Discussions around entrepreneurship in Europe often revolve around the creation of unicorns, which are businesses valued at $1 billion or more. There has been a longstanding concern across the continent that the lack of tech companies to rival those emerging from Silicon Valley is undermining the vibrancy of the European economy.
These concerns persist despite a report from i5invest that Europe actually created twice as many unicorns as the United States in 2021. Now, as a recent report from the European Innovation Council suggests, the concern has moved from creating to keeping unicorns. The authors bemoan the fact that many high-growth businesses have to leave Europe in order to secure the funding they need to reach unicorn status.
The problem is, these high-value businesses are, as the name suggests, pretty rare. Not only are they rare but they also represent a tiny proportion of overall entrepreneurial activity. The intense focus on them remains, however, with Emmanuel Macron recently announcing that he wants France to produce 100 unicorns by the end of the decade.
Access to capital
If the President is to achieve this goal, then the EIC report suggests that improvements will need to be made to the investment that is available to startups. It does beg the question, however, of whether policymakers are putting the cart before the proverbial horse.
The tech media is awash with stories about funding rounds, in large part because the VC community is happy to share press releases around each funding round because they want future investors to pump up the value of their original investment. There is considerably less coverage given to operational matters, such as growing revenues, an expanding workforce, or indeed any of the numerous matters by which we tend to assess most other businesses.
This fallacy was underlined by a recent paper from the IESEG School of Management, which examines whether our obsession with unicorns is actually harmful to the economy and to society more broadly.
An unhealthy focus
The authors highlight that while such a lofty valuation “may” be an indicator of a startup that is not only doing well commercially but is also making a positive contribution to society more broadly, it’s by no means guaranteed, especially as many unicorns pursue a hypergrowth strategy whereby they try to grow as quickly as possible and grow at all costs.
By contrast, the research found that when companies try to achieve profitability over growth, they’re actually 2.5 times more likely to achieve both profitability and growth over the medium to long term than if they only focus on growth itself. This shouldn’t be too big a surprise, as much of the hypergrowth in valuations in recent years has been driven by the historic aberration that is the decade-long availability of near-free credit.
As the energy crisis digs in, those credit taps are being turned off and startups are being forced to rely on the income they’re generating themselves to survive, and sadly a large number are proving unable to do so. This was echoed in the French study, which found that companies that focus primarily on growth were 2.6 times more likely to exhibit poor performance not only in terms of profitability but also in growth itself.
Cutting corners
This obsession with growth can also prompt entrepreneurs to cut corners and engage in various irresponsible and unethical behavior in order to maintain their lofty valuations. Theranos is an obvious case of a company that engaged in unhealthy means of maintaining the expectations of them from investors.
The risks of this happening are not helped by the lower ethical standards entrepreneurs are held to. Research from the Kellogg School shows that we tend to give entrepreneurs the benefit of the doubt when it comes to ethical behavior. The researchers suggest that we tend to view startups as more prosocial in their strategies, with any failings they have viewed more charitably.
The results revealed that startups tended to benefit from a kind of halo effect, where their transgressions were viewed more charitably than those of the larger firms. This pattern held true even when the age and size of the firm were accounted for, which suggests that startups continue to benefit even as they grow.
Unicorn industrial complex
Rather than focus on mythical unicorns, policymakers might be better off focusing on the much larger pool of small and medium enterprises that make up the bulk of the economy. About 90% of firms globally are considered small- and medium-sized enterprises, with such firms representing around 70% of all jobs.
In a report last year, from the World Economic Forum, the authors examined the biggest concerns businesses face today. They found that the biggest challenge faced by SMEs was around talent acquisition, with over half citing this as a major concern. This was then followed by concerns around the pandemic, with access to finance some way further down the list of concerns.
“These businesses play significant roles not only in the global economy and labor markets but also in enabling, constraining, and shaping the nature of innovation within those markets,” the authors explain.
That Europe is so besotted with unicorns is particularly egregious given the tremendous successes achieved by Germany’s Mittlestand, which is a group of smaller companies, often operating in niche fields, that eschew rapid growth and are happy to be world leaders in their small niche. That many of these businesses are located outside of the capital cities that often hoover up so much wealth and prosperity that they create very real inequality concerns should also prompt policymakers to think afresh about just what they want to achieve.
A thriving economy and a thriving innovation ecosystem need a plethora of healthy and thriving businesses, not just a tiny proportion of mythical beasts that sprinkle stardust over society. I will be exploring some of the ways SMEs can be helped to innovate in a subsequent article.
