for Western European companies to expand their R&D
capacity and better compete with other startups in the global market,"
says Edward Braginsky, a partner at TVM Capital in Boston.

Garlik’s Ilube, for example, was stunned to discover that his Polish
software engineers were working all night long to crack the coding
needed for the company’s first product. "There is a fascination with
the technology and a hunger to prove their worth," says Ilube. "They
don’t want to miss a deadline. We can go very light on management
because we know they will deliver." Other venture capitalists agree
that Eastern European entrepreneurs are more driven and hungrier for
success. "It’s phenomenal. They work as hard as engineers did in
Silicon Valley 30 years ago," says TVM’s Braginsky.

Better Brain Trust than India

For tech startups, cheaper brainpower in Eastern Europe speeds time
to market and turbocharges returns (see BusinessWeek.com, 5/30/07, "Where the VCs Are Flocking Now"). Venture-backed Dutch software startup Tridion
set up a joint venture with a Ukrainian software house and outsourced a
large chunk of its core R&D for three years to the Kiev-based
operation. "We use Eastern Europe as a talent pool to lower the cost of
R&D," says Ivan Farneti, partner at Doughty Hanson Technology Ventures in London. "You can support 22 software engineers in the East for the price of six in the U.K. It’s a no-brainer."

Doughty Hanson netted 250% on its $6.7 million early-stage investment
in Tridion when the company was sold last month for $93 million to SDL International.
"The results of this kind of outsourcing in Eastern Europe are
phenomenally good compared to India, where they are more random," adds
Farneti.

Eastern Europe’s brain trust may outshine India’s and China’s when
it comes to the creative talent for developing new products, some
venture capitalists say. Eastern Europeans excel at building systems
from scratch, and they rank tops in the programming contests hosted by
the likes of Google (GOOG) and Microsoft (MSFT) to cull the world’s
best software talent. "Russians and East Europeans tend to be more
creative and less disciplined," says Esther Dyson, an investor in
several Russian software houses. "If you want a problem solved, go to
Central and Eastern Europe. If you know the solution and want to farm
out the work, go to India."

Gail Edmondson is a senior correspondent in BusinessWeek‘s Frankfurt bureau.

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